Executing Firm Growth

Those who have started a retirement planning practice or been tasked with growing one often face what Troy Hammond, president and CEO of Pensionmark, calls the “inflection point.”

There is no precise ratio of assets under advisement (AUA) per staff member that pushes advisers beyond the inflection point: when they start feeling considerable anxiety over how to meet service agreements and maintain the good will of clients within the confines of the existing team or staff structure. But Hammond says a growing firm will inevitably face the challenge of successfully matching resources with service demands as it grows and matures.

“The challenge of owning a retirement plan business is that you can handle 25 or 30 clients yourself,” Hammond explains. “But then you hit a point where you have to decide: ‘Am I going to stick with what I have, or am I going to start developing—or buying—more infrastructure?’”

This is a question contemplated often at Pensionmark, headquartered in Santa Barbara, California, and other firms that offer services to help retirement advisory businesses plan and execute growth. In Pensionmark’s case, Hammond says, the focus is on providing technology and back-office support—often to advisers looking to break from the small-plan segment into larger-plan markets.

The model depends on two assumptions: first, that a dedicated team of investment specialists at a third-party provider focusing solely on, for instance, investment reviews will perform those reviews more efficiently than a busy adviser who runs them less frequently; and second, that by gaining access to aid such as participant and sponsor call center resources and a robust online presence, advisers achieve better scale potential.

Such retirement support offerings take considerable responsibility off the shoulders of advisers, Hammond says. “We’re giving them 20 hours a week back that they can use as they see fit, whether that’s on sales or client servicing or playing golf.”

Some other networks of retirement plan assistance, according to Hammond, are CAPTRUST, SageView and 401(k) Advisors. To work with those networks, an adviser would typically sell his firm and be integrated into the larger provider, becoming a partner or employee with access to a host of back-office and other resources.

Both growth models have appeal, Hammond says, whether a firm is affiliating or being acquired, and the one an adviser chooses hinges on both personal and business philosophy. Interestingly, Hammond says his firm and those that offer the acquisition model do not compete heavily for new advisers.

“We really look at our competitors as the ‘co-op-etition,’ because we’re looking for different types of people,” he says. “Some advisers want to capitalize on their business and sell it off and become an employee. Then, there’s another group that’s not ready to sell the practice, but they want access to the expanded infrastructure [through affiliation].”

A third option is to pursue organic growth by hiring additional sales/operations staff or engaging technology resources directly to build more efficient service capabilities.

Whatever model an adviser pursues, Hammond and other experts say it is key to understand what options for growth exist and, equally important, how to translate objectives into action without damaging profitability.

Growth by Affiliation and Acquisition

A recent analysis from Charles Schwab shows that, with the financial crisis receding and demand for financial servicing growing, 2013 was a strong year for merger and acquisition (M&A) activity in the financial and retirement advice industry. The observation was based on data collected by Schwab Advisor Transition Services, a unit that works with advisers to set growth strategies and plan exits from a business line or channel.

The firm says it observed 54 completed M&A transactions in the registered investment adviser (RIA) space last year. The deals totaled approximately $43.6 billion in assets under advisement, and the number of transactions rose 20% from the year before, although overall acquired AUA decreased by 26% from 2012. Schwab says RIAs emerged as the leading buyer category in 2013, representing about 44% of overall deal activity for the full year.

The data neglect to show how many of the RIAs are retirement specialists, but Jonathan Beatty, senior vice president of sales and relationship management at Schwab Advisor Services in San Francisco, says both retirement advisers and financial professionals generally see consolidation as an opportunity to spur growth.

Beatty cites four primary reasons behind the typical retirement adviser’s decision to expand his business through M&A. These include growing assets under advisement to achieve better scale and profitability; quickly securing new staff with specific expertise, such as plan compliance or investment reviews; adding client accounts to improve market reach; and expanding the scope of offered services.

“Any of these can certainly be part of a strategy for increasing share of the retirement planning market,” Beatty says. He is quick to add that each M&A decision is unique and dependent on individualized strategies and business goals; however, judging by the consistency of activity, it is likely firms do meet success through consolidation. He estimates that about one-quarter of all advisory firms actively seek to acquire another RIA. “That strategy was seen disproportionately among firms with slower rates of organic growth,” he notes.

