Figure one Advisor Count by Assets Under Management (AUM) CAPTRUST

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1 The Advantages of Scale in the RIA Industry

2 CAPTRUST The Advantages of Scale in the RIA Industry Introduction It is undeniable that, by any definition or metric, the registered investment advisor (RIA) community is comprised of very small firms. Publicly available information from the Securities Exchange Commission (SEC) identifies a total of approximately 15,000 RIAs offering wealth management services as part of their practice. Eliminating those with less than $50 million of assets under management still leaves a total of 5,719 firms. Only 7 percent of these firms have more than $1 billion of assets under management. [Figure One] Contrary to views expressed in articles and papers by well-known industry insiders, we strongly believe that small RIAs are not in danger of extinction from overzealous regulators, robo-advisors, the next market meltdown, or aging clients. Ours is an industry built on personal relationships and trust. Small firms are quite capable of delivering quality service and building trust effectively. And if being big is so great, why are brokers leaving the wirehouses to set up independent shops? Owning your own RIA, no matter the size, clearly creates a lifestyle opportunity that is appealing to many. even those who do an excellent job of planning for their clients do not take the time to strategize, analyze, and plan for their own personal and business success However, having a lifestyle firm does not immunize an advisor from eventually needing to address some key issues about succession, realizing value (or creating liquidity) from the business, finding ways to grow, or just plain managing a business in an increasingly complex environment. In his book Practice Made Perfect, Mark Tibergien writes: One of the great ironies of the advisory business is that many of its practitioners even those who do an excellent job of planning for their clients do not take the time to strategize, analyze, and plan for their own personal and business success Good managers have learned how to leverage their organizations so that the business sustains itself rather than depending solely on them. It is clear that what Tibergien wrote in 2005 is still true today: the vast majority of RIAs have not been able to leverage their organizations into self-sustaining business models. In other words, very few firms have grown to the point where they have created scalable businesses. Figure one Advisor Count by Assets Under Management (AUM) AUM Number of Advisors Over $1B: 415 $900M $1B: 46 $ M: 66 $ M: 96 $ M: 124 $ M: 176 $ M: 223 $ M: 370 $ M: 646 $ M: 1,685 $50 100M: 1,872 Source: CAPTRUST Research 2

3 Purpose Most young industries follow a natural progression over time in which some firms are able to reach the point of operating scale. A small number of these firms further accelerate the scale advantage they built organically (client by client) and by acquiring smaller firms and integrating them into a common operating platform, brand, and culture. The independent RIA industry is still in its infancy, with a few firms just beginning to emerge as fully scaled organizations capable of accelerating growth in this way. In this paper, we will examine what this level of scale really means for RIAs and how it is an advantage in managing the four critical business issues every RIA must eventually address: 1. Business succession 2. Realizing value or creating liquidity 3. Managing increasing business complexity 4. Sustaining growth As an RIA owner, we hope you find this helpful as you build your own business; or perhaps, having more insight into the advantages of a fully scaled firm, you may find the idea of merging into such a firm to be an attractive path toward gaining the benefits of scale rather than continuing to pursue it alone. Scale Defined In Innovation and Entrepreneurship, Peter Drucker wrote: It is not size that is an impediment to entrepreneurship and innovation; it is the existing operation itself, and especially the existing successful operation. And it is easier for a big or at least a fair-sized company to surmount this obstacle than it is for a small one. The Advantages of Scale in the RIA Industry 3

4 CAPTRUST For an RIA, scale is perhaps best defined as the point at which an organization is no longer reliant on the founder (or founders) to be involved for the business to be successful. In other words, the practice has transitioned into a self-sustaining business that is larger than the contributions of a few individuals. From our experience, we believe the revenue threshold for scale is around $50 million. With an estimated fee on assets of approximately 80 basis points, a firm would need a little over $6 billion under management to qualify. We believe that there are perhaps 20 independent wealthmanagement-focused RIAs that have reached this level. Although there are several serial acquirers of RIAs that have grown revenue and AUM well in excess of this amount, in our view, these roll-ups do not offer any meaningful scale advantage. Each firm they acquire continues to operate independently, maintaining its own management, operations, compliance, investment research, and other functions. Figure Two Percent of Advisors with a Succession Plan Separated by Advisory Revenue $ Thousand 86% 14% The benefits of true operating scale are evident in several important ways: Economics Revenues are fee-based, highly predictable, and well diversified by account, advisor, business line, industry, and geography. Incremental revenues produce increasing profit margins over time. $ Thousand 81% $500 Thousand $1 Million 70% $1 2 Million 63% $2 3 Million 57% $3 5 Million 68% $5 Million and Over 70% 30% 37% 43% 32% 30% 19% Management Each department is led by a full-time specialist, allowing for deeper focus and increasing effectiveness over time. Operations Automated processes and systems drive increasing efficiency and quality. Culture The organization is grounded in a shared sense of pride and collaboration. Employees know the mission, they believe in it, and they live it. These benefits lead to perhaps the most important scale advantage, the ability to successfully reinvest back into the business to accelerate shareholder value. No Plan or Inadequate Plans Well-defined Plan (implemented or ready to implement) Source: Moss Adams/InvestmentNews 2010 Financial Performance Study of Advisory Firms 4

