EPISODE 14

Matt Sonnen [00:00:00] Welcome everyone to Episode 14 of the COO Roundtable.  I have some very bad news for our listeners today…for this episode, you’re stuck with just me.  I apologize upfront…I’m sure this is horrible news to our listeners.  While I promise the topic today is very COO-heavy, it is clearly missing the “Roundtable” component.  So I apologize for that…

But it’s late January when we are recording this, the calendar has officially turned to 2020, and Devoe has just released their M&A report; Echelon has just released their report, Fidelity has put out a year-end M&A report as well, and the numbers are just staggering.  All three of them are reporting record highs for M&A deal volume in 2019.

Echelon reported 203 deals for the year, which by their records would be a 12% increase over 2018; Devoe counted 132 acquisitions in 2019, which by their count, would be a 31% increase over the prior year.  Both firms admit that many transactions aren’t reported at all, so they believe their numbers are low compared to the actual number of deals that occurred last year.

Devoe notes that already in the first few weeks of January, we’ve had 12 transactions announced, compared to 6 in the first few weeks of January of 2019.  And they also point out that over the past 5 quarters, deal volume has topped 30 transactions per quarter, so they are anticipating that trend to continue into 2020 and we could even get to over 40 transactions per quarter going forward.  Echelon is reporting higher numbers, as I mentioned, they reported 203 deals in 2019, they think 2020 could top 210 total transactions, which would be over 50 deals per quarter.

I’m not a deal guy, I’m an Ops guy, so to me, my head starts to spin and I think, “this is absolutely nuts.  There’s no way this pace can continue.”  I mean, the only headlines in the industry press any more…every single day you look at WealthManagement.com, Financial Planning, or InvestmentNews…it’s just one headline after another, “So and so buys so and so…”  It’s non-stop.

But Devoe mentions in their report that the RIA industry has over 5,000 firms north of $100 million in AUM…and given the age of our industry, or I should say the age of the advisors that make up our industry, just on succession planning needs alone, Devoe thinks we could hit 300 transactions a year…and remember, by their numbers, we broke records last year with 132…so at 300 transactions, they think just based on succession planning, not even accounting for all the other reasons advisors merge practices, we could more than double from the numbers we are at today…

As I said, I’m not a deal guy, and I’m clearly not an investment guy, but the one fly in the ointment that I see is the fact that it’s an election year and I have to imagine the markets are going to be beyond volatile this year…that volatility may distract advisors and could potentially slow things down a bit, as they may be forced to be on the phones all year calming their clients’ nerves, and won’t be able to be out negotiating deals with other advisors throughout the year…but the fact remains that everyone is very excited by the concept of inorganic growth, and why not?

I imagine a lot of RIA owners sat down at the end of last year, and on the heels of a long bull market, noticed that they are starting to run into the law of large numbers…they are realizing as they have grown and grown organically for several years, they are realizing that the rate of growth is beginning to slow just a bit, and after meeting with the other owners of the business, they’re business partners, they’re deciding that 2020 is the year they want to pursue an inorganic growth strategy.  They’ve been reading headline after headline of all the acquisitions going on in our industry, and they’re thinking, “We should get in on the action!”  So I’m guessing we will have more and more first-time buyers looking into the M&A game this year.

And with that framework, I want to selfishly promote the concept behind this podcast, which is: PFI Advisors firmly believes that RIAs cannot meet their organic or inorganic growth goals without a competent COO in place.  We’ve talked about this a lot with our guests, and will continue to do so…We actually have two heavyweight RIA acquirers lined up for our next Roundtable interview – I’m interviewing both COOs later this week for Episode 15, and we’ll talk to them about how important having the right infrastructure in place before looking to make an acquisition is.

And we’ve written countless articles on our website around this concept, including two white papers around How to Become a Successful RIA Buyer (actually, we’ve written three white papers around M&A if you include the marketing and branding one we did with the DeSola Group…) and will continue to write more and more around this concept, because we think it’s such an important topic, given just how frenzied the pace of transactions is becoming in our industry, with no slowing down in sight…

So I thought I’d take a short break from our interview format and simply riff on this idea for a bit, if our listeners will indulge me for a few minutes.  I’m assuming the COOs and Operations professionals listening will pump their fists in the air as I’m talking and say, “Damn right you can’t do this without us!”  So this should be fun…

