#FASuccess Ep 179: Investment Banking For Wealth Management And The Evolution Of Advisor Enterprise Value, with Elizabeth Nesvold

Author: Michael Kitces

Team Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Wealth Partners, a turnkey wealth management services provider supporting thousands of independent financial advisors.

In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

What You’ll Learn In This Podcast Episode

• How Wealth Management Firms Have Evolved Over The Years, And The Services That Investment Banks Can Offer Them [00:04:58]
• How To Calculate Whether A Business Is Getting A Good ROI [00:31:23]
• The Dynamics Of Raising Capital When Starting A Firm [00:53:40]
• Why Advisory Firms Engage Investment Bankers To Facilitate Mergers And Acquisitions When Selling A Firm [01:09:24]
• The Typical Success Fee That Investment Bankers Receive To Ensure A Deal Actually Goes Through [01:16:41]
• Liz’s Advice For Firm Founders Getting Ready To Sell Their Businesses [01:26:12]
• What Surprised Liz The Most Throughout Her Journey [01:30:44]
• The Low Point Throughout Her Journey, And What Comes Next For Liz [01:37:54]
• How Liz Defines Success For Herself [01:46:21]

Resources Featured In This Episode:

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Full Transcript:

Michael: Welcome, Liz Nesvold, to the “Financial Advisor Success Podcast.”

Elizabeth: Thank you, Michael. So delighted to be with you.

Michael: I’m really excited about this podcast today. This is maybe a little bit of a different direction or conversation for us – you come to us from the world of investment banking – particularly in the context of financial services and financial advisors.

I know, you’ve been involved in helping to close a number of very large RIA transaction deals. And I’m fascinated by the space, because I feel like investment banking just didn’t really exist in the advisor space until the decade of the 2010s. It suddenly appeared, where firms got large enough that investment banking in our space became a thing, but I feel like most of us in the advisor world still don’t really actually know what an investment bank does in an RIA context, and what it means when firms get built to a larger size and get sold.

I think we see a lot of these firm-to-firm deals, where a mid-sized firm gobbles up smaller firms, slightly larger firms gobble up mid-sized firms, and a lot of transactions up and down the spectrum. But I feel like there’s this whole other element of what happens in transactions in the large-firm space, which I ultimately view as a harbinger for what will ultimately happen all the way up and down the advisor vertical, as what happens with large firms tend to roll down over time.

And so, I’m excited to talk about the business of investment banking, how an investment banker looks at our independent advisor world and the buying and selling of firms, and all this stuff that happens in our space from an investment banker’s perspective.

So, I guess just to start, for people who don’t know, what exactly does an investment banker do with an independent advisory firm? I’m going to imagine you get this question a lot from firms that just get told, “We’re thinking about selling. Someone told me to call Liz, so I’m calling Liz. What do you do, Liz? What do you do?”

How Wealth Management Firms Have Evolved Over The Years, And The Services That Investment Banks Can Offer Them [00:04:58]

Elizabeth: I’ll take it back a little further. So, I’ve been in investment banking for 25-plus years as I continue to mature in my profession. But there’s so much confusion, especially just thinking about the word “investment” before “banking”. So, for the first five years of my career, my extended family – these are my aunts and uncles – they would always ask me if I had any good tips on stocks. What I can tell you I don’t do is I don’t manage money.

But in the simplest term, an investment bank really is a financial group that engages in financial advisory transactions. Generally, in my space, on behalf of institutions, my area of expertise is mergers and acquisitions and my focus has been in the asset and wealth management space.

In terms of the wealth management space – I’m really going to date myself here – I actually started focusing on the wealth management universe back in 1996, if you can believe it. At the time, it was “investment counsel” and there were maybe six transactions in any given year. I was a baby banker trying to figure out what to cover.

Most people won’t remember back then, but for those who do, a lot of the activity was really around the asset management side: mutual fund transactions, institutional money management transactions, a lot of deals on the security side of the financial services spectrum. And then there was this small, was a cottage industry back then, called, really, investment counsel.

Michael: And the investment counsel, these were the folks that were providing investment advice to large firm institutions? Like pension and foundation investment counsel folks?

Elizabeth: No. They were actually providing advice to individuals. It was money management for high-net-worth individuals at its core. And obviously, as the world evolved, people began to provide more holistic service offerings as client demand increased.

But way back then it was really people who might’ve come out of big institutions where they had managed money. A number of my early clients came out of banks and trust departments, and they set up their own registered investment advisor to provide advice on the investment side to high-net-worth individuals.

So that’s where I started to get my footing. I was really looking for an area to cover. In every large firm, every insurance company, everybody was covered by more senior investment bankers. This was the space that nobody was paying attention to. And that’s really how I got into it.

Michael: Interesting, because part of the dynamic, when you’re early in an investment banking career is that before you’re a deal-maker you just have to be like a ‘deal-understander’, so pick a segment of the industry, study it, follow it, understand the deals that are happening, and the people and the dynamics so that you know the space. And then, at least someday you can maybe help facilitate deals in the space. But first, you have to pick the area where you’re going to make your mark and learn ideally one that not everybody else already covers. Because then it’s hard to differentiate.

Elizabeth: That’s exactly right. And back then, they used to consider this sort of a training ground for young bankers, because these businesses had more simplified business models. There’s really only, mostly one way that they generated their revenues, and that was fee-based income. So it was a fee on top of asset to the client for whom they were providing a service.

Michael: So relative to complex, multichannel enterprises with a lot of different offerings, here’s a firm where they sit across from their clients, they give them some advice, they collect a fee… kike, got it?

Elizabeth: Exactly.

Michael: Okay. How do I analyze this!

Elizabeth: I totally got it back then. I just fell in love with it. I fell in love with the people and the services they were providing their clients. So, that’s really how I got my start.

But you’re right. What does an investment banker do with these few firms that want to do something?

Michael: Well, I know what RIA businesses doing wealth management for high-net-worth individuals look like today. When you were looking at these firms in the mid-1990s, was it basically still the same kind of business it is today? But there just weren’t as many of them and they weren’t quite as large and scaled yet, or was the business different and actually quite large, but we just didn’t follow them the same way then? What did that business look like compared to what you see in the landscape today?

Elizabeth: Sure. I would say that relative to the number of pure asset managers, there were far fewer, but it was gaining ground, and there weren’t many notable transactions at the time. A lot of the business had been done on behalf of high-net-worth individuals with big trust companies. And you can think of the names. It was the US Trusts, the Northern Trusts, the Wilmington Trusts, the Mellons, Bank of New York…

It was a small space at the time and it had just started to get some traction. So there was a pretty dramatic increase in terms of the number of registered investment advisors over my career. And what’s interesting is I contrast it with the banking community. So, M&A bankers who cover banks, depository institutions.

From the time I started in the business, our universe of registered investment advisors has increased despite as much consolidation as you think you see on an annual basis. We’ve increased by 60% over the last 20-some years. The banking community is probably a fraction of itself – maybe 40% of the number of banks exist today that did 20 years ago, even though banks get consolidated and new banks get formed. The number of banking institutions is still much smaller versus the number of registered investment advisors.

So, as the industry proliferates, as firms continue to grow, invariably people will run into continuity planning issues – founders who formed businesses have created valuable businesses and their next-generation can’t necessarily afford to buy them out, maybe the way that they bought into their own practice.

Michael: And so, when you were looking at wealth management investment counsel RIA deals then, who were typically buyers? Would this be like bank and trust companies that would buy them back? Like, “you used to work for us. You went out and started your own firm, you built a successful client base, now we’re actually just going to go acquire it and bring it back in.” Was it mutual fund companies that wanted to cross-purchase and be in this business? Who were the traditional buyers of RIA wealth management firms back then?

Elizabeth: Back then, it was more notably either the local or regional bank trust company or broker-dealer securities firms that were the acquirers, then it moved to more of a national player. So again, some of the names that I mentioned could have been US Trust. US Trust was a pretty frequent acquirer of these businesses, BNY Mellon, First Mellon, and then Bank of New York merged with Mellon on the wealth side and certainly became a material player in the space.

Michael: And so, just trying to get some context – what were the size of firms getting acquired? Were there still multibillion-dollar RIAs then as large then as they are today? Were the firms smaller? Were the firms actually bigger? What did that landscape look like?

Elizabeth: If you look at the number of transactions that occur in any given year, there are still a number of firms that are below a billion in assets that are regularly acquired on an annual basis. That was the lot of them. So there were no firms that were $4 billion, $10 billion, $15 billion. It was very few and far between.

And for those firms that were more sizeable, they often sprung out of investment consulting practices, maybe for family offices. And so the assets looked very large, but it was still very much a cottage industry, smaller businesses that may on the average be $500–600 million in assets.

And so, when I started covering the space, critical mass for a firm that now today called wealth management, back then investment counsel or financial planner, would have been a quarter of a billion in assets was a good living. Then the quarter of a billion sort of moved to half a billion, and half a billion was sizable. And then half a billion moved to a billion as more of a new critical mass threshold.

