When merging two books of business makes sense

What does it take to make a merger work in the rapidly consolidating registered investment adviser industry?

Good planning, according to two enterprising solo practitioners, David Gardner and Judy McNary, both of Boulder, Colorado, who merged their books early this year to form Confluence Financial Advisors, a fee-only RIA.

Improving client service was the main issue. Both wanted to build their businesses, as well as plug the gaps in client service because each travelled extensively and had to cover for the other in their absence.

“We discussed the idea a year earlier and then spent a lot of time working through the why, the how, the where, when and what a merged firm would entail,” McNary says.

At the grassroots level, McNary, a baby boomer, and Gardner, a Generation Xer, who are both CFPs, represent a growing trend in the larger RIA industry.

The demographics in the industry, with most advisers at RIAs in their 50s and 60s, are creating an environment in which many firms must look at an external merger or sale if they want to capitalize on the value of what they have built.

“We are in the eye of a succession crisis and are just in the early innings. There is about to be too many retiring advisers and a dearth of sophisticated, well-trained, next-generation talent to fill the vacuum,” says Louis Diamond, vice president and a senior consultant who specializes in the RIA industry at recruiting firm Diamond Consultants in Morristown, New Jersey.

“Few have the infrastructure, value proposition, capital or deal expertise to [fulfill] a retiring adviser’s succession-planning needs,” he says. “The savvy principals who recognize an internal deficiency look to [M&A] because they value the scale, infrastructure, next-generation bench strength, maximum liquidity event and superior level of client service over complete and total control.”

Randy Warren, chief investment officer at Warren Financial Service in Exton, Pennsylvania, blames the merger trend on increasing compliance costs that are squeezing RIAs.

“Why does [a merger] make sense today?” he asks.

“Because revenues are going down due to fee compression all over Wall Street, and at the same time costs for RIAs are going up” mostly due to new compliance rules beginning with Dodd -Frank and now the Department of Labor’s fiduciary rule, Warren says.

After advising on many mergers at Acorn Financial Services in Reston, Virginia, a hybrid RIA/broker-dealer, catering to well-heeled families and other ultra-high-net-worth individuals, James Gambaccini, a CFP and managing member, adds a cautionary note.

Mergers can work, but only under the right circumstances, he says.

“A well-crafted and understood operating agreement can be the key to success,” Gambaccini says.

This story is part of a 30-30 series on smart strategies for RIAs.