Cap­i­tal Ideas

Ag­gre­ga­tors, pri­vate eq­uity firms and fam­ily of­fices are all in­vest­ing in RIAS. You need to know the key dif­fer­ences.

Financial Planning - - Contents - BY BRENT BRODESKI

Ag­gre­ga­tors, pri­vate eq­uity firms and fam­ily of­fices are all in­vest­ing in RIAS. You need to know the key dif­fer­ences.

Just a glance at in­dus­try head­lines makes one thing clear: A lot of cap­i­tal is chas­ing RIAS. Ag­gre­ga­tors, tra­di­tional pri­vate eq­uity firms, mi­nor­ity-in­ter­est pri­vate eq­uity firms, fam­ily of­fices and var­i­ous lenders are all in on the act.

There are ma­jor dif­fer­ences be­tween them, how­ever, and nav­i­gat­ing the op­tions is like run­ning across a mine­field.

The wrong deal can wreak havoc on your team by dis­rupt­ing a healthy cul­ture, not to men­tion cre­at­ing a mis­align­ment be­tween your goals and those of the out­side cap­i­tal provider.

The right part­ner, how­ever, can help you ad­dress suc­ces­sion and liq­uid­ity needs and grow your busi­ness to the next level.

I first be­came in­ter­ested in this area 2½ years ago when Sa­vant needed to re­cap­i­tal­ize. My co-founder was ready to re­tire but he would only sell if he got all cash with no strings at­tached. My team and I were will­ing to com­mit many mil­lions in new money, but even then, we came up short.

I needed to raise out­side cap­i­tal or sell the com­pany. We wanted to stay in­de­pen­dent, con­tinue to grow or­gan­i­cally and com­ple­ment it with highly se­lect, ac­cre­tive ac­qui­si­tions. I started talk­ing to any­one who could pro­vide cap­i­tal.

The process killed many brain cells, but I feel I got an hon­orary PH.D. in cap­i­tal rais­ing. I in­ter­viewed more than 70 cap­i­tal sources, got pro­pos­als from 20-plus, speed-dated 10, whit­tled it down to three and fi­nally went to the al­tar with new in­vestors.

It has been a great mar­riage so far, but to spare you some of the headaches, I’ll share a few in­sights I gained on RIA cap­i­tal sources.

Ag­gre­ga­tors: This cat­e­gory in­cludes com­pa­nies where the pri­mary busi­ness is to use some form of fi­nan­cial en­gi­neer­ing to ac­quire RIAS and place them un­der a com­mon hold­ing com­pany.

Ex­am­ples in­clude Fo­cus Fi­nan­cial, Fidu­ciary Net­work, United Cap­i­tal and AMG.

The pos­i­tives: They’re real pros at do­ing deals and they of­fer turnkey tem­plates and con­sis­tent deal struc­tures. Their of­fers were rea­son­able but not great. The neg­a­tives: they typ­i­cally will buy con­trol, but not 100%, of your busi­ness. This may be OK if you only want par­tial liq­uid­ity and if you and your team are OK for­go­ing the abil­ity to later sell the rest of your firm.

The big­gest is­sue is their deal struc­tures shift most of the risk to you. Es­sen­tially, em­ployee own­ers may give up part or all of their re­main­ing prof­its to the ag­gre­ga­tor in a mar­ket down­turn since the ag­gre­ga­tor gen­er­ally gets the higher of ei­ther 100% of the eq­uity re­turn, or a guar­an­teed (pre­ferred) re­turn. Heads they win, tails you lose!

Tra­di­tional pri­vate eq­uity: Pri­vate eq­uity firms of all sizes have been ac­quir­ing RIAS. Ex­am­ples in­clude Parthenon, Hell­man & Fried­man, Lightyear Cap­i­tal, Stone Point Cap­i­tal, KKR and Lovell Min­nick. These buy­ers tend to pur­sue larger firms

It’s not just about the money. Cash is table stakes. Terms re­lated to the cash are just as im­por­tant, maybe more so.

that are will­ing to sell con­trol through a mix of cash and debt. As part of their endgame, they seek firms that are ca­pa­ble of be­com­ing a plat­form for fu­ture ac­qui­si­tions.

The pos­i­tives: Some­times they pay the most and you might get an­other bite of the ap­ple when they re-sell your firm. They will want you to roll a piece of your eq­uity to keep you around. The neg­a­tives: Their time frame is short and they use lots of lever­age. Es­sen­tially, they will pump you full of steroids and auc­tion you off to the high­est bid­der in three to six years. Their funds have time lim­its, so they sell even their best in­vest­ments. A fi­nal warn­ing: PE firms typ­i­cally change the CEO so you also might find your­self un­em­ployed.