So the industry sort of grew up as the markets continued to evolve, and there was a greater recognition of services that may have historically been provided by banks and trust companies that could also be made available by independent firms that were serving clients locally or regionally.

Michael: How did firms get valued at the time? Was it similar to the value mechanics today? Were the  rules of thumb – like, ‘two times revenue’ – still hold then? Was it more cashflow-based? Were there other models for evaluating firms at the time?

Elizabeth: I would say in the early days people were still trying to figure out if it was a function of assets. So AUM played a role to some extent, and how much you managed invariably transitioned to what kind of revenues you had. Because the earlier models were still trying to start with a 1% fee. So if everybody starts with a 1% fee, then really you’re trying to gauge size of assets, size of clientele, but as the industry continued to evolve, and as there was a rising of multifamily offices and advisory firms for more substantial families, that rule of looking at assets and looking at revenues went out the door, because what you found was that the bigger the family, the bigger the relationship, or even it could be multiple families aggregating one family relationship somewhere.

It was sort of a Walmart-type pricing. You were trying to make it up in volume, but the fees were discounted so it was hard to just assume that a firm with a billion dollars serving ultra-affluent clients would be valued and have the same revenues that a firm with a billion serving a more mass-affluent clientele might generate.

Michael: Interesting. Because I sort of feel like there’s this evolution of, first it was valued based on assets, either because everyone charged fairly consistent fees or because acquirers are coming and saying, “I don’t really care what your fee model is. We’re going to buy the assets. This is what we’re going to do. What we’re going to charge. So I just need to know the asset based on which I can apply my fees. I don’t actually care what you were charging. If you were charging less, we’re going to get them up to our fee. And if you’re charging more, then we’re going to put them on our fee schedule anyways.” Then it started shifting to, “Oh, I guess clients actually don’t like fee changes so much. Maybe we should pay attention to what you are charging. So, let’s look at your fees and your revenue base.”

And then it went one stage further to say, “Oh, okay, but not everyone charges the same. Not everyone gives the same pricing relative to the size of the relationship. Some of these people are running firms a little better. Some of these are maybe underpricing for their services. We probably have to drill all the way down to what is your revenue and what is your costs and what’s your actual profit. And let’s start looking at this as like profits and free cash flows when we’re trying to value the firm.”

Elizabeth: Exactly right. It’s so interesting, too. I haven’t thought about that journey, ever, Michael. So thank you for taking me down memory lane, because you think way back when, and there was so much conformity to what people were doing and how they were charging. And now there are so many different models today with maybe bespoke services and solutions, some more broad-based and holistic, others with still more investment bias in different geographies, charging different rates with different cost infrastructures and different layers of complexity and technology. So you really have to look at the whole picture and it’s not just a static cashflow number, either.

So, even that has changed pretty materially because, even if you went 10 years ago, still, it was many larger players who were looking at smaller players combining. So they didn’t necessarily focus so much on momentum of these businesses. Now, as we see many more impactful and sizable organizations, they may stand alone post-acquisition. And so those firms, you have to think about not only what they do, for whom they do it, is there any concentration, and how do they run their business? Is it efficient? Is there some operating gearing embedded in what they do? Are they driving business through organic means, meaning sourcing those clients? Are they growing through sub-acquisition? Are they doing both or are they showing revenue growth and they’re really not actually growing organically post those acquisitions?

So you really have to peel the layers of the onion back pretty carefully to try and assess value.

Michael: Well, I’m struck as well by this evolution that, I feel like there’s a lot of discussion today of sort of the proverbial ubiquity of the 1% AUM fee in that, like everybody kind of charges the same thing for sort of similar services, but that, still at the end of the day, maybe we are broader in what we do for our fees, or there’s a more of a range of what firms do for these fees than there was in the past when the model and the service offerings really were simpler. Like, I charge you 1% and I throw on the blinders and I manage the pot of money that you’ve got, and everybody kind of knew how that model works. And there was this, at least in advisor world, somewhat infamous chart that fidelity had put out two or three years ago, that sort of showed this graph of the fees that advisors charged on one axis, and then the number of services that advisors provided for that fee on the other axis. Like, do you just do money management only? Do you also do financial planning? Do you dig into retirements? Do you dig into estate planning? Do you do tax stuff?

And normally, you would sort of expect this linear relationship. Like, the more services I provide the higher my fees are because I’m doing more things so I got to charge a higher fee schedule. And what they found in practice was, basically, it didn’t matter whether you did 1 or 2 services or 12, median fee was 1% at all levels, and all levels had a huge range above and below it. There was basically no relationship between the AUM fees that advisors were charging and what they were doing for those AUM fees. You had high fees and little service – just crazy profitable businesses; some might even argue too profitable – and you had low fee services providing a ton of support for their clients and great clients, and great relationships, horribly not profitable relative to the fees they were charging. And everything in between, which I guess gets back to this point that you’ve made of why we’ve moved from, let’s just look at what your asset base is to, let’s look at what your revenue base is to, oh, I guess we really actually have to drill down to what is your revenue? What is your cost structure? What are you doing for these clients, for your services? And then going even one stage beyond that, which is, now let’s talk about your growth on a forward-looking basis. And are you growing? Are you not growing? Are you growing profitably? Is it actual organic growth? Are you buying growth with acquisitions and doing even more just to deconstruct? What is the actual forward-looking health of this business?

Elizabeth: Yes, that’s exactly right. One would think exactly as you’ve articulated, more services equals more revenues. But what happened is that people were trying to differentiate their service model from someone else. So they were throwing in, “I’ll give you a free oil change annually with that car,” to differentiate against the auto dealer down the street.

And so, it began to be expected that you would provide more services for the same fee, or everybody would just talk about wealth management, and to a client who maybe ran a dry cleaning chain and sold that, it all sounds the same upfront. Only until you get in deep with the first advisor that you ever used do you start to understand what you’re getting for the fees, and even then, it may take them two advisors before they really understand what they’re getting and how it’s being charged. And in a bigger institution, are they losing money on something to gain opportunity elsewhere? Meaning on the product side, the asset management side of the equation.

So it’s still very confusing in the marketplace. But for me as an advisor, looking at these businesses, I was so excited to learn more about the holistic nature of wealth management and the broad spectrum of services that could be offered whether it was investment management and financial planning, trust and estate planning, tax compliance, doing your tax returns for you as well, and how people would charge. And when people started to bundle everything, what I realized is that people weren’t saying to clients, this actually costs me money. You want me to be in business to make a profit because if I am profitable, I can have wonderful and talented people servicing your relationship. If I am not, I will have to skimp on something. You just don’t know where.

And so it prompted me, years ago, to write an article for the industry called “How to Make Money in Wealth Management” and it was published in “Trust & Estates.” It really was a deep-dive into the fee models and where people were getting it wrong, because this is a wonderful business and your clients should want you to actually make money. You’re not a not-for-profit, but if you give things away, and I’m glad we’re having this conversation right now as we face an environment surrounded by a pandemic, people are so tempted to drop their fees, provide more services, waive fees, and make concessions in volatile markets because they feel like they need to show stability or growth.

These are the times where people make, I would say, not the best decisions on their fee model. And so, for the industry at large, you provide so many wonderful services. You are working harder today than you were a year ago for those client relationships, holding more hands, looking daily at the market, trying to come up with strategies to hedge, doing more planning, trying to think more creatively about the tax environment with all the things that are going on, do not give way to concessions on your fees because you earn your money and you should charge it fully.

Michael: Well, and that to me is one of the interesting things about even how the business has evolved over the timeframe that you’re talking about. Firstly, just it strikes me, we have spent 20 years talking about the crushing pressure of fee compression and how our fees are doomed to collapse as all of this technology crops up.

But here you are talking about wealth management in the RIA business in the 1990s, dare I say, the pre-internet era, I guess we can say that now. We have the pre-internet era, advisory firms are providing individual wealth management services to clients charging a 1% fee. And now here we are, 20-plus years later, with a mind-blowing evolution and development of internet technology and automation and APIs and workflows and all of these things that we didn’t have that make the business unbelievably more efficient than it was, and we’re charging the same 1% fee providing holistic wealth management services.

All of the discussion I feel like we seem to have collectively had around this collapse in fees has not happened despite, like literally, exponential improvements in technology and efficiency, but what has happened on the other end that I think you’re making a good point about particularly in sort of transition environments like this is, it does sound like at the end of the day if I add up what a firm does for its clients to justify that 1% fee, we do a lot more than we used to.

We only do more because we can, thanks to all that cool technology and efficiency stuff, but it’s not that fees are getting compressed because the technology is automating all that stuff. It’s that, it’s game on for us to constantly do more to justify the fee and we have to use the technology, get efficient to do more and justify the fee, or then we get out-competed by someone else. There’s a ‘service creep’ phenomenon much more so than a fee compression phenomenon.