Beatty also observes that not only small advisers consider affiliation or acquisition a means to join a vastly larger network and immediately improve their technology and scale. An identifiable trend also appeared in the second half of last year wherein larger firms were acquiring midsize firms—an indication that all-size firms looked to M&A to quickly lengthen their footprint.

Hammond agrees with the premise of the Schwab study, which indicates strong consolidation should continue in the independent retirement adviser space. “I think you’re going to see, over the next decade, tremendous consolidation,” he says. And while many advisers are going independent, Hammond expects to see “a lot of advisers moving toward a model where they become a part of a larger organization—however that happens—to gain the types of efficiencies we’re talking about.”

As this occurs, Hammond predicts that both the affiliation model and acquisition model will continue to attract independent advisers at a strong pace.

One of the primary forces driving consolidation in the retirement plan adviser industry, he explains, is that small adviser businesses find it harder to grow against their largest competitors. They typically lack specialized teams to deliver the wellness programs, comprehensive investment analytics or participant education programs plan sponsors increasingly demand.

“In the past, [solo] advisers had been able to depend on their relationships to address this. But as consolidation accelerates more and more, matching the level of service from the big providers will become more and more difficult for independent advisers,” Hammond says.

Organic Growth Not Dead

Ken Favaro, a senior partner with the consulting firm Booz & Co. in New York, explains that firms struggle to grow organically for many reasons, none of which mean organic growth should be ignored in favor of developing partnerships with external providers or entering a merger or acquisition. Increased scale does not always translate to better profitability, he says.

The foremost challenge for retirement advisers seeking to achieve organic growth is the same short-term pressure all companies face, he says. This is to maintain good profitability and efficient service-delivery—especially during times of protracted economic volatility.

“A problem with organic growth is that the cost hits the [profit and loss statements] before the revenues do,” Favaro says. “That creates a problem for companies that, understandably, have to prioritize current profit and manage operations to a target margin. The risk they face is to under-invest at the bottom of a cycle and to overinvest at the top.”

Another tendency that holds some retirement advisory firms back from growth, Favaro says, is that they devote too much time to their most loyal customers. “The strategy makes common sense, but the risk is missing out on customers in the market that aren’t yet loyal to anyone and who are heavy buyers,” Favaro says. “In fact, that’s often where strong organic growth opportunity tends to be.”

Beatty points to another recent piece of Schwab research, which supports Favaro’s claims. “Our 2013 Benchmarking Study showed a remarkable organic growth trajectory over the last three years—between 2009 and 2012—with the median firm realizing an 11% compound annual growth rate,” Beatty says. “We also saw that, by the end of 2014, roughly one-third of advisers will have doubled in size over the previous five-year period, and another 25% of RIAs are growing at a rate that puts them on track to double in size by the end of 2016.”

When it comes to actually securing organic growth without a merger or a new affiliation, Favaro says an important mantra is, “Make it free.”

There are several broad ways to pay for organic growth, he says. First, advisory firms can look for what he calls “continuous cost savings.” He says almost all firms have places where they can better save money, then redirect the resources to new staff or marketing campaigns—whatever is needed to help them grow more effectively. Savings opportunities can range from finding a less expensive office location to negotiating a new contract with the firm’s internet service provider.

A second strategy—one of the most powerful, he says—is for the firm principal, over time, to develop a capital account that sits outside of the operating budgets and provides flexibility for funding organic growth opportunities when they arrive. This can be an appealing strategy for firms that may have larger cash flows but worry about how capital expenditures could damage short-term profits, he says.

“This can be helpful where the executive concludes it would not otherwise be feasible to fund growth within the day-to-day operating structure,” Favaro says. “It’s a very powerful way to, in effect, give your company a tool to work around the limits of its own operational barriers.”

Hammond reminds advisers that organic growth requires a strong planning effort.

“You can’t build all the infrastructure in one day or one week,” he says. “You can’t just say, ‘OK, I’ve hit 35 clients, now it’s time to hire an investment person, a relationship manager, an operations person, a conversion person.’ It takes an incredible amount of planning.”