By Charles Paikert

The good news for next-generation financial advisors is that valuations of registered investment advisor firms are at a record high.

The bad news is that skyrocketing multiples have made buying equity in the firms they work for extremely difficult.

"What's happened with valuations precludes G2 employees just being able to pay out of pocket," says DJ Hunt, a 48-year old advisor for Moisand Fitzgerald Tamayo in Melbourne, Fla., referring to second-generation staff. "Nobody has that kind of money."

But there are ways next-gen RIA employees can buy in -- with some help.

Firm founders who own the company outright can offer shares of equity through seller financing, selling promissory notes to younger employees at favorable terms. Owners who have third-party investors can use that outside capital to help finance the sale of shares to next-gen employees. More-traditional loans can be obtained through commercial banks and specialized lenders familiar with the wealth management business.

Hunt began buying 3% of Moisand Fitzgerald shares from the founders in 2023 using a 10-year promissory note at an interest rate just under 8%, with the first year being interest only. The internal valuation price was less than the owners could have commanded in an external M&A deal.

"They left a little money on the table because they wanted to keep a legacy firm that is 100% employee-owned," Hunt says. "That was more important than squeezing the last dollar out of the place."

The loan is paid back from distributions of the firm's profits that Hunt receives as a part owner. If the distributions don't cover what he owes, the difference comes from his compensation or personal account.

Showing an owner mentality. Matthew McKay was hired by Briaud Financial Advisors in College Station, Texas, another employee-owned RIA, in 2020. He made it clear from the beginning that he was interested in a leadership role at the firm. "If you want to become an owner, you have to demonstrate an owner's mentality," the 34-year-old McKay says.

His ambition ruffled some feathers in the office, but McKay's persistence and work ethic paid off. Janet Briaud, the firm's founder, offered to sell him a 5% stake two years later at a price that was a discount to the firm's value to an external buyer. McKay's down payment was 20% of his stake at what he describes as a "very generous" 5% interest rate. To date, his profit distributions have covered his loan payments.

Talent retention. Brett Bernstein, CEO and co-founder of XML Financial Group in Bethesda, Md., is also willing to sell equity shares to next-gen employees at a discount to the M&A market to keep the firm independent and "make it more desirable to attract and retain talent." Favorable terms include a willingness to adjust the amortization schedule on the promissory note and defer payments "if the market goes south."

In Atlanta, wealth management firm Balentine recently took in private holding company FJ Management as a 20% minority partner, a move that Balentine CEO Adrian Cronje says substantially boosts the firm's ability to finance selling shares to younger employees.

"Next-gen advisors face a real conundrum," Cronje says. "The world has figured out how lucrative wealth management can be, making it difficult for them to afford equity. We wanted to find the right minority partner who can help us underwrite a succession plan so younger advisors don't have to go to a bank."

PE's role. Private equity is also being used to aid internal equity transfers. One of the industry's most aggressive aggregators, Mercer Advisors, has had a number of major private-equity investors since 2008, most recently Altas Partners, Genstar Capital, and Oak Hill Capital. Since five Mercer principals took on outside capital 17 years ago, the RIA now has 470 employees who are shareholders.

Mercer believes in "creating a larger pie," says CEO Dave Welling, describing capital from outside investors as "a catalyst to providing support we needed for growth and to expand the equity options for employees."

Selected employees are given equity in the form of "profit interest unit" grants as part of a compensation package that combines cash and equity. All Mercer employees can also participate in an equity purchase plan that includes a financing option.

Commonwealth Financial Network, one of the industry's largest independent broker-dealers, offers next-generation advisors direct financing to buy equity, typically via a five-year or seven-year note. But Commonwealth also has an option for founders that helps younger advisors indirectly.

If founding owners want to monetize some of their shares immediately, Commonwealth will buy between 20% and 40% of their shares. The investment is "passive," Commonwealth senior vice president for business solutions Matt Chisholm maintains, allowing founders to preserve control. It also reduces the number of shares they need to sell to the next generation, theoretically making equity transfer more digestible for the next-gen buyers.

More financing options. Specialty lenders such as PPC Loan, Live Oak Bank, and Oak Street Funding have become increasingly popular financing options for younger advisors. "Demand continues to grow," says Dustin Mangone, director of investment advisor services for PPC Loan. "Doing an internal succession is a different mind-set from taking the top dollar in an M&A deal."

PPC offers next-gen advisors conventional loans from $200,000 and up with no down payment requirements and up to 100% financing with 10- and 12-year fully amortized loans. Current interest rates are between 7.5% and 8%, and while those rates are slightly higher than rates offered by banks, PPC's terms are twice as long, Mangone says.

Banks are often given a bad rap when it comes to making loans to financial advisors for an equity purchase because they normally require a personal guarantee from the debtor -- which would be anathema to a young advisor with a family -- because RIAs don't have hard assets that can be used as collateral.

Emigrant Bank, however, invests in RIAs as a minority partner and helps founding owners finance succession transactions using cash flow. Dynasty Financial Partners also works with banks to help younger advisors finance equity purchases. A standard term for a loan is six years with interest-only payments for the first year, says Harris Baltch, head of investment banking for Dynasty.

"Banks are becoming more comfortable with RIAs," Baltch says. "Many local banks have had great working relationships with RIAs, and despite the unsecured nature of the business, have gotten to understand and trust the people who work there."

The surging demand from next-gen advisors and employees to obtain equity in the firms they work for is ironic because it contradicts financial advice they would give to clients, says Caleb Arringdale, a 37 -year-old tax advisor for The Planning Center in Moline, Ill., who recently bought shares in his own firm. "We're constantly preaching diversity, and by buying into your own firm, you're making your source of income your largest investment," Arringdale says. "It's like marrying your job."

Nonetheless, he's glad he was able to get a 15-year loan from The Planning Center's owners at a very favorable rate. "It's a big decision with lasting consequences," Arringdale notes. "But you know better than anyone if the business is well run and whether you want to bet on yourself and the people you work with."

Write to advisor.editors@barrons.com

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February 12, 2025 11:21 ET (16:21 GMT)

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