Elizabeth: And I would say, you’re right. It’s not necessarily the fee compression. The service creep is one thing, but what people state in their ADV that they actually charge is often markedly different from what we see when we get under the hood. So people will make the decision.

And again, it depends on what are the incentives for originating new business? How does that work internally? Sometimes they don’t understand when you talk about that iceberg and seeing what’s below the water, what they’re doing to their own business model, by virtue of the incentives they may proffer to the advisors bringing in new business.

So if there aren’t rules of engagement around, okay, this is the type of relationship. There is a deep dive in terms of the complexity of the relationship, the services. Sort of like a service matrix, if you will, to try and figure out what does it cost us there? And then, what kind of a margin is a fair margin to put on top of that business? You can have people making concessions without even really realizing it.

So you say, “Hey, isn’t that wonderful that advisor brought in another quarter of a million of annualized revenues this last year, give him or her a pat on the back and an extra bonus and some kind of incentive there.” And then when you look to see what had been charged relative to the services that are promised to the client, you don’t even realize you’re not even making much of a margin.

So there is often when we get into the mix on valuing businesses, we start very, very granularly in terms of looking at the clientele. We want to understand when did the clients come in? So inception date of the relationship. Have they been good adders of assets? Are they draining their accounts? Who services the relationships? How many services do you provide in that relationship? How automated or how processed is it in terms of your, you talk about workflow and API, are you moving from person to person without dropping any balls or is it much more manual in terms of what you’re offering?

And then at the end of the day, you get through the analysis with the client. They don’t realize that in some cases they have a 30% margin on this relationship and in this relationship, it’s a larger relationship, but they’re actually losing money, given the number of services relative to what they’ve charged and the incentives that they may be paying internally for somebody who sourced the business separate from somebody who’s managing the relationship.

How To Calculate Whether A Business Is Getting A Good ROI [00:31:23]

Michael: So, can you give us maybe some examples of structures you see that get set up that the firms are very proud of, and then when you get in there wearing your investment banking valuation hat are looking at and saying, “Oh no, no, this is not as profitable as you think it is, or this isn’t profitable at all. Let me deconstruct your business and show you why.” Are there common practices that you find that turn out to be more problematic than most firms realize?

Elizabeth: Often, they want to provide financial planning for free. There is a cost to that, and maybe you can minimize that cost and maybe you’re doing it upfront. Maybe you’re doing it annually. That is often the way somebody starts the relationship. But sometimes a client may come in on the investment management side and you want to throw that in for free. There are a number of firms that are now doing tax planning and prep. Again, the tax prep side of the equation is not a high marginal contributor. So, some firms that we’d seen actually were giving away that service. And again, it was a drain on the margin, and maybe it was a volume business at two points in time, in the year, sort of heading into April, and then towards October, still giving away that business as part of the holistic package, if you’re not charging fully or at least building up to the full fee became problematic.

Michael: And so the firms that say, “I have to do this to win the business. I have to do this to compete for the business. This is what affluent clients expect of us now. I can’t charge the same fees if I don’t do this.” Are they off base on that? Or is the point, “Well, okay, if you’re going to do that, you need to be charging more? Your fees aren’t aligned with all the things you’re doing.” Because again, I feel like, for some firms, they would just say, “Well, yeah, you could say those things lower my margins, but I wasn’t going to get and keep the client if I didn’t do that stuff. That’s what I got to do now.” Is that not a valid way to look at it?

Elizabeth: Probably for the industry at large, that is the way that they’re looking at it. But now we’re going to distinguish the best firms in the industry. The best firms in the industry think about their value proposition and they learn, and often it’s bringing in a consultant or a coach to help them think about the messaging.

To the end client, if it all sounds the same, then you need to work on your message. Clients will want you to be in business for the long term. It is a competitive marketplace, but often, they’re really connecting to one individual, in particular, that they feel comfortable with because they feel that individual is transparently articulating what will be provided versus what it’s going to cost. And that really wins the day. If you don’t have your message on squarely, and you’re not proactively thinking about the dirty word in the wealth management space sales, you probably will get stuck in that trap.

I remember in the early days in wealth management, really, when I was dealing with single-family offices who’d open their doors into multi-family offices and for more of the planners who turned holistic wealth managers, “sales” was such a bad word, they didn’t like to talk about sales. They didn’t like to profile themselves. They didn’t want to be in the press or noted in any particular way, because it felt contrary to the confidences of these high-net-worth individuals for whom they were managing assets and advising on their financial life. But at the root of it, if you are going to run whatever the business is, you have to think about sales.

And if sales don’t become part of your culture, you will find yourself making concessions merely to win the business, to be more sustainable for your next generation to show that you’re bringing things in because if you’re bringing something in and then you’re not doing a good job advising the client, you get backdoored. So you may be offsetting a relationship out with a relationship in.

So you have to think about the whole holistic picture of managing a business. And that is where I think somebody like me comes in to start to talk about, how do you grow and manage and evolve as a business from a practice? Because again, from the early part of our conversation, this industry started out as a cottage industry. There were these small boutique organizations that slowly evolved. And it still is a practice mindset, but now it’s time to think of ourselves as a business.

And in any good business, if you’re any portfolio manager and you’re peeling the layers of the onion on the best businesses, the marquee businesses, they really are thinking not only about the product that they provide, but the channels that they’re selling into and how they’re going to continue to grow and become a more valuable enterprise.

We need to do that within the industry ourselves. I had one, probably the best student of our services, debating on whether to name names or don’t name names. He’s a longtime friend of mine now. A gentleman named Gregg Fisher became a student of our services to try and understand how to build a business. How do you drive value? It wasn’t just our services – he engaged a number of the best coaches around messaging, around operations, around you name it. He was always trying to improve, not only in terms of the efficiencies, the technology, the breadth of the offering, but also trying to understand the messaging as well. The brand build.

I met Gregg when he was about $300 million in assets and we did some early valuation work together. And a big part of what he found valuable was the qualitative assessment, really breaking up his business into modules to talk about the service aspect of what they did, the fees that they charged, the technology that they used, the people that were structured around the teams to service the clients, and trying to gauge those things relative to the competitive set of people he deemed competitors.

He did such a phenomenal job to really understand what drives value. He built a wonderfully valuable business that invariably we sold to People’s Bank, but in that journey together he grew 10X. So it was about $300 million when we started our relationship together. And I think he sold it for maybe $3.5 billion in assets. And that’s his mindset. His mindset is a 10X mindset.

More often than not in this industry, people are just living and breathing their day jobs and they don’t lift their heads up. And that’s why I’m so grateful to you and to the podcasts that you do to explore more of how people have become successful in the different aspects and facets of the business that people can learn best practices from. But this is a person who thrived on learning to do better.

Even when he thought his team was doing the very best job in advertising, marketing, client service, whatever it was, he was always looking to do better. And that kind of mindset creates an invaluable business. People will see it when they look at the model, they’ll see that there is leverage in the model. It was a 10X experience for me as well and just watching him evolve as a manager and advisor.

Michael: I’m very struck by the way you frame this service creep to substantiate value that yes, clients may demand more for the fees that we charge to justify the value, but that in some cases, this isn’t actually a value problem for the fees that you charge. This is a sales problem and a marketing problem and a differentiation problem that we’re trying to solve for by saying, “Well, I’ll also do this, I’ll also do this, I’ll also do this, I’ll also do this.” Like to try to throw enough things onto the pile to get the client on board. I sometimes inelegantly call this value-barfing. Like, I’ll just keep barfing. I’m like, “I’ll do this and I’ll do this and I’ll do this. Well, here’s a whole bunch of value. Now, pay me.”

I think we do get trapped in this sometimes where you feel the pressure. Someone says, “Well, why should I work with your firm and not the other two that I’m talking to?” Because I feel like they always interview us in threes. It’s always us and two others. Right? And you get into that moment of, “Well, why would I hire your firm over someone else’s?” And I feel like you sort of end out with three ways that you try to solve this. Number one, we’re cheaper. Right? So we compete on costs or I can discount my fees. Number two, we do more. So I start throwing in more services. Or number three, well, we’re different than those two. Let me tell you why.

And if you’re good on number three, if you can clearly explain why you’re different, then the way you’re different actually lines up with what the client needs. Like, “Oh well I guess you’re the only one that’s going to do that So clearly, I need to work with you.” But if you can’t answer for the differentiation question in some meaningful way that’s relevant for the client, we all get stuck on the other two. Either we start value-barfing our way there, throwing more for free and more for free and more for free and then kind of erode the margins down or we start discounting. Like, well, my fee schedule says that, but I’ll give you this breakpoint or I’ll pretend you got here or I agree at your household or I’ll I agree your assets with the person who referred you so you can get a group discount rate. Whatever it is that we do.