5 So, Does Size Matter? Let s examine how firms with true scale can navigate each of the four critical issues for RIAs: Issue 1: Leadership Succession Figure three Breakdown of Advisor Age by Range This is perhaps the biggest challenge facing our industry today. Statistics conclusively show that it is all too common to put off succession planning. In fact, more than 70 percent of advisory firms have failed to define or implement succession plans for their businesses, valuable assets that may represent the partners life work and a significant portion of their wealth. [Figure Two] The need for succession planning becomes even more critical as the advisor population ages. According to Cerulli Associates, more than 50 percent of financial advisors are over age 54, and less than 5 percent are under the age of 30. [Figure Three] This does not provide much time to identify and groom a suitable successor. Meanwhile, finding an individual or team qualified to assume a leadership role is a challenge in itself. Potential successor candidates must possess both business management acumen and client relationship skills to effectively replace a retiring leader. Furthermore, maintaining the entrepreneurial spirit of a first-generation RIA owner can be difficult to do when potential replacements have only served as employees. If a suitable successor is identified, plenty of work remains for the founder to execute a successful leadership transition. To ensure continuity, client relationships must be maintained by advisors who can provide the level of service and wealth management expertise to which clients have grown accustomed. The transition process will be successful only if implemented gracefully and over time; clients must be willing participants in this process. The Advantages of Scale in the RIA Industry 4% 4% 17% 18% 35% 32% <30 <30 39 <40 49 <50 59 <60 69 >69 Source: Cerulli, Advisor age by age range,

6 CAPTRUST The three primary functions managing the business, client relationship management, and growing the business are typically handled by the same person or group of partners at a small firm. Now consider all of these succession challenges as addressed by a large, fully scaled RIA: At a large, scaled firm, each role is specialized, meaning there is no one successor to be identified. There is a career path for executive advancement that develops leaders with management potential across the many functional areas of the company. Client relationships are distributed across multiple advisors and professionals within a firm. This means clients are less reliant on a single individual; they are more loyal to the firm than to an individual. Yes, there is the need to identify next-generation advisors who can take primary responsibility for client relationships, but at a large firm, there are many advisors of different ages from which to choose. A large firm has the resources to recruit and train new advisors, knowing that part of the cost of doing this is that some will fail. Lessons are learned in failure as well as success. These lessons accumulate over time and get baked into the DNA of a large firm, leading to higher success rates with new advisors. Issue 2: Realizing Value (or Creating Liquidity) This issue is closely related to leadership succession, since most owners are unable to realize any value for their businesses without also identifying a successor. Small firms are clearly challenged in this area, since it is unlikely that, even if a suitable internal successor is identified, he will have the financial ability to acquire the business. The same usually holds true when trying to merge into another local or regional firm. In contrast, a large RIA has many advantages and options for creating liquidity: Ownership is typically held by many employees not just the founders. Widespread ownership helps build a common culture and creates a powerful incentive for growth and risk management. Widespread ownership, coupled with the higher margins of a scalable business, means there is sufficient internal cash flow to buy out retiring shareholders. Should a significant shareholder retire and stretch the internally available cash flow, large firms are able to finance the purchase either via bank lines or through additional purchases from existing shareholders who are likely to want to own more, not less, equity in a fast-growing firm. A fully scaled RIA, with multiple offices, professional management, strong growth, and diversified revenue streams, is significantly more able to attract financing from sources such as private equity or public investors via a stock offering than a small firm. 6

