While limited industry data has made it clear that the pace of wirehouse recruiting, and the size of typical deals, has increased in recent years, there has been remarkably little information about the terms and details of the 'typical' deal. For the most part, this is because broker-dealers have not been very public about the deals that they're offering, likely because too much knowledge limits their ability to negotiate on an advisor-specific basis for a more favorable deal. At the same time, brokers themselves are usually not very open about the deals they complete. In part, this is because many broker-dealers require them to sign non-disclosure deals to keep the terms secret, but in some cases the reality is simply that the broker doesn't want other advisors or his/her clients to know what was paid to entice a change in firms (an area that FINRA is now scrutinizing).
The end result of this environment is a highly inefficient marketplace for advisors looking to transition from one wirehouse to another. Notwithstanding all this confusion, a new firm is looking to bring an end to the opacity of brokerage firm recruiting deals. Called "AdvisorHUB", for $9.99 advisors will be able to download a current report detailing the recruiting deal terms of dozens of broker-dealers, private banks, and wirehouses in today's marketplace via an Apple or Android app, based on the intelligence that the AdvisorHUB team is able to gather from its available connections and networks.
And an early glimpse at the data reveals a startling reality - it turns out that in a world where the 'typical' RIA deal is approximately 2X revenue, the typical wirehouse recruiting package is as much as 350% (3.5X) trailing revenue. In turn, this suggests that the reality the breakaway broker trend has been more of a trickle than a flood may have less to do with the captive confines of the broker-dealer world, and more to do with the simple reality that notwithstanding the lack of "equity", a broker can actually monetize their practice for as much or more than many RIAs. On the other hand, the reality is that the amounts that wirehouses are paying may well be unsustainable, especially if AdvisorHUB brings so much transparency to deal terms that every broker demands such treatment. Nonetheless, it seems that for the time being, having built a practice in a wirehouse - and staying there - may have been far more lucrative than the independent community ever realized, and that the decision to breakaway is far more nuanced than just the concept of "having equity [to someday sell] in the advisory practice."
Understanding The Typical Broker Recruiting Deal
So based on the Advisor HUB recruiting data, what does the typical broker recruiting deal look like?
The starting point for a recruiting deal is to look at what the broker generated in revenue over the preceding 12 months. Let's say the advisor had roughly $200M of AUM and was generating $2M of revenue (and likely receiving compensation of approximately $900k at a 45% payout rate). In today's market, AdvisorHUB indicates that a "typical" deal - based on what Merrill Lynch is currently offering - would be recruiting compensation of approximately 325% to 350% of this trailing 12-month revenue (with a few wirehouses or large banks paying slightly more, and a number paying a bit less).
So to put this into dollar amounts, at a 325% recruiting deal, the payment to the advisor would be a total of $6.5M, paid out over a series of years. For instance, the terms might stipulate that the first 150%-of-trailing-12 is paid up front, with another 25%-of-trailing paid in 6 months assuming at least 65% of client assets have transferred, and another 50%-of-trailing paid after a year as long as the advisor has brought over at least 75% of the AUM and has generated at least 75% of prior revenue. At this point, the advisor has already received 150% + 25% + 50% = approximately 225% of the trailing 12-month revenue that he/she was earning at the prior broker-dealer (in addition to being paid under the usual payout rules for the actual revenue now being generated at the new firm).
To receive the remaining ~100%-of-trailing-12-month payments that would remain (to get from 225% to the "full" 325% amount), the advisor might have additional revenue growth benchmarks to meet in subsequent years; for instance, the end-of-year-2 payment requires the advisor to be back to 95% of assets and 95% of revenue, and by the end of 5 years needs to reach 150% of prior assets and 150% of prior revenue to receive the last, full payment. To the extent these payment benchmarks are not achieved, the prior amounts already paid are not forfeited, it's just that the new amount isn't earned. Thus, for instance, and advisor who transfers with a recruiting package but fails to hit the benchmarks beyond year 2 may still have earned 265%-of-prior-revenue in payments, but won't reach the full 325% target.
The biggest "caveat" to these payments is that they are typically structured as an advance on a forgiveable loan, such that if the advisor actually quits/retires/is fired/leaves (exact details vary by recruiting contract), any outstanding payments must be repaid. Loan durations may be as short as 5 years or as long as 12, though AdvisorHUB indicates about 9 years is typical. Thus, for instance, if the advisor has hit all the benchmarks and reached a total of $6.5M of recruiting payments over 5 years, but leaves after the 7th year of a 9-year contract, then only 7/9ths of the advances have actually been forgiven, which means the advisor would have to repay 2/9 x 6.5M = $1.44M. Once the end of the loan term is reached, the deal is closed for good. Again, though, failing to meet the growth benchmarks typically will not trigger a loan repayment, but simply fail to generate the next incremental amount of the recruiting compensation; the advisor usually must actually quite/retire/leave to trigger the loan payback provisions.