All those different ways that we start compromising our fee. Like, I’ll waive the planning fee for you since you’re a meaningful relationship. All those things that we start doing that in some way, shape or form begins to drive down the fee and we essentially compete on costs when we’re usually not actually scaled enough to compete on cost. Right? Usually, the winners on costs competition are the biggest with the most economies of scale. We compete with costs without scale and then we start to erode the margins again.

So, you kind of framed up this interesting look at what it means to get a valuation on your business. I guess like at ‘Gregg stage’. Right? He had $300 million under management – which is still a very sizable firm – and wanted to 10X to $3 billion and was trying to figure out how to get there. Right? I feel like for advisors that go that route, who want that kind of growth, it tends to be a “Well, I’ll get a practice management consultant or an executive coach or a marketing coach or help to go after some area of the business.” I don’t feel like there’s a lot of firms that say, “I’m trying to figure out how to 10X my business, let’s get a valuation for where it is today.”

Elizabeth: There aren’t. I think more and more people are trying to at least get their arms around it because there is some pressure as you think about next-generation talent to find ways to incent them. But apart from estate planning, sadly, sometimes divorce settlement were continuity planning, I don’t necessarily think people really want to engage on that front. And it’s not that they don’t want to, they probably don’t think about it. So think about what they do. So they do the most incredible work for their clients to help them plan their financial lives.

But back to your iceberg analysis, I think they keep their heads down so much and trying to serve the client that they forget to pick it up and say, “Hey, you know what? Let me take stock and where I am, what I’ve done, and where I’m headed.” And somebody told me this once and I believe it’s true, but it wasn’t Wayne Gretzky who said skating to where the puck is headed. It was actually his father. But the advisor community, by and large, doesn’t generally do that. They do that for the clients in the planning, right?

They’re always trying to figure out, okay, let’s use some analyses, and it used to be, okay, average age is 75. Now people are probably saying average age of 90. And how do you spend annually? What do you want to leave? All that planning, trying to think about taking the client who’s 55 to the age of 80 or 90 or however far out we’re going these days. And this is what you need to do to get there, Mr. Smith, Mrs. Smith. This is your earnings. This is what you need to reinvest. This is how we’ll invest it. This is how much you can spend. So they do all of this work to help people project for the next 20 years. And they don’t do that for themselves.

So if you think about some of the larger firms, these are the firms who are thinking with their business hat on. And sometimes it is an entrepreneur who says, “You know what, I am great at the CIO side of the equation. I don’t like managing people. That’s not my thing.” You have to figure out what is your thing. If you are the predominant owner, more often than not, you wear the CEO hat. Or if you’re one of the early founders, more often than not, one of those founders wears that hat.

But sometimes it’s good to take stock in the business to say, where are we headed? And are we the right people in the right roles? And do we have the right people in the right roles on the bus or do we need to start thinking or planning for ourselves?

And that is often when we’re doing the valuation strategic advisory work. What we’re trying to help people do is take stock in their business, really understand where are they strong and where do they need to do some work or where are they missing human capital that could help them. So, I remember being called in by a past client who I had sold to a multifamily office, and my client then was actually running the combined firm. And they thought they were going to go out and make a regional acquisition.

And we did this advisory work right up front, and what we realized is that they were just starting to get their marketing message honed. They were just starting to hit major pipeline traction on the business development and organic growth side that we actually said, “All right, bad for my business, but you don’t need to hire us right now. You’re growing too quickly, organically. This is where you spend your time. If you can grow organically, beautifully, let’s not create noise by trying to do some sub-acquisitions when you’re not yet ready. Focus there because that is the Holy grail is figuring out how to grow the business organically.”

So it was sort of a therapeutic moment for them. And they said, “Holy cow, you’re right. We should spend our time.” And this is probably seven years ago, and they haven’t done an acquisition since, but they have grown nicely. They’re more than $5 billion in assets. But it is really important to find moments in your business evolution to pause and take stock and find somebody to engage with.

Sometimes it’s just a CEO coach. It could be somebody to help you think about the operational aspects. It could be someone to help you think about valuation and the business dynamic. But there are going to be these important points in time. And the natural reaction is to not spend the money, right? But the well-trained mind who has sort of a thirst for knowledge and doing better and growing better and being stronger, that is the person who’s likely to engage.

And sometimes we have clients who’ve engaged with us multiple times over the years, and then they come in for their quote tune-up. And from my perspective, I think that’s wonderful because they’re doing for themselves what they do for their clients.

Michael: And so, broadly speaking, valuation work a big piece of literally what your firm does at this point? Helping advisors do valuations on their businesses and the extension that comes from it, actually understanding the moving levers of your business by doing evaluation on your business?

Elizabeth: For us, given where we are in our evolution, and you’ll remember, I was in a practice who built a business that then sold. Ours is about relationship-building. So we don’t tend to just do an annual evaluation for the sake of doing an annual evaluation. For me, in particular, it is really a way to engage, to start building a relationship. If someone just needs a cheap valuation, I’d be more than happy to provide referrals.

But if it is somebody who is, much like Craig Fisher, really trying to think about the journey, value creation, better business management, tighter operations, happy employees, and happy clients, that’s where I like to engage on the valuation strategic advisory side.

So, we tend to have clients, and my husband, who, as you know, was our COO and really helped put in place a lot of the things that we do that is much more process-oriented. But Peter’s own analysis of our business was that if we engage people long before they’re thinking about selling, invariably they become, a multiple-time relationship.

I have one client who we’ve done seven things together. And so we’re really building a relationship to continue the growth trajectory. So that’s where I engage on the valuation side. But there are a lot of wonderful firms who provide just purely valuation guidance and sort of an annual evaluation test on what the security is worth.

Michael: Can I ask, who do you typically look at as firms that you would send people out to do valuation work for? If someone’s at least looking at this and saying, “I’m not necessarily ready to sell yet, but this idea of actually getting a professional valuation and seeing how someone else would look at the value levers of my business is interesting.”

Elizabeth: So, a long-time friend of our firm is a gentleman named Matt Crow who runs the practice group at Mercer Capital around this space…

Michael: Not to be confused with Mercer Advisors who’s an advisory firm in this space.

Elizabeth: Exactly.

Michael: The other Mercer.

Elizabeth: The other Mercer. One of the other Mercers. So, he’s done a wonderful job around this space, in particular, and has really grown a big practice group for it.

Michael: So, help me understand a little bit more now, having looked broadly at the industry and the evolution of the industry, bring us back to, what does an investment bank do? We’ve sort of talked about what valuation services are. Just what valuations do for your firm. Not just for literally valuing it, but kind of looking at it as what are you going to build and how are you going to move to value levers in your firm to build enterprise value. But what does an investment bank itself do in the context of our industry?

Elizabeth: Boy, you think it would roll off the tip of my tongue. An investment bank can provide a broad array of financial advisory services on behalf of individuals and institutions, and it really can do so at various stages of a company’s lifecycle.

So it could be capital raising in the early stages. It could be M&A in terms of a growth cycle. It could be, obviously, valuation, fairness, opinion in the context of some combination or for estate planning purposes. It could be recapitalization in the instance of taking an ownership block out of the business. It could be a restructuring in tough times. It could involve services for more sizable players. Something like a focus financial of an IPO advisory, IPO offerings, follow-on offerings, debt capital markets solutions for some of our larger clients. And especially in an environment where lower for longer went even lower on interest rates. That is a good source of financing for transaction. So we have an incredible debt capital markets group who will help put a very competitive package together that may be in the form of a deal line of credit for more acquisitive firms.

So, there are a variety of things that we can do. Obviously, a big part of probably one of the marquee areas for many investment banks is the M&A advisory, mergers and acquisitions advisory work that firms like us do for our clients.

The Dynamics Of Raising Capital When Starting A Firm [00:53:40]

Michael: And so, I want to actually dig a little bit further into some of those because I think, to the extent advisors are aware of investment banks, I think we tend to think of this in the context of M&A, in particular. And you noted a couple of other things there that just are out there, but we don’t necessarily talk about as much.

So, capital raising for firms in the early stage – talk to us a little bit about what that looks like. Like, what size firm does that? Where do you get capital? How does that mechanism work? I think most of us are sort of used to, you run it until you run it, and then you sell it when you sell it. What’s capital raising in the context of an advisory business?

Elizabeth: So, for a startup firm, you’re really looking for seed capital. It could be from an angel investor community, it could be venture capitalists; invariably, you’re looking to find somebody who can help you. You obviously have more than, hopefully, a business plan. You have the early-stage business that really needs capital to continue to grow.

But the first way you can do it is obviously, to bootstrap your own business. You put your own personal wealth in it. I would say, even today, so we started in the ’90s on our journey, Michael, and now we’re here in 2020, there’s even crowdsourcing and crowdfunding campaign means. There are loans that you could look for. And there’s always the friends and family network.