Mi­nor­ity-in­ter­est pri­vate eq­uity: These play­ers are sim­i­lar to tra­di­tional PE firms. Ex­am­ples in­clude Rose­mont In­vest­ment Part­ners and Es­tan­cia Cap­i­tal. The pos­i­tive: They make smaller in­vest­ments and leave you still in con­trol. So they may be vi­able part­ners if you are not ready to exit. The neg­a­tives: Mi­nor­ity PE firms typ­i­cally as­sure their liq­uid­ity within five years by re­quir­ing you to guar­an­tee their exit.

If you do not sell the com­pany, you have to buy back their in­vest­ment at a much higher price. You have to pay them ei­ther 100% or more of your eq­uity re­turn or a full re­turn of their in­vest­ment plus an 8% to 12% pre­ferred an­nual re­turn.

There­fore, you get all the down­side risk if things go awry. They also typ­i­cally charge baby sit­ting (mon­i­tor­ing) fees, get paid board seats and

The process killed many brain cells, but I feel I got an hon­orary PH.D. in cap­i­tal rais­ing. Here are the lessons I learned.

de­mand mi­nor­ity pro­tec­tions and con­sent rights.

Fam­ily of­fices and UHNW in­vestors:

Well into our process I dis­cov­ered a grow­ing con­tin­gent of bil­lion­aire types who make di­rect “pa­tient cap­i­tal,” or long-term, in­vest­ments in RIAS. Some fam­i­lies are house­hold names while oth­ers are lesser known.

They like RIAS be­cause they dis­trib­ute high cur­rent cash flow and can be great long-term in­vest­ments. The big­gest pluses: these in­vestors have long time hori­zons (20 or more years) and can buy com­mon eq­uity with rea­son­able mi­nor­ity pro­tec­tions. In ad­di­tion, the last thing they want to do is op­er­ate your busi­ness. That said, the right ones can make great board mem­bers and ad­vi­sors.

The down­side: Deals with mul­ti­ple in­vestors can be com­plex and are in­evitably less turnkey. The price they of­fer may also be lower than tra­di­tional PE, but they do not want to heap on ex­treme debt and quickly flip your busi­ness. There­fore, you have more time for com­pound­ing.

Tra­di­tional and non­bank lenders:

We in­ter­viewed four lender types: 1) large banks, 2) com­mu­nity banks, 3) SBA banks (i.e. Live Oak Bank) and 4) non­tra­di­tional lenders (i.e. Oak Street Fund­ing). Tra­di­tional bank pluses: bank cap­i­tal is the least ex­pen­sive and you do not have to sell eq­uity or lose con­trol, un­less you de­fault. The down­side: too much debt can sink your ship if the mar­ket gods get mad.

Large banks work with large RIAS. Com­mu­nity banks can work with large or small RIAS and are a great so­lu­tion — with less red tape — if you know them. Rates vary de­pend­ing on per­sonal guar­an­tees, loan terms and loan size. SBA loans work for small RIAS but al­ways re­quire per­sonal guar­an­tees and are laden with fees. Non­bank lenders in­clude mez­za­nine and busi­ness de­vel­op­ment com­pa­nies. The plus: they will lend you a lot with good terms (e.g. in­ter­est-only loans). The neg­a­tive: rates are high and you of­ten have to give up war­rant cov­er­age.

So where did Sa­vant land? We took cap­i­tal from four fam­ily of­fices and strate­gic high-net-worth in­vestors and bor­rowed from our lo­cal com­mu­nity bank (with­out per­sonal guar­an­tees).

We re­tained con­trol and now have pa­tient cap­i­tal part­ners, so they can never make us sell nor buy them out. And we got more than just cash — our in­vestors of­fer lots of ex­per­tise and con­nec­tions and pledged ad­di­tional fol­low-on cap­i­tal to sup­port M&A.

Maybe the most im­por­tant as­pect of the trans­ac­tion, though, was the fact that we in­creased the num­ber of em­ployee own­ers times three (we now have nearly 50 em­ployee own­ers). I was not in­ter­ested in Sa­vant end­ing with the founders, so hav­ing a cap­i­tal provider whose time­frame aligned with Sa­vant’s tra­jec­tory al­lowed us to make own­er­ship steps that fos­tered suc­ces­sion and long-term vi­a­bil­ity.

What should you do? First, un­der­stand your goals. Do you want to sell 100% soon or stay in busi­ness for 100 more years? Is con­trol im­por­tant? Do you have a one-time or on­go­ing need for cap­i­tal? Do you want ad­vice or just hard cash? Are you OK of­fer­ing per­sonal guar­an­tees? Do you care how the trans­ac­tion af­fects em­ploy­ees and clients?

Once you are clear, it will be­come ev­i­dent what cap­i­tal provider is best aligned with your plan, pref­er­ences and unique needs.

Fi­nally, re­mem­ber, it is not just about the money. Cash is table stakes. Terms re­lated to the cash are just as im­por­tant, or maybe even more so.

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