The author of this article reflects on what counts as a successful RIA lift-out. At present, the main approach is to consider transfer of assets under management, how much those assets costs, and the break-even point. However, there are other factors in play.

Allan R Starkie, a partner at Knightsbridge Advisors, who has appeared in these pages before, writes here about the “lift-out” trend in the registered investment advisor space. The editors of this news service are pleased to share these comments; the usual editorial disclaimers apply, and we urge readers who are interested to dive into debate. Email tom.burroughes@wealthbriefing.com 

Earlier this year RIA EDGE hosted a wealth management conference for RIAs. They invited me to moderate a panel focusing on non-organic growth. I was surprised by the multitude of conference attendees, comprised primarily by hundreds of new, fledgling RIAs, as well as a respectable turn out of the more established success-stories.

Naturally, statistics played a pretty large role in the presentations of many of the speakers, and the audience was often reminded that the current body count of extant RIA’s numbers is slightly over 18,500. A startling additional data point is that 90 per cent of that enormous field of competitors possesses AuM of under $300 million. Most of the participants in this event represented this hungry 90 per cent. Most were newly-established and, as far as I could tell, their major form of differentiation was the often-whimsical names they had chosen for their firms.

I contemplated what their motive might be for entering this highly-competitive industry, armed with a small asset base, a ubiquitous investment management offering, outsourced: trust and estate planning, compliance, operations and financial planning, and very limited operating capital. It reminded me of the early days of the gold rush in Alaska of 1896. 

Seattle was the general starting point of the dangerous trek to the Klondike. So many prospectors perished along the way, that the Seattle mayor dictated that they must carry one-year’s supply of food and equipment in order to receive permission to undertake the expedition. I think that, like the prospectors, the founders of these RIAs have heard stories of amassing great wealth by building and then selling one’s firm for mind-boggling multiples. Indeed, this very conference hosted several firms that had done just that.

As I stood at the podium looking through the dimly lit room at the innocent, excited faces of the audience, it occurred to me that in a metaphoric way they resembled newly-hatched sea turtles, faced with the long and perilous march to the sea. Along the way, small and weak, they are easy prey for raccoons, coyotes, and most of all predatory birds. Only one out of every thousand ever reach the ocean and gratefully throw their tired bodies into the shark-infested sea. So I guess it is no surprise that a lecture on non-organic growth would be greatly valued by this crowd.  Most of them must have begun to realize that they needed to acquire critical mass to even seem appealing to a predatory bird. 

Several investment banks had regaled the crowd with the current statistics on the high volume of M&A activity within our space, and the relative valuation criteria. I had decided to focus on team lift-outs, as my firm had just completed its 57th lift-out over the preceding five-year period. I would now like to expound on that presentation and share the criteria I have come to believe are associated with the most successful lift-outs.

It is important to consider what constitutes a successful lift-out. Most people focus on the transfer of portable assets, and that is always a major consideration. But there are often strategic advantages to performing a lift-out that are not solely focused on the acquisition of assets. These are strategic benefits such as acquiring a new capability from the team, geographic expansion by virtue of the team’s location, or assimilating a new demographic (particularly UHNW clients). Sometimes the acquisition of a well-known team is a clever marketing strategy, and beneficial in attracting other teams to follow.

Yet, the overriding tendency used in evaluating the success of a team is the actual transfer of AuM, the cost of those assets, and the break-even point. As I regard the last 57 lift-outs, through the lens of portability, I can clearly see the primary characteristics found in the most successful teams as well at the pitfalls of those less successful.

The absolute, single most important factor in predicting portability, is an analysis of how the book of business was built. In other words: did a member of the team personally source those clients from his/her network. If one were to only use a single criterion to decide on the viability of a lift-out, this would be the one to use. 

Most relationship managers sincerely believe that they are adding value to the client, and most egos are ready to accept that they are doing a wonderful job. But an inherited book of business, no matter how beloved the advisor might be, is much less prone to follow the advisor to a new firm. The difference is that a client that was self-sourced by the advisor made an active, conscious decision to select that advisor. Whereas an inherited client made a passive decision to accept the judgement of a trusted financial institution in appointing a new advisor. In the absence of that appointed advisor, the letterhead on the monthly statement will still say JP Morgan or Goldman Sachs, their personal and business accounts will remain unchanged, and their corporate trustee will be the same. All that will have changed is that a new face will look at them, with earnest eyes and say, “we are on the same side of the table”. 