But if you’re going to start to organize that effort, you’re really looking for somebody who can raise assets with maybe a more retail or high-net-worth oriented community for smaller businesses. And that is certainly something, depending on the size of the mandate, that Raymond James does.

As you think about it with larger businesses that start to become more mature, who are really at this high-growth, high-octane part of their trajectory, they may be looking for growth capital. So, in this wicked environment, a lot of what we’re doing right now is we’re doing minority raises for firms that feel like the next three to five years are going to be the most opportunistic time. And so they’re looking for growth capital. And that could come in the form of a family office, a pension fund, a long-life capital investor, a fundless sponsor, a private equity sponsor.

From where I started in my career to today, there are so many more choices for capital than there ever have been. But again, where would one even begin? And so often it is somebody who is either very focused on capital-raising or M&A advisory. So a minority sale, technically. And that minority sale could be some de-risking for some people who aren’t ready for the growth cycle, and capital infusion for the partners who are going to take it to the next level. But this itself is a very big business. There are boutiques that do this, there are more sizeable investment banks, midsize investment banks.

And this sourcing of capital is an important feature for firms that are really in the J-curve of their growth cycle. Those that really have a head on where they’re heading, they see it in terms of, you need more human capital that costs money. Looking at a sub-acquisition, doing more R&D, and some tech leverage point for the business. All of that takes capital.

And the way our industry started, they started by bootstrapping, just doing it themselves. Right? Start with a couple of clients, have some profits, reinvest, grow a little bit more, grow a little bit more. But we’re now at the point in the evolution of this industry where the opportunities are, is ginormous a word? Ginormous, coming out of…

Michael: I’ll accept it. I’ll accept it.

Elizabeth: …coming out of all these horrific environments. And it’s sort of, chance favors the train mind, but chance also favors those with a wallet to draw from.

Michael: Chance favors the prepared mind and those with war chests.

Elizabeth: Exactly. And so you look back to 2008, and some of the firms we talk about and we know well and those CEOs who’ve been interviewed by you on your podcast, those are firms who got while the getting was good, coming out of the crisis, they were hiring people, they were doing lift downs, they were doing tuck-in acquisitions, they were doing things that were a little bit more transformational. They were opening offices. They were doing all the things that you probably say, “Oh my God, I could never envision doing that. Sitting now quarantine at home, I could never put that into my business plan.”

But the firms that are now really sizable, independent or boutique players that are names that everybody knows now, those are the firms that over the last 10–12 years were taking advantage of market opportunity. Even when people would rather just put their heads back down and just hold on to things. They were making brave and bold decisions to get to the size that they are. And they came out of a horrific market environment.

Michael: So, help me understand a little bit more about how some of these deals come together. Even when we talk about things like firms that want growth capital, sort of translated like, “We give you cash, you use cash to go spend on marketing or buying other firms or whatever thing you’re going to do that is your growth strategy when you have some cash on the books.” Can you give us some sense of, what does a deal look like?

I don’t even know if there’s a prototypical firm that does this. I’m at least imagining, “We have $250 million under management, a solid business with $2-plus million of revenue. We think there’s a lot of opportunity to grow. We’ve got some neat opportunities in our local market. Liz, I heard you’ve got access to capital. We want a piece of because we want to grow.”

What would a deal look like for a firm like that? Well, I guess first, is that even the type of firm you would work with? What does a deal look like for a firm at that size? Like, what do you get? How do the mechanics work? How much do you get for what you give up? What does a real growth capital deal look like?

Elizabeth: Sure. And for a firm like that, it could be that there’s a platform partner who is really going to help finance some of that growth activity. And so, there are some platforms, I’ll take the other side of the house at Raymond James on the wealth side of the business. They have a bank associated with the wealth side of the business and they have provided capital to advisors looking at these combinations.

So, sometimes the partner already exists, meaning the capital partner exists within your own domain. It could be a platform partner that you’re doing business with. Whether it’s a dynasty, it could be Schwab or Fidelity helping you think through, other advisors who might want to combine. So, you need to be organized in your thinking because you don’t just go out and say, “Hey, I want growth capital.” We’ve got to decide what we want to do here. Are we a buyer, a seller, a merger?

And what we are seeing out of this industry – and it’s so much fun versus when I started in the industry where it was your local banker or broker or trust company who was making the acquisition – now the industry itself is doing 40% of the transactions. So advisor-to-advisor deals are the biggest community of acquirers-mergers of the potential sellers.

So it really is, “Are we a young team and we want to continue the growth trajectory and we have developed more infrastructure?” We’ve got to grow a lot of great operating gearing and leverage points. We might be looking for a firm where there is a continuity issue. Meaning a founder who built a practice and really doesn’t have a logical next-generation successor. And so we’re really looking to combine, but that founder is hard-pressed to turn over the keys to what he will believe is a Maserati without de-risking, right? He might roll some equity.

So now, here we are, we’re a $250 million asset advisor. He’s got $150 million. We’re going to combine our firms, and he wants to take some money off the table. So, the good thing about this environment, is there are now financing sources that come in the form of sort of the SBA loans. There are firms who will provide, as platform partners, capital. There are private equity firms, as I mentioned before, who will help smaller firms because they are really smaller pools of capital. So we need to be organized in our thinking. Can we afford it ourselves? Do we have a strong bank relationship so the bank is willing to give us a deal line of credit? How much do we need?

So we’ve had our negotiation, we’ve determined that his business is worth $4 million. We’re not going to write him a check for $4 million up front. Now, we’ve got a thing about the form of consideration. Is it a cash and stock combination? We know he wants some cash. And the timing of those payments. Are we issuing a note? Is it payable over five years? So he’s really giving us the seller financing and we’re going to be able to use some of the cashflow for that financing.

So it’s sort of all over the map in terms of how you fund these deals. A big part of this, and hopefully, if people take nothing away from our conversation, other than planning – that’s what it’s about here. So, a lot of people do engage with advisors to get their deals done, but there are many people who do deals without advisors, but it is about an awful lot of planning and discussion and vetting to make sure that you understand what are your sources of capital, what are you looking to do, how well-positioned are you if you’re going to go through a credit committee because you’re going to get debt financing, or are you prepared to sell majority interest of your firm if you get equity financing with a private equity sponsor? You’ve got to think through all of those levers.

There’s an awful lot out there to educate yourself, but it’s important that you show up with at least some homework under your belt and some sense of where you’re heading. Back to Wayne Gretzky’s father, we want to be a half a billion in assets, we’re at $250B today. We’re good organic growers. We’re growing at 15%, compound annual growth just organically. That’s a great grower, certainly in this market. And we want to merge with somebody who’s like-minded. Maybe that’s a cashless exchange. We don’t need the cash. But we also want to look at acquiring somebody bigger than us because that’s a founder who needs his exit. We’re going to need capital for that. But we have to have a game plan.

Michael: And so, you also mentioned that firms can even look at capital as startups. Is that something you actually see happening in the RIA space? Can Joe Smith, who wants to start up his own advisory firm, go out and get dollars invested to his startup RIA to hang the shingle and go try to start getting clients and doing his thing? Does that kind of startup capital exist for RIAs? Are you talking about different kinds of firms and different kinds of, I guess, aspirations for firms that go out for startup capital?

Elizabeth: Well, there has to be some there, there. So, there needs to be more than just a plan, “Aha, I want to open up an advisory business.” Often, these days, it could be somebody who is in a bigger institution that has a clientele that is thinking about going independent or thinking about combining with somebody who’s lifting out and somebody who’s already in the RIA spectrum that may need their financing. It’s hard to go out and say, “Hey, I’m doing a start up? I don’t know when I’m going to get my first client. I haven’t really been in the space, but I think it would be a neat idea.” I’m not sure where you get financing for that, but if you find it, call me and let me know.

But for those who are really thinking about branching out of a bigger institution, there is capital available for firms that may be smaller in nature that are trying to recruit a team or a couple of teams, that capital is available. But there has to be something that someone who’s looking for a return or some credit committee that has to go through a process can hang their hat on. Because there’s no dearth of good ideas out there. But invariably, those good ideas have to make it through proof of concept into practice or business. And that’s what would get funded.

Michael: And so that’s kind of the framing of there does need to be some ‘there’, there. Right? Just to be fair, not, “Hey, I think it’d be neat to be a financial advisor. I’m going to go get some startup capital.” But instead, “I have an established track record. I’ve already built and sold a firm and I want to do another one. I’ve built a practice over here, but I want to go out as an independent and I need some dollars in order to make that happen.” Or, “I built a business, I want to do a side business or a second one.” That kind of stuff. Some combination of, there’s revenue or there are clients and there’s a track record there. There’s a ‘there’, there. Put some of that on the table. But otherwise, we’re still not in a world of just getting staked to start your own RIA from scratch.

