In the late spring of 2015, Brooks Hamner and I were having lunch and started talking about creating a blog to explore what we were seeing regarding valuation and advisory projects in the RIA space. The big question was not whether we could start it, but whether we could keep it going.

Most blogs start strong for a few months and then kind of fade out. When we got back from lunch, I pulled up a Word doc and Brooks and I started brainstorming topics. In a few minutes, we had several dozen ideas, so it was pretty clear we had enough to say.

Ten years later, we still haven’t run out of ideas.

Looking back, though, we do see a few themes on heavy rotation. I doubt that will change.

1) Consolidation is happening, but we still don’t know why.

Industry rollups have been happening for longer than RIAs have existed, but few industries have attracted as many attempts at consolidation as has investment management. RIAs are usually founded by entrepreneurial advisors who feel trapped in banks or wire-houses and want the opportunities that come with independence. Having succeeded by building their own cultures and their own financial success, often they eventually sell to consolidators who want to rebrand them, retrain their staff, reprice their services, and reorient their clients.

For the sellers, high valuations and the certainty that comes with a well-funded acquirer can rationalize joining a rollup. The buy-side, to us, is harder to justify. Consolidation vehicles are high-overhead operations with complex cap tables trying to make cash flow at the margin in an industry that generally defies financial synergies and often exhibits weak post-transaction growth. Maybe that’s why, despite the volume of consolidation in the RIA space, the aggregate number of RIAs continues to grow.

2) Valuation is more complicated than it looks.

When we started blogging, the RIA community was still getting over the idea that firms were all worth 2% of AUM. Then they moved on to the concept that all firms are worth 2x revenue. Wanting valuation to be easy doesn’t make it so. Our consistent experience is that rules of thumb are only correct by coincidence, and most formula prices omit key considerations. Some firms have rich fee structures; some don’t. Some have big margins; others don’t.

Some firms have debt, or excess working capital, or some other balance sheet consideration that formulas ignore. Cap tables can be complex. Some compensation programs make no sense. Some firms have dependence on one person, strategy, or client. Valuation is dynamic, which is why we have a job.

3) The investment management industry is both homogeneous and nuanced.

Most of the thousands of RIAs and independent trust companies derive revenue from the services they provide, cover an expense base that is mostly related to compensation, and pay out substantially all of their profits in distributions. From there, however, the similarities end. With each project, we learn something new about the industry. It is truly a community of independent thinkers who build business models based on their own perspectives and expectations. For us, it never gets old.

4) The PE community loves RIAs almost as much as the public markets dislike them.

In the old days, the end game of a rollup was an IPO. That hasn’t worked so well in the RIA space. Over ten years we’ve seen lots of IPOs abandoned, and several public platforms taken private. Through it all, organizers of public and want-to-be public firms have twisted capital structures and gerrymandered business models to try to make it work – all in vain.

Since most public investment management firms are asset managers that have been hemorrhaging AUM for years, it’s possible that attempts to get positive attention for growing wealth management platforms is a fool’s errand. Maybe it’s the IPO environment in general. Whatever the reason, the public market’s appetite for RIAs will have to change to justify the interest of the PE community. Without an end game, there is no game. Continuation vehicles can only get you so far.

5) Organic growth is as important as it is hard to come by.

The best growth is and will always be organic growth. Growth by acquisition is expensive, messy, and unreliable. And growth from market activity is fickle. The longer we study in the industry, the more we see that firms that consistently execute successful strategies to attract and retain clients end up being the big winners.

6) The RIA community is still maturing.

The advisory community we know traces its roots back to the passing of ERISA in 1974. In the decades that followed, talented money managers left wirehouses and bank trust departments to set up RIAs. Initially, firms were mostly amorphous entities that provided financial planning, wealth management, and asset management. Once specialization set in, groups could focus on specific sectors, client types, and service capabilities. While some see a maturing industry, we see ongoing innovation, as asset management leans to new sectors of private assets, and wealth management delves deeper into family office services. The number of firms is still growing, and the jury is still out on which consolidation models will be the most successful. It’s hard to imagine another service industry with so much opportunity to think and flourish.

7) You can measure the value of a good business model.

What makes a good RIA business model? One that exhibits the fewest tradeoffs between growth and margin. Consistently running above-standard margins and better than normal growth rates is the mark of a good model – one in which the culture, marketing program, and cost structure align to produce strong, profitable growth. In the SaaS community, the merits of a business are judged based on whether revenue growth rate plus EBITDA margin equal or exceed 40%. I won’t draw a line in the sand for investment management firms, but you get the idea.

8) Compensation programs are at the heart of successful firms.

Despite numerous attempts to recast investment management as something it isn’t, RIAs are still professional service firms, and professional service firms are owner-operator models. After you pay rent for your office, buy coffee for the kitchen, cover expenses for marketing and compliance, and a few other items, everything on your P&L is a tradeoff between returns to labor and returns to ownership. And ownership is a residual return. Thus, great compensation programs are at the heart of every great firm.

9) Succession is always on people’s minds.

An inconvenient fact of life in professional services is that companies are indefinite-lived assets, but careers have a beginning, a middle, and an end. Whether you view succession as an act of perpetuation or capitulation, it’s a grounding reality for every firm. You can ignore it, but that doesn’t make it go away. Most firms think about succession, but put off actually doing anything about it. The best ones institutionalize it in the normal course of business.

10) The RIA model works in good times and bad.

In the past decade, we’ve seen good and bad financial markets, waves of technological threats and offerings, prosperous and lean economies, strengthening and weakening labor markets, huge shifts in geopolitical circumstances, wars, and a global pandemic. The financial press never bark that we’re living in an era of heightened certainty. Through it all, what we haven’t seen are clients going out of business because of industry conditions. Most are genuinely thriving, which tells us that the RIA space is agile and resilient. It also hasn’t hurt that the S&P 500 more than tripled over that time….

More to come. Thank you for reading.

About Mercer Capital

We are a valuation and advisory firm organized by industry specialization. Our Investment Management Team provides valuation, transaction, litigation, and consulting services to a client base consisting of asset managers, wealth managers, independent trust companies, broker-dealers, PE firms, and alternative managers.