That new person will sometimes even be invited to the client’s family events and can often mistakenly overestimate this new “friendship”. But that new advisor, just like the one that departed, will have a very hard time convincing the client to follow.

The most successful of our 57 lift-outs was a team originating from an International Money Center, which is unusual as 72 per cent of our lift-outs have come from the RIA peer group. As I describe the criteria of a successful lift-out, let me use this team to illustrate how each criterion applied to them. The team was managing more than $7 billion in AuM and comprised two private bankers and one senior asset manager, supported by four associates. It was an UHNW team, so the client base was very small in number, but very rich in assets. The leader of the team had personally sourced each client. And, in this case, almost every client shared a passion for a very specific sport, in which the advisor excelled. This activity required the advisor to travel with the clients and maintain an active social interaction with them. By the third year of the lift-out the team had exceeded $7 billion in AuM and were lauded by their new firm as an exemplary success story. We will revisit this team with each of the following success criteria.

The next task of analyzing portability, is the team and client’s dependency on their current institution. For example, in deciphering how a book was built within the bank peer group, it was essential to analyze how much of their client base came from internal referrals. Many advisors sincerely believed that developing an internal network of commercial lenders, investment bankers, and even branch managers was the same as creating an external network of trust and estate attorneys, CPAs and other, more esoteric sources.

I have never been able to discern whether this is self-deception or chicanery. But regardless of the motive, it simply is not truly “self-sourced,” and cannot be valued as such, in estimating portability. Those bank referrals are clearly tied to other lines of business within the banks – especially when the introduction came from commercial lenders. The wealth management relationship is often secondary to a more pressing credit dependency, and sometimes nothing more than an accommodation made by a commercial client to placate his/her lender. Our experience has shown that on average 20 per cent of those internally-sourced relationships will follow. 

Other platform-oriented referral sources are those within the RIA peer group that have gained access to referrals by Schwab and Fidelity. Here, we are dealing with a client who has been introduced essentially as a custody relationship with an RIA, and in turn to an advisor. We have found that, although some of these relationships tend to be slightly more portable than internal referrals made within the bank peer group – they should not be weighed in the same manner as truly self-sourced clients. 

Digital marketing has begun to become more prominent among larger RIAs which are able to afford the costs, and are structured in a way to exploit it. Again, I would warn that these relationships, by the very way they were acquired, do not bode well for portability. Imagine a client who sees a banner for an RIA stream across their screen while shopping for Gucci loafers. In many cases, lacking any in-person human contact, the client decides to open an account. Does this bode well for the strong human bond essential in future portability?

The second major criteria for a successful lift-out is “maintaining the structural integrity of the team.” Please do not connote integrity to mean their honesty! Ideally one wants to lift out every functional member of the team, with which the client has frequent direct contact. Every voice that the client has heard, and every face that the client has habitually seen should be moved, to include relationship manager, portfolio manager, trust officer (if applicable), estate planner (for an UHNW/family office team) associates, and always try to move the administrative assistant that answers the calls.

In the case of our favorite lift-out, we captured everyone with whom the client had frequent contact. It is a compelling scenario if one can get the client to regard moving as less disruptive than staying, and having to watch as each specialist, intimately involved in his/her affairs, is replaced by a stranger. We once moved the entire Westchester Regional Office of a different International Money Center, and that lift-out included the RM, PM, associates, and administrative assistant. 

Like our first example, it was a huge success, and within 10 months almost the entire asset base had transferred over. The success was attributable to a combination of the two most significant portability criteria: a book of business directly sourced by the team, and the internal integrity of the team lift-out. Not only is the integrity of the lift-out important for its feature of surrounding the client with familiarity, but it also mitigates the risk that any team member left behind can try to convince a percentage of the unsure clients that they should stay.

Compensation naturally plays a major role in incentivizing the team and getting them to overcome the anxiety of a move. I will devote a future article to discussing various compensation models in detail. For now, let us say that these are the most important factors in developing a competitive model:

1. Do not try to force the team to finance their own transition period. Many firms hope for the illusive “accretive team”, which is not only self-financing, but cash flow positive. Think about how unlikely such a thing can be. Even the most loyal client base needs time to make a move, while many teams have notice periods or even “garden leave”, and almost everyone has some form of non-solicitation agreement.  A prudent approach is to guarantee the team exactly what they were earning at their prior institution for a pre-defined ramp-up period.