Elizabeth: Exactly. Unless you are a serial entrepreneur who’ve had exits that have been successful. So, a couple of people that I think of is Joe Duran did it before. Did it again with United Capital. One of my favorite past clients, a gentleman named Steve Lockshin who built a firm called AdvicePeriod. Steve built and sold a number of businesses. So, if he wanted capital tomorrow on a neat business idea, that would be available. Again, for those who’ve done it, have a following, and want to do it again, there is capital, but generally speaking, you have to have more than just a good business idea.

Why Advisory Firms Engage Investment Bankers To Facilitate Mergers And Acquisitions When Selling A Firm [01:09:24]

Michael: So going to the other end, you talked about other areas where a firm like yours may be involved, things like recapitalizations when buying out an owner. And I think for a lot of advisory firms, we don’t think in terms of capitalization in the cap table and recapitalizing the business. So, can you just talk us through, what does it mean to say I want to recapitalize my business in buying an owner out?

Elizabeth: It may be when you look at your capital stack that somebody needs liquidity. There could be a couple of things going on. Something happened that was a negative life event and now you’re dealing with an estate. You have an investor who needs liquidity and you’re also looking for growth capital. Invariably, what we’re trying to do is find fresh capital to recapitalize or freshen up your ownership table because there are needs for some people who will no longer be attached to the business.

Whether an investor, former partner, or, sadly, somebody who has passed. This is really a business that wants to continue to stay the course in terms of their growth trajectory, but they need to satisfy some needs within the business and maybe there’s something that exists within their buy-sell agreements that say someone has the right to be taken out and they just don’t have the wherewithal to do it.

So, those are situations where you try to be creative in your thinking. Again, in the good old days, there really wasn’t a lot available. So, that would be a prompt or even if it was minority ownership that needed an exit, that was the prompter for the 100% sale in the early days.

Now today, what is more exciting is that there are opportunities to freshen up that capital table with new partners taking out old partners. And as I mentioned before, there are some sophisticated family offices that have put around investing verticals to do that in this space. There are capital sources that are either fundless sponsors or maybe they’re convertible preferred, convertible debt. Definitely in private equity. Private equity in the early days in this space always wanted the technical control, 50 plus 1%. Today, more and more, sponsors who are really focused around financial services have investing arms that are willing to do minority stakes. So, that’s really what you’re looking for when you’re looking to recapitalize the business.

Michael: And so, how would a transaction like this come together? Jim died, he owned 30% of the firm. We’re trying to figure out what to do. We didn’t exactly have the cash around to buy Jim’s 30% share. How does this work in practice?

Elizabeth: Oh wow. So we went through one of those situations, which was a sad situation, for a predominant owner, a 50%-plus owner. And she had cancer. And so we were brought in to help facilitate the liquidity for what we knew would be her estate. And this group – I’m not going to name names – had an incredible partnership, just the most phenomenal people, they just could not afford to buy this founder out.

So we went on a very fast journey together to try and think about what are we accomplishing, how broad do we want to be in terms of the choices with either debt financing or a minority investor or a private equity partner? We went right up through the financial and strategic partners that you would think of that sort of roll off the tongue. And we got great engagement from the marketplace. It was a very sad event that we knew we were really financing out, but we were really looking at a growth partner because this incredible group was again, on a tear growing their business beautifully.

I would say we were in the 11th hour of our process picking our finalists, and all of a sudden, death came much sooner than we ever anticipated. So we had to fast-track this process. We picked the very best of the very best partners. We moved at warp speed to see if we forgot about everybody else, we’d put them all on the side. And we went laser-focused on one. And we had a lot of quality time in a very short period to figure out if we loved each other. And then, how could we structure a deal to satisfy what is now the estate, satisfy partners who are just coming into the ownership stake, satisfy partners who were accumulators of ownership, and satisfy a new much larger platform that we were combining with?

So hopefully, that’s not the journey that everybody takes, but I can tell you, in that particular situation, everything worked out as it should have despite a very sad situation.

But back to planning. Planning is really, critically important in these events. If we’re thinking about recapitalizing, we need to know what we’re trying to accomplish. So it’s almost like doing a sketch of a business plan. What are we looking to do? What are our partnership criteria? Let’s make sure that we narrow the field because we could wander aimlessly for years looking at different partners. There are so many out there today, versus the environment that I started in.

And we really try and get clients to think about it as a funnel. And if you don’t think about it as a funnel to narrow the field, you won’t get there smartly and you won’t get there timely. So you really have to think about it in terms of all these partners out there. There’s a partnership continuum from, as I mentioned, could be senior debt, mezzanine, it could be a minority investor, it could be private equity, it could be a financial holding company, it could be a strategic buyer. Somebody who integrates, somebody who doesn’t integrate. There’s so many choices. We have to narrow the funnel and say, “Do we still want to be us or are we open to being part of somebody else? Do we have a really big need? Can our partners here help finance that? Are we financially lucrative or are we in a position where we couldn’t even finance this recapitalization or this event?”

So we have to go through that exercise to figure out what are our choices and we’re essentially trying to narrow the funnel into a dozen choices as opposed to, I’m going to guess. Our database has thousands of people in it. So you really, really need to narrow the field to make sure you get this done right.

The Typical Success Fee That Investment Bankers Receive To Ensure A Deal Actually Goes Through [01:16:41]

Michael: So, how do investment banks structure their compensation? When you were involved in these things, how does a firm like yours actually get paid? We live in either an hourly world or an assets-under-management world. What does it look like in the investment banking world? If a firm’s coming to you and saying, “We need help with buying out an owner, we want to acquire someone, or we want to get acquired.” How does your firm get paid for the work that you do?

Elizabeth: We are mostly success-based. So I guess that’s the good news for the end consumer. But for us, in particular, we charge a small retainer, and then a success fee. And that’s usually a function of the transaction value.

Why do we charge a retainer? I’ll sort of fast-track that. If someone’s thinking of hiring us, we charge it so you will be laser-focused on our mandate. If you don’t pay for anything, then you could be a great consumer of services without really having an end game in sight. So if you write me, even if it’s a small monthly check, you are going to take my phone call, you’re going to return my phone call if you miss it.

Michael: Once you’re paying for it, it’s like, “Why am I paying Liz and not taking your phone calls? I guess I should probably be prompt in replying to these things!”

Elizabeth: Exactly! But it also gets people to really, for us, it helps determine those who are serious, who’ve done enough of the mental work or at least the work with their partner group to know that this is really something that they want to accomplish. And that’s really important because we have a high completion rate with our mandates.

But just taking a step back from what the client sees in terms of our engagement letter, we vet things pretty carefully as a former partnership, now a unit of Raymond James. But it doesn’t go into our workstream unless we push back on each other to say, “Is this a client who has a serious client? Is this a mandate, with at least 80% conviction, we think we can complete? Is there enough clarity around their objectives? Are there enough opportunities in the marketplace to satisfy that mandate?” If we don’t feel like it is actionable for us, we will graciously decline the mandate because we don’t want to not be successful on somebody’s behest.

So, looking at the client’s side of the engagement, it’s a monthly retainer fee. And that stops when we get into a document that will essentially suggest that we’re going to get something definitive done. And then it’s a success fee. And our success fee, I would say, broadly speaking in investment banking, is sort of 2% to 4% depending on the mandate.

If you’re on the technology side of the equation, there’s some mad talent there and it’s usually a little bit more expensive. If it’s sort of on the bank side, it could be a little bit lower because it’s a very different process. But for us, it’s funny; clients will sit back and think on it and say, “My goodness, I’m going to pay you 2%, 3%? That seems very expensive.” And then you say, “Well, if you had a $25 million estate in Connecticut, how much are you going to pay that broker for a listing on Zillow or on their website?” And the answer is 5–6%.

And we earn every cent of what we do, but it is something that if you’re on the Southside, it feels like there’s a great alignment of interests because the more value we create for them, the more reward we create for us. So they’re probably 30 times more successful for every dollar we create for them than we do for ourselves. But if you’re on the buy-side, sometimes that can feel like you’re not on the same page. So wait a minute, I’m going to pay more for this franchise? But you’re going to get more.

So sometimes we try to be creative on that front because invariably, we want our clients on the buy-side to do great deals and we don’t want them to worry going in that we’re going to push them for maximum pricing merely to boost our fees. So, we do try to think through that very carefully in how we can make sure we feel like we’re on the same side of the table.

Michael: It’s an interesting thing to me. So as you said on the one end, if I build $1 billion-plus advisory firm with $10 million of revenue – I might be looking at a $20-plus million sale price – and you start talking about numbers like 2% to 4%, that’s $400,000 to $800,000. In real dollar terms, it’s a lot of hourly if we start converting that into an hourly fee. But then I look it from the flip side, does Liz’s 25 years of expertise give you a decent chance that maybe she can figure out how to haggle $1 million more? What’s the chance she can get your firm sold for $21 million instead of $20 million because she knows 470 people who are buyers and you know 1 from up the street who you’ve talked to once?

