I embarked on my career in this industry almost three decades ago, working with what was then the up-and-coming RIA custody organization known as Charles Schwab Institutional. Now known as Schwab Advisor Services, the custodian has become synonymous with the independent advisor model with over 7,000 RIAs and $3.5 trillion in assets.
Back in 1995, the concept of the independent 1099 financial advisor was still in its infancy. The majority of financial advisors were W2 employees of large wirehouse firms like Merrill Lynch and Morgan Stanley. At that time, the independent model was viewed by many as the “Wild West” of wealth management, reserved for professionals who either couldn’t make it in the W2 world or were fiercely entrepreneurial.
Fast forward to today, and the independent advisor model has become the preferred choice in the industry, with over 35,000 independent firms across the country. Business owners and their clients alike now prefer independent advice due to the transparency and avoidance of conflicts, real or otherwise, found in wirehouse and other W2 models. Independent broker/dealers, in particular, embraced the independent advisor model and built large, successful businesses supporting 1099 business owners.
But take a careful look at the IBDs, particularly the larger firms, and you’ll see them developing a business structure they’ve forever sold against—the W2 model. Independents and W2 advisors under one roof?
Well, not exactly. We at Gladstone have dubbed this the “Indeployee Model”—it’s independent part-time and employee full-time or something along those lines—and requires advisors to lean in about decisions that impact their future path.
To be clear, there are b/ds, such as Ameriprise and Raymond James, who maintain both independent and employee advisor platforms, but the Indeployee Model is different.
Based on Gladstone research, about 50% of assets and revenue at IBDs and custodians are managed by independent advisory firm owners who are over 60 years old. The baby boomer generation started turning 65 in 2011, and those who own advisory firms are retiring rapidly over the next 15 years. Based on what we experienced in the credit crisis of 2008-2009, experts expect to see the retirement process accelerate if we go into a recession, but regardless, the tsunami is upon us.
Rising enterprise valuations make it challenging for second generation advisors or partners, including even the children or trusted successors of business owners, to buy out the owner, especially if they want to borrow the money at current interest rate levels. Based on current research by Cerulli Associates, 30% of advisors plan to sell their businesses to an external buyer, while 25% don’t even have a concrete succession plan. (Cerulli aside, many of those owners with the makings of a succession plan don’t really have it “papered.”)
Few aggregators or strategic consolidators in our space use an IBD, even a self-clearing b/d, as a custodian. If these buyers acquire a firm affiliated with a b/d, the assets will likely be moved to a custodian like Schwab, Fidelity, or Pershing.
The undeniable demographic factors align with another big trend amongst independent advisors: the desire to outsource the varied and complex components of running of a business, such as compliance, asset management, marketing and tech support.
Independent b/ds are becoming aware of this succession planning situation and realize that this aging advisor base presents both opportunities and risks. They can either lose advisors, assets, and clients to “true” custodians when consolidators buy these businesses, or they can capitalize on the situation and retain these relationships.
So, what are the options for independent b/ds?
- Hope that the buyer of an independent firm will continue to use the seller’s b/d after the sale. But the risk level is high. It’s not really a strategy, but more of a hope and a prayer.
- Arrange for an advisor group, such as a large enterprise (or super OSJ), affiliated with the b/d to buy that smaller business. Pros: Transitioning internally to another group is less stressful for the advisor and their clients; it can provide the seller with more resources and scale benefits; and the large enterprise can provide more hands-on support than the seller would get directly from a larger b/d. Cons: The economics for the b/d are poor as these large enterprises often receive larger payouts, cutting into already thin margins. Moreover, the b/ds have no real control over these buyers, leaving the possibility that they may eventually exit the b/d or set up their own RIA, transferring assets to another custodian.
- Then there is the “Indeployee” model. The b/d itself acquires their own independent advisors and makes W2 employees out of them and their staff, promising they will still be able to enjoy the many aspects of independence. Pros: For the advisor, it’s a path of least resistance with a buyer that they know, and transitions are far less complex. For the b/ds, buying their own advisors allows for better overall economics, control over product and service cross-selling opportunities, improved access to client data, and the power to hire and fire as needed. Cons: For advisors, valuations offered by their B/D may not be market-competitive, and they risk losing any aspects of the independence they’ve always enjoyed. For the b/d, they now are in clear competition with their own 1099 advisors for the same target.
Top independent b/ds such as LPL Financial, Cetera and Osaic initially championed the independent advisor model, countering traditional firms. However, as they face the demographic challenges outlined above, these b/ds must adapt.
The rise of the Indeployee model offers some advantages, providing a middle ground for advisors. They can enjoy a degree of independence while benefiting from the resources and capabilities offered by their b/d-turned-employer. They’re told that they “own” their clients or their books of business after converting to W2.
But make no mistake about it. In this Indeployee model, advisors under the same roof—W2 and 1099—will compete for new business in their communities. Independent contractor advisors should be prepared to take a backseat when new features, services, or platforms are introduced, as it makes more economic sense for the employee advisors to be at the front of the line for these benefits.
Further, b/ds are likely to honor their promises that advisors still own their clients in the W2 model. However, advisors who sell should expect multi-year agreements, layered with strict non-compete language, that keep them at their new employer, with the b/d striving to control costs and insert hooks into the clients via product and service enticements.
Is the Indeployee model the right path for advisors? For some, yes. But advisors should approach this business succession option with open eyes, carefully weighing the pros and cons.
The rise of the Indeployee model represents a pivotal moment in this ever-changing landscape, requiring advisors to weigh the benefits against the drawbacks and make informed decisions about their future path.
Derek Bruton is senior managing director at Gladstone Group. Drawing from three decades of experience in the financial services industry, he provides comprehensive M&A guidance, investment banking support, and strategic growth consulting to financial institutions and advisors.