Christina Townsend from Pershing…I met her near the end of last year and I’ve become a big fan of hers.  She is the head of platform strategy and consulting, and her and I think a lot alike.  She recently put out an article in InvestmentNews titled, “RIAs: Shopping for M&A Deals?  Better Get Your House in Order First…” And in her article she says, similar to what I just did with the backdrop of these incredible M&A numbers, she says, “It would be easy to conclude that M&A is a logical strategy for virtually any RIA…but firms need to take a hard look at their goals and the realities of the marketplace before making a major move.”  She then says, “Are the partners thinking beyond the deal calculus to analyze the 50 other factors involved in a merger?”  She says, “Think about capacity, people, and technology before making a major move…”

As you all know, because M&A is so crazy hot right now, any industry conference that you go to is going to have an M&A panel, right?  And if you’ve listened to those panels, almost all of the successful buyers that are being interviewed on those panels, almost every one of them will say, “If you aren’t growing organically first, you won’t be able to grow inorganically.”

And taken at face value, if you hear that headline, you just assume the guy or girl on the panel is simply bragging about their sales team…you assume that statement is simply saying, “Ha!  My advisors are better than your advisors!”  But if you unpack that statement, and you think in terms of what Christina says about capacity, people, and technology, what they are really saying is, “If you don’t have the infrastructure in place to support the growth of your RIA today, you are opening yourself up for a world of hurt if you attempt to go out and add 150 or 200 client relationships overnight through an acquisition…”

Because I’m a comedy junkie, and because I’m often politically incorrect, I’m going to use an analogy from the movie Old School…If you remember the movie, they get stuck doing an athletic competition.  And each member of the fraternity has to perform a different gymnastics event.  Will Ferrell does the floor routine with the ribbons, which is hilarious, but there’s a different scene, where this young kid, who is very overweight, is tasked with doing the vault, where he runs across the room, hits the springboard, and is supposed to vault off the horse, flip in the air, and stick the landing.  And visually it’s very funny because you can tell right away that they are asking him to perform this extremely tricky move, and you can see very clearly that he is not the right size, nor does he possess the athletic ability to pull this off.  But they then take the joke even farther…the kid looks at Vince Vaughn and says, “I can’t do this, it’s physically impossible for me to pull this off,” and Vince Vaughn says, “You have nothing to worry about…Abdul is down there to spot you!”  And they cut to Abdul, who is a 70 pound, scrawny kid who very sheepishly waves at the camera, and it makes the audience crack up because this little kid cannot, under any circumstances, support this large kid barreling down the room at him…they are both going to die if they attempt this.

I think about that scene all the time.   If you are struggling from a capacity, people, and technology perspective, and you can’t support your own business today, I understand why RIAs perform their annual review and come to the conclusion they aren’t growing as fast as they’d like, so acquiring assets seems to be the right thing, but there are many, many Abduls out there, who are standing at the end of the room trying to spot this gigantic tank barreling down at them, and they are going to get absolutely run over if they attempt an acquisition.

We’ve had several phone calls from $50 – $75 million AUM advisors call us up and say, “Yeah, hi.  I’ve realized that I need to be at $500 million or more if I’m going to have the scale to compete in this industry…do you have any $450 million RIAs in your back pocket that I could buy and tuck-in under me?”  And that sounds very funny because just like the Old School scene, that’s a tiny guy trying to swallow a behemoth…ha ha!  Funny!

But there are plenty of $2 billion RIAs out there, like Christina says in her article, that don’t have their houses in order that want to swallow a $250 million or a $500 million RIA.  And on paper, just looking at the sizes of their organizations, you’d think, “Yeah, that will work!  The buyer is 5 to 10 times the size of the seller, that should be a match made in heaven…”  But when you look under the hood, the $2 billion firm is 15 or 20 years old, has never upgraded it’s systems, has no documented job descriptions or organizational chart, is manually billing in Excel, has never turned on a client portal, runs a 25-stock investment portfolio and has never incorporated Financial Planning into it’s practice, so there are no Financial Planning tools or process for the acquisition to plug into, uses Microsoft Outlook Contacts as it’s CRM (and I put CRM in air quotes),

and they think 1) that they are capable of integrating 4 or 5 more advisors and their support staff, along with the 125 client relationships into their business without anything slipping through the cracks with either the new clients or the existing ones, and 2) which is probably even more ludicrous, that they are going to appeal to a smaller organization who has 40 other buyers wining and dining them and promising them the world should they join their organization. This $2 billion shop, that is going about it’s business like it’s 1998, thinks it’s actually going to win the right to partner with this RIA.

