I think we all will remember March 17, 2020, and the fear it brought for all of our businesses. Would the market hold up? Would our employees be able to service clients while working from home? Jump ahead to today, and who would have predicted that practically every RIA in the country would be reporting two straight years of record growth? In a recent article from Family Wealth Report, Charlie Paikert spoke with Dave Barton of Mercer Advisors who reported, “Prices for RIAs have increased around 20% in the past 18 months.” This past summer, InvestmentNews published a cover story simply titled, “How High Can RIA Valuations Go?” That article opened with this report, “Valuations have skyrocketed at registered investment adviser firms, recently hitting never-before-seen levels, with bankers and executives whispering that a limited number of transactions have reached valuations of 18 times to — gasp! — 20 times a firm’s annual EBITDA.”
It truly has been a tremendous 18 – 24 months for the RIA industry! The stock market’s hiccup over the past month and last week’s comments from the Fed warning of interest rate hikes in the near future have a lot of RIA watchers asking, “How long can this party last?” While these macro-economic factors clearly present headwinds for our industry, as an operations minded person, I am much more concerned about the overall complacency so many individual RIAs exhibit with respect to turning their practices into true businesses. We can’t control the market or the Fed, but we can all take steps to further institutionalize our firms – creating repeatable processes and workflows to ensure the client experience is consistent, and investing in our employees to maximize their effort and attention to detail while caring for our clients’ financial well-being. We also need to be investing in the technology tools we are putting in the hands of our employees and clients, living up to the claims on our websites that tout ourselves as “digital first” advisors.
With all this talk of private equity excitedly investing in our industry and valuations at all-time highs, I am continually shocked and frustrated by the number of RIA owners who still self-identify as financial advisors first, and business owners eighth or even ninth. In conversations with them, the overall attitude is typically, “We don’t need to make those investments – revenue goes up every year…we seem to be doing fine. I’m just concerned about where my next client is coming from.” Advisors left the confines of the wirehouses and IBDs for all the right reasons – they didn’t want the pressure to cross sell investment products; they wanted the ability to offer the most appropriate solutions to their clients, regardless of the economics to the firm; they wanted the ability to market their services in their own unique way, not in a watered-down version that was acceptable to an overworked compliance department handling 15,000+ advisors. But after making that leap and starting their own RIA, many advisors – even 5, 10, or 15 years later – have never made the mental shift from, “I am a financial advisor” to “I am the owner of a financial advisory business.”
If this RIA party is to continue at the pace it’s been going, RIAs across our industry need to begin running their practices as real businesses. Investments in infrastructure need to be made. Training of staff and documentation of “how we do things here” need to occur. Career paths need to be laid out for new and existing employees, and a formal onboarding plan beyond, “Go sit over there and we’ll begin your training when someone is free” should be implemented. Clear and distinct C-suite roles and responsibilities should be assigned and hired for. An audit of your fee schedules and the documentation associated with the debiting of client accounts should take place. A client segmentation exercise should occur to help hone in on your firm’s client niche/specialty, as opposed to the bland, “We work with clients with $2 million to $5 million of investable assets.” The list of business-oriented tasks that RIAs are not performing today is seemingly endless.
To give a quirky 80’s rock and roll analogy: Van Halen’s debut album in 1978 spurred an onslaught of 80’s “hair bands.” While Van Halen’s musical prowess, lyrical content, and overall stage presentation was second to none, record executives lulled themselves into laziness and began signing any band that looked the part, regardless of their musical talents (or lack thereof). If the guitar player posed with a flashy instrument and the lead singer hooted and howled and wore tight pants, the record companies were willing to take a chance on these unproven bands in hopes they could coax one power ballad out of their newly-signed Van Halen look-alikes.
We may not be there yet, but I fear private equity firms will begin acting like these record executives of the 80’s. “Did you say you’re an RIA? You’re fee-only? You call yourself a fiduciary? Here’s a check!” Just like the record executives who forgot to ask, “Does that hair sprayed band in tight leather pants actually know how to sing or play their instruments?” are private equity firms at risk of forgetting to ask, “Is this a real business? Can they continue to grow their AUM outside of market appreciation? Are clients happy with their experience and are therefore willing to refer friends and family? Are the key employees thriving and eager to grow with the firm?”
You may be saying to yourself, “Oh Matt – what does it matter, as long as they keep writing the checks!” And that’s exactly what the Aqua Net crew said on the Sunset Strip in 1990 – “I don’t need to practice my guitar playing, I just need to make sure I have the right eyeliner for our next music video! As long as we look good, it doesn’t matter how we actually sound!” For those of you who don’t remember 1991, there was a band called Nirvana that came along that doused cold water on the hair band party, ruining everyone’s perms and smearing all that makeup. Then bands like Soundgarden, Alice in Chains, and Pearl Jam came along and burned the party to the ground. Members of those hair metal bands thought they could ride the wave forever, but when reality struck, they were forced to take jobs at sporting goods and electronic retail stores. There were several suicides of band members that couldn’t come to grips with the fact that the party was over.
What will be the RIA industry’s “Nirvana moment?” When will the music stop playing and the checks stop being written? When will investors in these businesses dig a little deeper and ask to see true business plans and operations manuals? I’d guess the RIA industry is in about 1982 or 1983 with respect to the hair metal analogy. There were still plenty of good albums that came out in the subsequent years, with the peak probably being 1988 or 1989, which still left two or three years before the music stopped all together in 1991. We can’t control the macroeconomic cyclical pressures on our industry, but we can choose to evolve before reality forces us to, instituting a plan to “practice our instruments” and become investable businesses.