When the dollars get big, it doesn’t really take a lot to have the sale just end out being more than 2% larger. You can do that on just a tax clause. A little adjustment to the structure of the deal, never mind introductions and facilitation and running the deal to a close in the same way that realtors add up to 6% and can still do a great job earning their fee just by dressing your house properly for the people who walk through it.

I know there’s a similar phenomenon of what happens when you’re trying to sell a business, having someone that can make sure it shows well is a very material factor. I think your analogy to real estate is a good one of, “Okay, if we put this in raw dollar terms, it’s a lot of dollars, but if you put it in terms of, ‘Can this person influence the value in the deal by at least 2% to 4%?’ It’s like, oh yeah, yeah, that’s probably a pretty safe bet.”

Elizabeth: Michael, I am going to hire you to market our services.

Michael: I’ve seen from the other end too many advisory firms that came away with not good deals that they didn’t realize until after the fact, because for most of us, particularly as advisors that are building and selling firms, you’ve never done it until you’ve done it once.

And you won’t really have any lessons learned from having done it until after you signed the paperwork and figure out what happens when the dust settles. And just the number of firms that I’ve seen that go through transactions of, “Oh, my CPA just told me this is all ordinary income because we didn’t characterize something a certain way.” It’s like, Yeah, the buyer did that to you on purpose. Not to be mean, because when it’s ordinary income for you, it’s usually deductible for them. So they just got a 30% to 40% deal on this because you allowed them to structure it that way. It might’ve helped to have someone in your corner.

Elizabeth: You’re absolutely right. It’s funny because as you were talking, I was thinking back to one of our clients that I met through a group I’m in called YPO, Young Presidents’ Organization, and I met him through YPO. He had an offer on the table for $16 million, and he said, “I’m not sure if I need a banker.” He said, “I think I could probably goose them up to $20 million, and your fees look awfully expensive.” So he tried to haggle our fees. And I just said, “I’m so sorry.”

I try never to break. If you’re a $500 million franchise value, I’m probably going to break some, but at that size threshold, I try to stay very firm because otherwise, I do myself a disservice and to our business unit, but as we were talking, he said, “What do you think the fair value is?” And I always try to under-promise, and my team does a beautiful job in over-delivering. And I said, “I do think, $20 million is probably a good number, but I think $25 million is probably an opportunity here.”

And we spent a fair bit of time together. And finally, he did get comfortable, but it was a hard decision for him. And I get it, I get it. It’s real money. This is your life’s work. And you’re entrusting it into my team’s hands. But at the end of the day, we took his 16 million, which he thought he could get 24 million and it turned into $32 million. And he will be our best referral source and our best reference for the rest of our days. But we would never promise that outlier. And it’s a magical partnership. He’s so happy with his new partners. They love him.

But getting through that piece, we understand from the other side of the equation, it just looks like a ginormous number. And I’m going to now just tell them to listen to this point in your podcast and you will have pre-sold them before we get to that point in the engagement letter.

Liz’s Advice For Firm Founders Getting Ready To Sell Their Businesses [01:26:12]

Michael: So, speaking of that theme, what do you find most advisors don’t understand about building enterprise value in their businesses?

Elizabeth: Often it is the human capital. These are all intangible businesses so you would think that… The biggest part of business is the people. It’s the people dynamic that they don’t appreciate within their organization. And you can have very talented people, but they’re not in the right seat and they’re not compensated the right way. They’re unhappy because they’ve been doing a great job and they’re not equitized. It is often the incentive structure, the compensation structure that really puts people at a disadvantage for growth as opposed to helps power their growth. So, that’s definitely one thing. Making certain investments in things that aren’t correlated to revenues, that is another thing.

So, people may be able to get to, let’s say a half a billion, three-quarters of a billion, and it gets to be a great living, right? You can drive a lot of profitability, but the difference on somebody who’s got 750 million in assets to someone who’s got 2 billion in assets, probably includes a bunch of C-level people that they’re very reticent to hire. So, a chief operating officer, a chief financial officer, a general counsel.

For me, I’ll just take it back to my business evolution. I did start our business at the dining room table, but my husband – so I’m the gas, he’s the brake. He said, “So you’re thinking of setting up your own business. Where’s your business plan?” Which, I said, “I have a following, what do I need a business plan for?” But to his credit, he made me put a business plan together. And we agreed that we would invest the money to a certain point where I felt like it was a good practice and then said, “I am wearing so many hats. I’m so diluted.” That’s another thing that often happens. And that inhibits value.

People don’t realize that… A friend of mine, Dave Patrick calls it, stepping into the valley of death. If you really want to grow your firm, you have to take your business into the valley of death. And that means on profitability. You’ve got to reinvest in these human capital components that once you have done it, you look back and you say, why didn’t I do that earlier?

So my husband actually stepped into our businesses, our COO and chief strategy officer. And until he did, I never realized how much stuff I was doing that was not related to my clients, which is what I’m passionate about. And then we hired a general counsel and operations manager. And until we hired that person, my husband, Peter, didn’t realize just how much stuff was on his plate.

So it’s this wonderful ripple effect to the positive that you begin to bring talented people in and start to take hats off. And the taking hats off is, for people who are generally control freaks – type-A people in this business – a hard thing to do. It’s hard to give decision-making and authority over to other people.

It’s hard not to be seeing everything. But it’s a freeing exercise. And those that will take themselves into the valley of death, and I would say 90%-plus will come out the other side as a much better tighter organization that is better run, better managed, and has a greater opportunity for that 10X growth into the next cycle in the next business phase.

Michael: I do feel though like David could have found a slightly more benign analogy than the valley of death. Can we just call it a valley of drudgery? Because it’s going to be hard for a while.

Elizabeth: Dry times.

Michael: Yes. Yes. The dry desert.

Elizabeth: I’m sorry. The desert of profitability.

Michael: There we go. Yes. You must quest through the desert of profitability to find the promised land on the other side.

Elizabeth: I shall quote you, Michael, on that when I use it!

What Surprised Liz The Most Throughout Her Journey [01:30:44]

Michael: I’ve read books where people make it through wandering in the desert. I’m a little more concerned about the valley.

So, having kind of lived this journey yourself, as you said, from kitchen table to practice, to business, to exit, what surprised you the most about building your own business on this kind of parallel journey?

Elizabeth: Oh my goodness. How quickly it went. I can’t even believe 13 years went flying in a flash. You look back, and it was more work than I ever envisioned. It really was a labor of love. So I always had an appreciation because a client once told me, and this is 20 years ago, “Liz, making the decision to sell my business was the hardest decision I’m ever making next to asking my wife to marry me and having my first child.” I guess, screw the second and third child. It was the first child that was a big decision.

Michael: Yeah. That’s when you change everything. After that, you’re really just kind of doubling down and tripling down on the first decision.

Elizabeth: Exactly right. They’ll take care of each other. But in that moment, I for the first time really appreciated for him how much he had put of himself into the business, but it sort of came full circle for me when we were eating our own cooking going through our process. Thirteen years went by in a flash.

I am so grateful for every partner that I had and every client who took a chance on us in the early days. But to really have gone through that, what do we call it now? We’re in the desert of…

Michael: Desert of profitability. Yes, I’m speaking about that. The desert of profitability.

Elizabeth: …desert of profitability, exactly. And a couple of key points, and investment bankers are not cheap dates, I should say, to hire them. So a good VP range of $350,000 in New York City. So these are not expensive people that we would add, and certainly with a COO and GC as well. And so those are hard decisions to make, but our business was always better for it to get more minds around the table who had different experiences, always made us not only better as an organization, but better at providing advice to our clients.

And then actually going through the process myself, I was really making sure that I could take the emotion out of it. I was the lead negotiator on behalf of my partners, and so that I felt like I was doing my day job, I had to treat it as if it was our youngest partner’s business. Jeff Brand is my more youthful partner, and I would always think to myself, “Would that work for Jeff?” So I probably used him a million times when I was negotiating with the head of the investment bank at Raymond James. Like, this is not going to work for Jeff.

But to think about that next phase, I really had to embrace the fact that it was not going to be my shop. And these are tough things for people to go through. And these are the things that I whip out my leather couch out of my back pocket when we’re doing a little bit of psychology with our clients. We have to talk about how life will change under these circumstances and so I can much better appreciate for them what it’s like to turn over the reins to somebody else who’s going to run the business while I am going to do a day job now.

I think I am a much better steward of their assets having gone through it myself. I think I did a pretty good job before, but I’m much more attuned to what life is like after – where are the rubs? Especially when you’re integrating, how do you navigate those reps? And so, I think it will help my skillset having gone through this and hopefully, give me the ability to do a better job on behalf of clients.

Michael: What was the thing that has surprised you the most in the post-closing transition, that shift as you said, from being business owner and founder into employee mode?

Elizabeth: So I’ll give you the negative. And I always say this to my client. It would be difficult, but now I can say for sure, integration sucks eggs. That’s a tactical term.