We recently wrote an article for WealthManagement.com titled, “Post Merger Integration: “Yes” is Nothing Without “How”.”  We stole that phrase from a fantastic book called “Never Split the Difference” by Chris Voss.  Chris Voss is a former FBI hostage negotiator.  He was the guy on the phone with terrorists trying to negotiate the release of hostages all over the world.  He did that for 25 years, and now he teaches negotiating techniques at USC’s MBA school, as well as Georgetown’s MBA program.  He’s taught at Harvard, Northwestern…he’s just incredible.  He now has a consulting firm where he teaches negotiation tactics in the business setting.  His book is fantastic…and in it he writes, “Your job as a negotiator isn’t just to get to an agreement – it’s getting to one that can be implemented and making sure that happens.”  Because if he negotiated an exit strategy for a hostage, if he got buy-in from the terrorist that, “Hey – if we do this, you’ll do that, and then we’ll do this, and then the hostages can go home,” whatever it may be, if he gets buy-in for a certain plan, but then his team goes off and does something completely different, he loses trust with the terrorist and things can get ugly very quickly.  And so he focuses a lot on implementation.  Obviously, that’s a life and death scenario.  Later in the book he moves away from his hostage situations and starts talking about his business consulting and negotiation tactics for the business world, he writes, “You don’t get your profits with the agreement – they come upon implementation.”

And so using his concept of “Yes is nothing without How” as a backdrop for the article we recently wrote, we say, “Imagine two different negotiating tactics: You’re the buyer in both scenarios, and in this ultra-competitive M&A environment, where there are 40 buyers for every seller, imagine you meet with a potential acquisition candidate/a potential merger candidate, and your presentation is something like, “Yeah, so it’s our way or the highway.  You will shut down your systems and processes and immediately come onto ours.  We’re not sure exactly how to go about doing that, because this is going to be our first acquisition, so let’s figure this out together and really make something great together!  How does that sound, Mr. or Mrs. seller?”

Or, in contrast, imagine your tactic is, “We’ve reviewed all of your people and processes, as well as ours.  We believe our firm can solve these pain points of yours, and we feel that your firm can fill these holes in our current offering.  Here is our documented onboarding plan of how we intend to implement our systems and workflows alongside yours, creating a repeatable, scalable, and profitable business for us all.”  If you actually have a plan of how the merger is going to be implemented, and you can show that plan during the negotiating phase, you have a chance of outshining all other buyers that the seller is interviewing with.  If it’s, “I don’t know how we’ll do it, but I’m really committed and I’m going to write you a nice check so you should totally trust me,” I think you will lose.  It’s all about the implementation.

We wrote another article a few months ago titled, “The Emotions of an M&A Transaction.”  And this article focused not on the clients, but the employees of both organizations that are about to go through a merger.  So, assume the owners of both firms have reached agreement on deal terms thanks to the implementation plan laid out by the buyer, and now they make the announcement to the staff, “We’re merging with so-and-so…”  You can bet your bottom dollar that the first thing going through every employee’s mind is, “What does this mean for my career?  Am I going to fit into the new organization?  Do they have someone on the other side that already does my job?  Am I going to lose my responsibilities and my client relationships from a service standpoint?  What’s my title going to be at the new firm?  What’s my salary going to be?  Will we still have casual Fridays where I can wear jeans?  Does the new firm pay for parking?  I have a medically fragile child – will the benefits plan at the new firm be as good as the one we have now?”

And so, in our article, we recommend that sooner rather than later, the Buyer sits down with each employee one-on-one and show them a side-by-side comparison of healthcare, benefits, and incentives in the new world.  Additionally, if the Buyer is able to show the employee how they will fit into their org chart, what responsibilities are expected of them, and how they will work within the new organization, it eases the employees’ minds.  It shows that this process has been vetted and their personal contributions to the new firm have been taken into consideration.  If, there is the unfortunate circumstance that a particular employee isn’t going to fit into the new organization, both the Buyer and Seller need to be upfront and transparent with those individuals.  If possible, offer them a transition period to stay on and help throughout the onboarding and ensure that their responsibilities are properly transitioned to others.

You’re also asking these employees, at both firms, to learn new technology and new ways of executing their day-to-day tasks.  That can be very unnerving for folks who have settled in over the years and have great confidence in their abilities.  The fear of the unknown is very powerful.  It’s crucial that you set up proper training and give employees the tools needed to feel empowered and confident in the new world.  If possible, bring your vendors onsite for face-to-face training sessions.  Show the employees how to use these new systems, what the new processes will be, and make them feel confident that there are resources set aside to help them be successful.

Buyers need to impress upon the Seller’s employees – their future employees – that this consolidation of firms is going to benefit both the employees and the clients, and that their well-being has been thought about and planned for.