2. Sign-on bonuses should only be used to replace monies left behind, to include unpaid bonuses, restricted stock, and long term incentives. We strongly argue against sign-on bonuses being used as a form of prepayment for estimated portability. 

3. Generously reward the team for what follows them. Define a period from one to three years (based on input from the team), at which point their annualized run-rate will be compensated at some multiple.  Reward richly for success. 

4. Plan on substantial equity grants. Keep in mind that the major personal reasons that a team will join an RIA are perceived nimbleness of the platform and the potential for significant wealth creation, through the appreciation of equity. It is therefore important to offer a transparent equity plan, superimposed on a clear business plan that presents a simple roadmap to how wealth will be created and monetized.

In addition to offering a competitive form of compensation and wealth creation, it is very important to guide the team through their transition. Starting prior to their resignation, the team needs to be properly led through their resignation process, by a transition team that guides them through the timing and legality of how to leave, and how to safely interact with their clients, in accordance with any solicitation limitations they may have.

As they are guided through their resignation, into the beginning of an integration process, it is important to assess to what degree their prior success was augmented by proper institutionalized support/leadership to include: client management, and pipeline management, so that the appropriate level of support and management can be provided. It is also important to help them acclimate to their new culture.  

It is always a mistake to look at a team as an entirely self-contained entity, that owns its client relationships and is able to move them with limited involvement by the new institution. It is essential that the hiring company assists in winning over even the most loyal client, as if for the first time. For among our successes, the few disappointing lift-outs we have experienced typically are the result of a hiatus in leadership during the transition period.

Finally, a thorough comparison of the team’s current platform and that of the hiring company must be made. The most obvious differences are apparent if the team relies on strong credit capabilities (particularly balance sheet lending). Moving such a team to an RIA is clearly risky. In all cases, one must analyze the client base to determine the prominence and significance of the credit piece, and its impact on portability.

The same analysis needs to be made on the significance of trust relationships, their frequency among the client base, their terms (revocable versus irrevocable), and the existence/future need of a corporate trustee).

The robustness of the asset management offering in both departing and receiving firms must be closely studied. In an extreme scenario, a team focused purely on using outside managers, moving to a proprietary shop, can be a worst-case example of the disruption a move would cause to the client base (both from a philosophical as well as a capital gains perspective). Yet we have seen examples in which this has still resulted in a successful transfer of assets, due to the personal relationships enjoyed by the team member that had sourced the clients, as well as a tailored transition strategy, offering adequate time to wind down the positions. The degree of use of private equity among UHNW clients is a prominent aspect of many team’s books, that needs real thought and planning as one contemplates a transition. 

The various platform considerations listed above need to be studied in the overall book analysis. This brings me to my closing point. A regimented analysis of the team’s book should be created using the most thorough information available. It should look something like this:

1. List of clients (never by name but described euphemistically); 
2. Exactly how and when client was sourced; 
3. Total assets (this needs a thorough breakdown with very specific allocation information); 
4. Total loans (are loans tied to assets); 
5. Trust versus agency (describe type of trust); 
6. Has the client followed the team in the past, and if so under what conditions; 
7. Revenues associated with 3,4,5 above; 
8. Likelihood of portability of each relationship within the next 12 months; and 
9. Likelihood of portability of remaining relationships in the period from next 12 to 24 months.

What we have found is that the estimates of portability for each client usually are fairly to surprisingly inaccurate, but the overall assessment of the portability of the book is usually surprisingly accurate. 

Even so, we always suggest a fairly large discount factor of between 20 per cent and 50 per cent of the portability estimate that the team provides. And we make another suggestion too. We suggest only hiring a team that you would want as your colleagues even if nothing followed them. I mean, assess the culture of the team and their ability to generate new client relationships at an acceptable rate (based on their track record of business development). Remember, you are not giving them extra compensation for what might come over, but what does follow- so your risk is somewhat mitigated to that of a normal hire, if they are not as successful as you had hoped. 

What I am suggesting is that you create a possible outcome continuum in deciding whether or not to move forward, after completing your thorough book analysis. On the left side of that continuum is a strong team that includes a track-record of exemplary self-sourced business development with no portability. I call this the black and white Kansas version. On the right side of the continuum is 100 per cent of the estimated portability (or more). This is the Technicolor version of the Land of Oz. 

Reality will almost always exist in the entropic hurricane somewhere in between those two extremes. But if you would gladly watch the film with Judy singing “Over the Rainbow” in dismal shades of grey- then you will love anything resembling a colorful Oz.