Wirehouse Recruiting Versus RIA Ownership
In a world where wirehouse brokers don't "own" their practices as independent entities and therefore generally cannot sell them, recruiting packages are important, because they represent a way to "unlock" the accumulated equity value of the wirehouse advisor's business. And as the deal terms above reveal, the value can be quite significant indeed - wirehouses are paying 325% (or 3.25X) of revenue in a world where the standard 'rule of thumb' for independent RIAs is only 2X revenue! Obviously, not every wirehouse advisor will receive a 325%-of-trailing-revenue package (it may be a 'typical' deal, but recruiters only offer deals to the most successful practices in the first place), but the truth is that it's only the most successful RIAs that receive 2X revenue multiples on their practices as well; thus, it's still arguably a "fair" comparison, at least amongst the subset of the most successful advisory practices in the respective channels.
Of course, the reality is that forcing brokers to unlock the value of their practice by leaving their firm and changing broker-dealers is not exactly the most efficient way to monetize a practice. It's difficult and time-consuming, not to mention rife with legal complications in navigating the various non-compete and non-solicitation agreements that brokers are typically required to sign. Nor, for that matter, is the process client-friendly, as it forces clients to go through a great deal of change that may or may not necessarily be in their interests, just so the advisor can be paid... thus the increasing amount of FINRA attention and the recent issuance of Regulatory Notice 13-02 that may require brokers to disclose recruiting compensation to clients. And of course, if the clients decide they don't want to go through the process and aren't retained, that's a loss for the advisor and the firm doing the recruiting in the long run.
On the other hand, the reality is that it's not only the wirehouse advisor who doesn't necessarily want to leave their company; the firm itself doesn't want to lose its advisors either (especially the ones that are the most profitable and therefore being enticed by competing broker-dealers). As a result, just as there has been a rise in the number of intra-brokerage-firm recruiting deals, so too has there been a recent - and equally opaque - rise in the number of retention deals that brokerage firms are negotiating. While AdvisorHUB indicates that the typical retention deal is not quite as lucrative as the compensation for a typical recruiting offer (perhaps 160% of trailing 12-month revenue paid evenly over 4 years), it doesn't entail nearly as much work, hassle, or inconvenience either, for the advisor or the client (and has less risk that clients won't be retained in the transition).
Either way, though, the potential for recruiting and retention deals for wirehouse brokers represents a unique form of monetizing a practice, with results that are remarkably similar to having actual equity ownership in the practice, and at what may be better revenue multiples than independent RIAs... an implicit acknowledgement that even while wirehouses nominally "own" the client, they clearly recognize that the true economic value of the client lies in the relationship with the advisor, who must be compensated accordingly. Yet it's notable that the "lack of equity ownership" is often cited as a primary reason for "breaking away" from a wirehouse in the first place, while the AdvisorHUB data suggests that in reality, the issue is much more nuanced; wirehouse advisors may in fact have opportunities to "monetize" their equity through recruiting and retention deals, though they will still be limited in how much control they have over the practice compared to a truly independent firm (yet on the other hand, wirehouses often give much wider latitude to their most successful advisory practices anyway).
Of course, a true comparison between the financial benefits of structuring under an RIA versus a wirehouse is more than just the sale-or-recruiting multiple; the portion of revenue an advisor takes home as compensation on an ongoing basis clearly matters, too. Yet while wirehouses are often criticized for their 40%-45%-of-revenue payouts, the reality is that the wirehouse structure also implicitly covers a lot of the overhead and expenses of the practice, and for large RIA firms the compensation of an advisor's salary-plus-profits where health profit margins are "just" 20%-30% suggests that with large firms the gap may not be all that significant (though clearly the relative comparison of which is better varies depending on the size of the firm).
Implications For Breakaway Broker Trends
Simply put, the AdvisorHUB data suggests that the financial gap between RIAs and wirehouses - including the potential to monetize the equity of the practice - may be a far narrower gap than many have implied, especially given the AdvisorHUB data. In essence, the existing of the recruiting and retention deals themselves are forcing the profits of advisors within the two channels to be more aligned; anything less really would drive an exodus of advisors from one channel to the other for sheerly monetary reasons. In point of fact, the financial strength of monetization in the wirehouse channel itself may go a long way to clarifying why it is that the breakaway broker trend isn't more pronounced; simply put, the financial benefits of breaking away may not necessarily be as great as some have suggested. On the other hand, it also suggests that the deals themselves may be a key factor preventing a wirehouse exodus; in fact, in Australia such recruiting and retention deals were recently banned as a part of their Future Of Financial Advice (FOFA) reforms, and sure enough there seems to be a significant recent uptick in the number of advisors breaking away to form their own independent practices.