Let me take a moment to run through the 7 components of a successful M&A strategy that we identified in our past M&A white papers.  Between both papers, we interviewed 9 large, successful buyers, and we came up with these 7 areas that, in our opinion, every aspiring buyer needs to have in place before they attempt to engage prospective sellers:

First, you need a clear value proposition.  We’ve written a lot about this one on our blog.  I call this your Advisor Pitch vs. your Client Pitch.  Many first-time buyers say to themselves, “I’ve been really successful as an advisor for many years…I’m really good at getting clients to trust me and articulate my value proposition of why they should work with our firm…I think I’m going to go out and start speaking with advisors and show them how they too could benefit by joining our organization.”  And that advisor grabs the same pitch book they’ve been successfully using with clients all these years, and they don’t understand why they aren’t having more success in attracting advisors.  And it’s because they are selling advisors on those things that are important to clients, not necessarily advisors.  The selling advisor already thinks he’s invented the greatest investment philosophy, or the greatest financial planning process, or he or she offers the best family office services…the Buyer isn’t going to win over the Seller with these things.  The Advisor Pitch needs to focus on the infrastructure of the firm.  It needs to talk about the scalability of the organization, and the fact that the combined entity can offer better technology, can get access to new and exciting investment opportunities that the Seller wouldn’t be able to access if he or she stayed on their own.  The Advisor Pitch needs to clearly articulate what the Buyer stands for, and what their vision is for the culture of the combined firm.  The Seller needs to walk away from that meeting understanding exactly what they are plugging into, what their clients and employees will benefit from if they join the larger organization.  The Buyer must answer the question for the Seller, “Why should I join your firm?”

Number two on our list is technology and operational expertise.  Going back to Christina’s article, you have to get your house in order from a capacity, people, and technology perspective.  In my example earlier, if your RIA is 20+ years old and you have never updated your tech…if you are still running on Advent AXSYS, you’re going to be hard pressed to get seller’s excited to come join your organization.  If you don’t have a client portal, you’re going to be in trouble.  If you are operating under the assumption that your part-time billing person, who is doing everything in Excel, is going to magically be able to handle 150 additional clients, which could equate to 700 more account numbers, with their own billing nuances and exceptions, if you think that’s going to get billing done in the new company, you are just burying your head in the sand and living in a dream world.  If you don’t have a CRM system to speak of, if everyone is just managing with Microsoft Outlook and there is no scalability to the organization built into your CRM system, and if your marketing department doesn’t have a centralized repository of client contact information from which they can run email campaigns, the smaller Seller, as I said earlier, is being wined and dined by 40 other prospective buyers…you are never going to stand out.  This seller is taking a risk by joining your organization.  They need to feel that the client experience is going to be better when they join you…if they feel they are taking a step backward from a technology and operational perspective, you are never going to compete with all the other experienced buyers out there.

Number three on our list is the need for a multi-disciplined leadership team.   This points to scale.  You need to convince the seller that you have built a well-organized, scalable enterprise.  And one way you do that is by showcasing multiple owners with specific management responsibilities.  By saying, “This is Bob, and he leads our alternative investments team,” and “This is Suzy, she leads our Financial Planning department,” and “Robin here is in charge of Family Office Services,” etc., it provides leverage and expertise so the selling advisor knows his or her clients will be better served.  Not only do these “departments,” so to speak, allow a less-sophisticated advisor to offer more complex solutions to his or her clients, but by potentially handing over the “servicing” responsibilities to these respective department heads, it allows the advisor to get back to growing their business and not having to worry about the day-to-day servicing.

The fourth item on our list of seven 7 key capabilities that all RIA buyers need to develop before engaging in M&A activity is management capacity for deals.  If your firm is hoping to stand out among 40 other successful buyers during the negotiating phase, it is critical that the management team of the buyer is able to follow through on the many logistical details, legal issues, financial implications, due diligence items, and client transition requirements of getting a deal to the finish line.  This speaks directly to Chris Voss’ focus on implementation.  You can’t simply push for a “Yes,” you need to be able to demonstrate the “How” to the seller.  The buyer needs to spell out for the seller how management will know if items are off track in the implementation project plan, and how both firms will address things if you find out you’re off track.  If the buyer’s management team doesn’t have the capacity, if they are more focused on their own clients and not as focused on M&A, or they are too focused on M&A and this is just one of several deals they are juggling at the time, the seller is going to uncover that fact during negotiations and will undoubtedly choose another buyer.