Michael: Technical term. Exactly. Like valley of death. Integration sucks eggs.

Elizabeth: Exactly. It just sucks, right? When you’re converting systems and you’re learning new things and new ways that people do it, it really isn’t very fun. It takes you off your game. And that’s why we’ve always known that that’s a tougher time. So whenever we’re structuring earn-outs and contingent payments, we always try to say to our clients, “Don’t ever do a payment in your first year, at the first anniversary of the deal.” And the reason you don’t do it is because if you’re doing a full-on integration, there’s going to be so much noise you won’t feel like you’re doing your best to achieve that milestone. So I can appreciate that.

But now on the flip side, having a freedom of not worrying about operations, compliance. We ran our broker-dealer for almost a year, post our announcement of our deal, starting to eliminate some of the obligations on my plate or Peter’s plate. Nobody raised their hand for chief compliance officer, but Peter drew the short straw of COO.

So that was freeing, not having to worry about the vendor side of the equation. Technology, we’ve got a huge technology team to draw from. And then starting to sit back and think more strategically about where do I want to head my group?

And for us, a big part of the reason on why we transacted because we were not going to cover off the ball was really about, back to Gregg Fisher’s 10X comment, we want to continue to grow and we want to grow smartly. And the biggest opportunity for us was cross-border transaction work. And we had missed a deal because we didn’t have an office in London that, in hindsight, I should have shoved a partner in there in a Regus space. But we didn’t have an office, but we were the right people for the job, but we didn’t have boots on the ground. We have boots on the ground. We’ve got 40 boots that are actually 80 boots on the ground, 40 times 2 at Hanover square now.

So I feel better equipped for that next mandate that really involves a client in the UK looking to do something in the US or a client in the US who wants to look at emerging markets for an international manager. I feel much better equipped today having colleagues across the pond who understand my domain. So that was freeing for me. That was exciting for me.

The Low Point Throughout Her Journey, And What Comes Next For Liz [01:37:54]

Michael: So, what was the low point for you in the building-a-firm journey over, I guess, your building career over the past 25 years?

Elizabeth: Oh, you know what, it’ll sound like a crazy thing. I’m a happy person by nature. A little Mary Sunshine is what one of my partners calls me. But I don’t see any low points. I see some times where you just want to break out in tears because you’re on your 14th hour of work, because after all the phone calls are done with the clients, then you got to turn around and now do reviews of employees. And you’re doing those at midnight with another partner who’s in San Francisco. And she and I would be on the phone late at night and I go, “Oh my God, I guess I’ll get sleep when I’m dead.” It was a lot of sleep deprivation, but it was such a happy time. I just enjoyed every moment of building that business.

And I am lucky. I am so fortunate by the people who chose to join Silver Lane as we were in our journey, and we’ve got the best team I’ve ever had in my whole career. And I am blessed to have that. So, it’s sort of like going through labor was a low point for a woman giving birth. You think back on it. And somebody told me there’s an enzyme that gets released in your brain so you sort of forget about the painful moments. And that’s why women will have another baby. It’s because they forgot that momentary pain.

But for me, it felt like such an incredible experience to watch something grow and be so much more than just a practice or just The Liz Nesvold show. And that’s when you know you’ve built something is where people, they don’t even know you, and they’re a client of your group when they never met you and they never heard you speak. That to me is a blessing. And it’s hard for some founders because again, we’re all Type-As in this business. But for me, it’s the blessing that this business lives on. And so that’s what I’m most excited about.

Michael: I liked that framing that you know you’ve really built something when a client joins the firm and they don’t even know who you are.

Elizabeth: Exactly.

Michael: So, what comes next for you now that you’ve made the transition? Where does this go from here for you?

Elizabeth: I don’t know. Well, I’m doing my day job. I have an incredible roster of clients that I personally serve. So, for me, that’s so fun. I’m spending more time now, one year post-integration doing the thing that I’m passionate about. And I’m not sure, longer-term, what the future holds because I will probably pass my prime as an investment banker down the road someday.

I hope to sit on boards and help people continue to grow their business and leverage my intellectual capital. But for now, I’m having so much fun with my clients. Even in this crazy wicked market, I’m so blessed that we are as busy as all get out.

Michael: So, speaking of these markets and just the craziness we’ve all collectively been through over the past few weeks and months now, I’m just curious, as you look out, not necessarily short-term, like we’ll handle the volatility and the craziness over the next 6 or 12 months or however long it is before we find some new normal. When you look out over the longer term, like 10-plus years out, what do you see changing or coming as a change from here that maybe is shifted from all of the coronavirus pandemic? What’s different about the future that we haven’t realized yet?

Elizabeth: I think this is a moment in time that is going to force change – that has, I should say – has forced change on advisors who may have been slower to leverage technology as much as they could. I was fortunate, starting a business 13 years ago, we did everything we could. And again, this is my fiscally-conscious husband. We leveraged the heck out of every bit of technology, whether it was Early Adopter to Salesforce or Zoom. And we were using Zoom when it was still VC backed. Expensive Five for expense management. You name it. We used it early.

But a lot of advisors still have been slower to really leverage technology or start to think about the workflows within the organization, because who would ever think that this is going to be an occurrence? More often than not, they were testing your systems for some kind of momentary failure, whether it was a flood or a tornado. And it was sort of, we have an offsite server or a server based in the clouds. They’ve got their business continuity planning, right?

But this is a huge, huge disruption of their business. And for those advisors who had been really hesitant to engage digitally, either with their clients or with their team, for those who never permitted work-from-home, and probably now realize the benefit of that in terms of productivity, and I’ll speak to that in a second; I think this has forced the industry to move very quickly into the future, or maybe where they should have been all along, but it’s forced change upon the industry that will be radical changes to the way they think about business continuity planning, it’ll be radical changes to the way they think about leveraging technology, and radical changes to the way they think about engaging with their clientele and developing business.

One of the best business developers I’ve ever seen through digital medium does a lot of podcasts, television and radio, educational seminars, they shifted to an online format and they’re developing business. They’ve got a ton of new business flow. It’s crazy enough coming out of this environment because they could shift it very quickly because they were well adept to doing that. But imagine going from maybe a third of your new business flow from digital engagement to know you have to rely on 100%, at least for, let’s say, one-quarter of activity. That’s mind-blowing. So I think, over the next five years, we’re going to see a different level of digital engagement that we hadn’t seen before.

Certainly, when you think about some of the Zoom breaches, we’re going to think about different security protocols, but clients, I think, are going to be much more comfortable. So for the advisor who gets on a plane to go see the client, that’s, let’s say 300 miles away. Maybe that advisor is going to leverage technology a little bit more to engage, and maybe it’s instead of four times a year visit onsite, I’m going to do it three times by video or two times by video and two times in person.

And I think that’s going to be liberating for the industry itself. It’s going to create more opportunity to scale. It’s going to open up more opportunity for, I will say millennial engagement and Gen-Z engagement, as these people are much more adept at technology than the old guard. Let me reframe that. Instead of old guard, we’ll call it the more senior states people. But I think there’s so much opportunity that comes out of this. And I know it’s a tough time that we’re all going through right now, but this is back to, chance favors the train, mind.

Out of this, I will be very, very disappointed in this industry if they don’t take some new lessons learned and some new ways to do business a way to help scale their business and drive profitability and drive process management and workflow. I think there’s a unique opportunity around the corner. And I also think that’s going to create the next wave of midsize and larger firms that we don’t yet know.

How Liz Defines Success For Herself [01:46:21]

Michael: So, as we wrap up, this is a podcast about success. And one of the things I’ve always observed is just, even the word success means very different things to different people. Sometimes it changes for us as we go through stages of our lives. So you certainly built what everybody would objectively call a successful business. Started from the kitchen table to build to a practice, build to a business, sold and exited, and now continuing on after the close. But I’m wondering, how do you define success for yourself at this point?

Elizabeth: Oh, that’s a really tough one. For me, I would say success is getting up every day and always doing your best. Trying to, and I think back to Gregg Fisher’s example for me has been transformational and I think very impactful for my own business. Always looking to do better. Even when you think you know it all, or you have it all, or you’ve done it all, there is always something you can learn or push yourself on or push to do better or smarter or faster.

But for me, I think it is just continuing to set and achieve goals, then creating new goals, and moving the goalposts even farther into the zone that makes you uncomfortable. And that people don’t like to take themselves into zones that make them uncomfortable because it’s easy to get real comfortable with, it’s a nice lifestyle, it’s a great cash flow business, but always pushing the goalpost. And I always want to continue to learn.

So it’s a really long definition I’m giving you, but just doing your best to continue to build and succeed and be happy. Happiness is the most important thing. If I die a happy woman, I know I will have been successful.

Michael: Well, I love it. I love it. Thank you so much, Liz, for joining us on the “Financial Advisor Success Podcast.”

Elizabeth: Michael, what a great privilege to spend the time with you.