7 Issue 3: Solving for Business Complexity RIAs today face an increasingly complicated business environment, with regulatory concerns often being top of mind. Add in the weight of managing people, a dizzying array of investment choices, and ever-changing technology, and it seems far more difficult to manage an RIA now than in the early years of this industry s development. Larger RIAs arguably face these same issues and on a larger scale so do they really have an advantage? Well, scaled firms have greater resources to devote to these issues. Their teams of specialized management need only focus on the complexities of their particular area. Teams are built and devoted to complicated issues. Perhaps as importantly, client advisors do not have to devote their time to anything but taking care of clients. It is also critical to note that the best way to address an increasingly complicated business environment is to invest ahead of the issues. This takes not only financial resources, but also strategic management capabilities. The ability to focus management on strategic issues and create solutions ahead of problems is a luxury scaled firms can afford. An RIA owner wearing many hats simply does not have the time for this; the result is problems that persist and grow worse over time. Issue 4: Maximizing Firm Growth These days, it seems that wealth managers are everywhere. Nationally branded firms are spending millions to build market share. Independent RIAs now number in the tens of thousands. Wirehouse brokers are turning independent and those still at the wirehouses offer sophisticated asset allocation strategies, banking services, and financial planning, all for a fee. It is increasingly difficult to differentiate oneself, and, therefore, to most potential clients, we all look the same! Not only is the competition fiercer than ever, but clients have also become more discriminating and demanding. Clients now come to the table seeking more sophisticated solutions to meet their specific needs. The growing influence of technology has led to segmentation of client groups along generational lines, making it more important than ever to address each segment in the manner and medium most comfortable for them. Baby boomers, by far the largest client segment, are beginning to retire and are demanding more advice and services than ever before. Generations X and Y, meanwhile, harbor a distrust of Wall Street and maintain a do-it-yourself mindset that will force RIAs to adapt their approaches to earn their trust and business. Not only is the competition fiercer than ever, but clients have also become more discriminating and demanding. Clients now come to the table seeking more sophisticated solutions to meet their specific needs. The Advantages of Scale in the RIA Industry 7

8 CAPTRUST Against this backdrop, how does a firm with true operating scale generate sustained growth? Consider the following advantages: Increasing advisor capacity Advisors at larger firms are free from the typical distractions of managing a business, thus affording them substantially more time to serve clients and develop new clients. Dedicated marketing resources Larger firms typically have a full-time staff dedicated exclusively to marketing. Successful marketing strategies can effectively soften the beach for advisors by creating more brand awareness and driving lead generation campaigns. Other marketing activities include: Creating relevant and actionable content for client and prospect communications; Managing prospect lists, campaigns, and marketing automation systems; Managing website content; Continuously improving client deliverables; Managing local marketing efforts via sponsorships, advertising, and special events; Supporting niche strategies, such as affinity group marketing to professional athletes, physicians, college professors, and business owners. Expansion of business lines and service offerings Larger firms can expand their client offerings in such areas as tax preparation, trust services, financial planning, family office services, and insurance solutions. Advisor recruiting and acquisition activity Larger firms can dedicate full-time staff and resources to support the hiring, training, and onboarding of new advisors. Additionally, some firms are active in sourcing and integrating advisor acquisitions as a complement to organic growth. Scale Advantage: A Case Study CAPTRUST Financial Advisors was founded in 1997 as an entrepreneurial start-up with about $2.5 million in client revenue and 12 employees. As of December 31, 2014, CAPTRUST was one of the nation s largest RIAs, with $142 billion of client assets under advisement, 305 total employees, 68 financial advisors, and 20 office locations across the U.S. [Figure Four] On track to achieve a 10-year revenue goal of $100 million by 2016, CAPTRUST employs a centralized service model designed to expand advisor capacity for growth. The following are examples of how CAPTRUST s size and resources provide solutions to the four key issues examined in this paper: Succession Planning The company is not reliant on any one executive or advisor for continued success. The company s senior management team is comprised of 17 senior executives managing a staff of 237 employees in support of the firm s 68 advisors. No single advisor is responsible for more than 5% of total revenue. Revenue responsibility is widely distributed across advisors. Many senior advisors have actively involved younger advisors in client relationships. Advisors under the age of 55 are responsible for 75% of total revenue. [Figure Five] Top advisors have equity ownership and long-term financial incentives that encourage client transition post retirement. Each of these activities provides meaningful advantages that allow larger firms to grow faster than their smaller brethren. 8

9 Figure Four CAPTRUST Employee Breakdown 68 Realizing Value (or Creating Liquidity) It is not necessary to sell the company to realize shareholder value. Financial Advisors Financial Advisor Relationship Managers Non-Financial Advisor Staff CAPTRUST is 100% owned by employees. CAPTRUST has no outside shareholders, private equity, or financial partners of any type. Out of 305 employees, 58 are vested shareholders and another 40 have been awarded options through an equity incentive plan Figure five Revenue Dispersion by CAPTRUST Advisor Age 6% 5% Source: CAPTRUST Research With revenue approaching $100 million, the company has ample cash flow and available financing to repurchase any retiring shareholder s equity. The company s internal equity valuation methodology has been validated externally as equity has been used as consideration in multiple acquisitions. Business Complexity Advisors are able to devote their full attention to client relationships. 17 senior industry executives, averaging 24 years of experience, lead key functional areas of the business. [Figure Six] Advisors are supported by these executives, who manage a centralized service model. Advisor time can be fully devoted to client relationship development. 4% 3% 2% 1% 0% Source: CAPTRUST Research The Advantages of Scale in the RIA Industry 9