Fifth on our list is not in my wheelhouse, but doesn’t mean it isn’t crucial in getting a deal to the finish line…and that is, the buyer must have a clear and transparent compensation structure.  The seller needs to easily understand any equity, compensation, buy-out schedule, etc. that is part of the deal.  And just as important, they need to understand the expectations for their role and responsibilities in the new firm.  Are they expected to stick around and service clients?  Are they expected to continue to bring in more clients in the years ahead, and if so, what is the expectation?  Are they anticipated to play any part in the investment committee or the management committee of the new, combined firm?  Chris Voss states in his book, “A surprisingly high percentage of negotiations hinge on something outside dollars and cents, often having more to do with self-esteem, status, and other nonfinancial needs.”  These items need to be clearly and easily communicated to the seller during negotiations.

Number six on our list is the one many feel is the most important – the buyer must have a strong, defined culture.  For many deals, it simply comes down to personality fit.  Having a culture that permeates the organization and can easily be felt by the seller who is evaluating his or her options, can ensure there is a good fit for both organizations.  The seller has to know what he or she is getting into, what they are joining.  And the more clearly the buyer can articulate that, the more confidently the seller can determine if the two firms are going to merge well together.  Firms tend to spend all of their pre-close efforts focused on the economics of the deal, but it always seems to come down to the ever-elusive cultural fit that will ultimately determine whether a deal is successful or not.

And lastly, number seven on our list of key areas that aspiring buyers must have in place prior to sitting down at the negotiating table, is something very near and dear to my heart, and that is transition support.  As we have said over and over today, in order to reach the promised synergies from a transaction, it is critical that the majority of clients transition to the new firm and have a good experience in order to ensure retention.  The buyer needs those clients to remain at the new firm, because they have just structured the entire deal based on revenue and profit assumptions post-close.  And the seller obviously would never agree to a merger if they thought for a second that operational issues would cause any clients to leave.  So as the buyer, having the ability to tell the seller, “We have a team dedicated to the success of your transition – you will not be left to your own devices to get the clients moved over,” is critical.  Laying out that onboarding plan, showing the seller the different milestones and the different responsible parties within your organization that will lead the transition of clients and employees is going to go very far in differentiating yourself against all the other buyers competing for this deal.

The punchline to all of this is, and the most relevant here to our COO Roundtable podcast is: Who do you think is in charge of all of these tasks?  During early negotiations, who is articulating to the Seller the onboarding plan that the Buyer has and convincing the Seller that implementation of this merger will go smoothly, to actually analyzing the systems and workflows of both firms and choosing which pieces of each firm should carry forward into the new world, to sitting down with each employee and assuring them of their position in the new firm and the role they will play and the benefits package they will receive, etc.?  Who do you think does all of this?  It is of course the COO!  So, potential buyers out there, if you are contemplating a merger in 2020, you had better go give your COO a big hug today and tell them how much you appreciate them.  As Christina Townsend said in her article, you need to get your house in order before you consider making a merger presentation to any potential sellers.  You need to make sure your organization has the capacity, the people, and the technology in place to support growth – whether that be organic growth, or inorganic growth – you need to make sure it’s in place first.  In her article, she even says, “If you get all of this in place and the merger falls through, you are still going to be relieved that you went through this process.  And if you go through this process and you revamp your organization, maybe organic growth kicks in so much that you no longer even need to consider an acquisition…in preparing your firm for the acquisition, you get to a point that you don’t even need it any more!”  How’s that for Irony?!?!  Huh?

But hopefully this rant of mine today has shed some light on these concepts, and the fact that you can’t just wake up tomorrow and say, “Let’s start buying RIAs!”  You need to have a plan, and you need to have a strategy.  I hope the articles and white papers we have written in the past, and will undoubtedly write in the future, will act as a roadmap for many.  And I hope that this podcast, with our continued interviews with top-notch COOs and the stories they share of how they attack their day to responsibilities of not only making their firms attractive to sellers, and not only their ability to prepare their organizations for growth, from a capacity, people, and technology perspective, and how they go about onboarding advisors, their teams, their employees, and their clients when their firms make acquisitions, I hope through these interviews we share ideas with other RIAs and other COOs, so they can hopefully incorporate some of these strategies into their own businesses.

I know this episode was a bit different than our norm, but I wanted to get some of these operational issues related to M&A off my chest.  I hope this has helped, and I hope you all tune in to Episode 15 next month, when we interview two top notch COOs from two very large RIAs that are running very successful acquisition strategies.  As always, thank you for listening!  If some of these articles that I’ve mentioned have piqued your interest, feel free to go to pfiadvisors.com and click Blog, and on the right hand side, you can subscribe to receive email alerts whenever we post new articles.  We’ve been publishing one new article or podcast every week.  Thanks everyone, we’ll talk to you soon!