Notwithstanding the financial appeal of the recruiting and retention deals and not leaving the wirehouse environment, though, there's little reason to expect the breakaway broker trend is going to end anytime soon either. For many advisors who break away, finances and profits are only part of the equation; it's also about true control of the business, flexibility of how the practice is structured, a desire to more clearly align advisor and client interests (and perhaps even communicate fiduciary as a part of the firm's marketing), or simply a desire to have more control of how the ultimate equity of the business is structured and how it may be monetized. Accordingly, "mid-point" solutions like Hightower Advisors should continue to grow, and our Pinnacle Advisor Solutions offering continues to receive interest from breakaway brokers looking for assistance in how to structure their independent practices efficiently (even as more and more independent RIAs come on board to the platform as well).
Yet ironically, perhaps the greatest temptation for the wirehouse broker is that while an independent firm can only be sold once, a wirehouse practice may even be more profitable by remaining in the wirehouse channel where it can be "sold" several times by simply engaging in a new recruiting (or at least, retention) deal every time their prior contract comes up for renewal, monetizing their practice several times throughout the span of their career even while continuing to be paid as an advisor as well (though clearly jumping firms continuously in such a manner may well eventually result in client attrition and almost certainly is not in client interests). On the other hand, given questions about the sustainability of wirehouses continuing to pay recruiting bonuses at these levels, it's also possible that the peak of wirehouse recruiting deals may already be passing and that while it's an effective current strategy to monetize a practice, it's less clear whether it will still be there in the future for those building a practice today (at least, compared to the greater certainly of having outright ownership of the business).
Advisor HUB As A Wirehouse And Industry Disruptor?
The reality is that these dynamics of recruiting and retention deals for wirehouse advisors have existed for years, though clearly they have been on the rise in recent years. A large burst of deals occurred in the aftermath of the financial crisis in particular, as large firm revenue plunged with the market decline (and the contraction of investment banking activity), leading to a big push for greater "stable" revenue from wealth management. The post-financial-crisis deal activity was likely further accelerated when the value of many brokers' deferred compensation plans filled with the stock of downfallen broker-dealers plummeted, further reducing the incentive to stay put. Yet given that many of those deals had 5-7 year time windows, as we enter 2014 a renewed interest in broker changes seems to be emerging, as the 2009 5-year deals come to an end and the most successful wirehouse advisors once again try to decide whether to pursue a recruiting deal, break away to independence on their own, or at least engage their current firm to "renew" their retention bonus and be "dissuaded" from leaving.
Accordingly, the launch of AdvisorHUB may be well-timed indeed - probably not a coincidence given the knowledge and background of its founder about the recruiting landscape - but also at a time that could potentially be highly disruptive to the landscape. Arguably, the recruiting deals from many wirehouse broker-dealers are actually so lucrative that they aren't sustainable; in other words, if all advisors consistently asked for the same 'typical' deal, the wirehouses couldn't afford to offer them all at once. Which ironically means that bringing transparency to all the deals may simultaneously put pressure on the firms that are behind the curve to up their offers or face slower growth as advisors decline for better offers elsewhere (or after looking at the available options on AdvisorHUB, decide to go another direction from the start), and in the longer run the average deal itself may have to come down if it's not sustainable for all broker-dealers in the aggregate. In turn, this can go even further to align the total takehome compensation over the advisor career span of the wirehouse versus independent RIA channels as the profit margins become more consistent industry-wide, making a wirehouse practice of the future less lucrative than how it happens to be able to monetize today.
While arguably these dynamics of transparency and market efficiency are a positive for advisors who have built their businesses on a broker-dealer platform, the prospective margin compression is a negative for the broker-dealers themselves, and even a potential threat to their businesses, as I suspect many have thrived in the recruiting world on the sheer inefficiency of the marketplace and that the advisors being recruited have to go through a time-consuming process just to get a "bid" from each prospective firm, and even then have little to compare to except spending even more time to get more other bids. Accordingly, it remains to be seen whether/how the large brokerage firms will respond - would they even go so far as to try to sue to get it shut down? - and whether AdvisorHUB itself can continue to get viable market intelligence on the typical deals that are occurring (though if/when the proposed FINRA recruiting disclosure rule its finally implemented, the available information may only expand).
Nonetheless, for the time being the AdvisorHUB platform has launched and is available, and the insights offer a fascinating glimpse into a marketplace that both independent advisors and even those within the wirehouse world have often had little access to. For $9.99 via an Apple or Android app, advisors will be able to download a current report of the broker-dealer recruiting landscape and find out the terms of the "typical" deal offered to advisors from each of dozens of broker-dealers and wirehouses in today's marketplace, based on the intelligence that the AdvisorHUB team is able to gather from its available connections and networks (its founder Andrew Parish is a former broker recruiter himself). On the AdvisorHUB website, advisors can pay $9.99/month for ongoing deal information, an interactive map and tracking of what recruiting activity is occurring, and the site will feature some content reporting on the latest trends in the advisor recruiting landscape.