10 CAPTRUST Figure SIX Years of Experience by Title TITLE YEARS Chief Executive Officer 29 Chief Operating Officer 37 Chief Financial Officer 23 Chief Investment Officer 16 Chief Compliance Officer 31 Advisor Support 20 Human Resources 15 Marketing 29 Acquisitions 32 Wealth Management Practice 34 Defined Contribution Practice 16 Asset/Liability Practice 16 Non-Qualified Practice 16 Participant Education and Advice 31 Information Technology 27 Operations 23 Application Development 27 Growth CAPTRUST has experienced compound annual revenue growth of over 22% since inception. [Figure Seven] CAPTRUST has grown consistently over the past 17 years despite two major market events and the increasing complexity associated with managing a larger enterprise. The firm invests heavily in developing new advisors each year through its innovative Blue Team program that recruits, trains, and coaches new advisors. These homegrown advisors today account for approximately 50 percent of total firm revenues. The firm began an acquisition strategy in 2006 and has since acquired and integrated 15 advisory practices. For acquired firms, post-transaction revenue growth has averaged 18% per year. [Figure Eight] CAPTRUST provides fiduciary advisory services including participant education and advice for retirement plans with over $142 billion in assets. As these client executives and employees approach retirement age, wealth advisory services are increasingly in demand, providing a virtually endless source of new clients for many years to come. Source: CAPTRUST Research Figure Seven CAPTRUST Total Client Assets Under Management (in Billions) $140 $142 B $120 $100 $80 $60 $40 $20 0% Source: CAPTRUST Research 10

11 Figure EIGHT CAPTRUST Organic vs. Acquisition Revenue Growth (in Millions) 2006 $1.7 $ $2.9 $ $0.8 $ $2.0 $ $6.7 $4.1 Total $4.2 $7.2 $2.3 $0.2 $10.8 Summary Hopefully we have provided some helpful insights into our industry by exploring the attributes of the relatively rare RIA where true operating scale has been achieved. As our industry evolves into its second generation, an increasing number of independent RIAs will grow into fully scaled entities. Yet for most firms today, the thought of growing into that type of firm probably seems impossible. Without a doubt, it is not an easy task. Very few firms will successfully reach that stage. As an alternative, you may want to consider exploring the option of merging your practice into a national RIA in order to gain the benefits of the scale it has already achieved. This option could very well be the best way to solve your succession issue, gain some liquidity, simplify your business management needs, and enhance your growth rate $7.1 $2.7 $ $3.7 $1.0 $ $8.1 $9.5 $ $6.7 $1.6 $8.3 Organic Growth Acquisitions Source: CAPTRUST Research The Advantages of Scale in the RIA Industry 11

12 About the author Rush Benton ABOUT THE AUTHOR Rush Benton Rush Benton Senior Director of Strategic Wealth Rush Benton serves as senior director of strategic wealth for CAPTRUST Financial Advisors. Rush leads the firm s private wealth business, growing assets both organically and through acquisition of independent, fee-based registered investment advisors. Previously, Rush served as cofounder and chief executive officer of WealthTrust, one of the first RIA consolidators. Under Rush s leadership, WealthTrust grew from a start-up venture to a wealth management platform with $10 billion of assets under management through the acquisition of 14 investment advisors across the U.S. Rush is a graduate of Vanderbilt University and is also a Chartered Financial Analyst (CFA ). About CAPTRUST CAPTRUST was founded over 25 years ago as an entrepreneurial start-up and is now a leading employee-owned retirement plan advisory and wealth management firm with more than $140 billion of client assets under advisement, 300 employees, and 20 locations across the U.S. CAPTRUST employs a centralized service model and one unified practice designed for advisor success, strong organic growth, and attractive returns for its shareholders. The opinions expressed in this paper are subject to change without notice. This material has been prepared or is distributed solely for informational purposes and is not tax or legal advice. This is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The information and statistics in this report are from sources believed to be reliable, but are not warranted by CAPTRUST Financial Advisors to be accurate or complete. All publication rights reserved. No portion of the information contained in this publication may be reproduced in any form without the permission of CAPTRUST: CAPTRUST Financial Advisors.