Equity…. the pros and cons. What’s really under the hood?
By Scott Abry
More and more advisors have shifted their focus from maximizing their grid and upfront transition deals to building Enterprise Value. Also known as owning Equity in the business they built or aligning to maximize an enterprise value bigger than themselves to have Equity in a bigger firm.
The old Wall Street Partnerships with a great culture and shared equity ownership where all incentives were aligned are coming back. The industry went through a major consolidation phase after the tech bubble burst of 2000 which took out many of those storied partnerships and scale became the driving force and the majors dominated. Then the financial crisis of 2008 changed all that — the majors teetered on bankruptcy, needed huge Government bailouts and their public equity dropped to pink sheet levels. Meanwhile the Independent Space went relatively unscathed: no bankruptcies and no TARP bailouts. In fact, they have steadily grown over that period and have seen a net inflow of assets from the majors especially over the last five years. The channel has matured to the point where there are many great solutions, platforms, tech stack alternatives, and investment offerings that one can argue are superior. However, the two biggest contributing factors are culture and the ability to own your business or be an owner in an enterprise bigger than yourself.
This is extremely compelling for advisors that are true entrepreneurs because they can build their own firms with like minded advisors. The best way to attract like minded advisors is to share in the ownership and be true partners through equity. Having said that not all equity is the same. Some firms have offered tiered equity were the Founders own one class, Management owns another class and Advisors own a third class. Some of these firms have diluted the advisor class shares to raise Private Equity money and hire more advisors, that is not a true partnership nor equity with much value.
Another way firms offer equity is on a forward valuation basis, meaning that they give you equity today that is already valued at a price it should be worth in say 7 to 10 years. In essence taking all the upside out of the equity and leaving you very little for taking the risk, that is not a true partnership either.
Then there is the “buy in” equity where the firm will buy a stake in your business with a combination of cash and equity in their firm. Thus, effectively owning your book creating minimum cash flow payments meaning they get all the upside of your business and you take the downside if your cash flow goes down. The restrictive covenants of that ownership and the minimum guaranteed payments to them locks you in so you can’t leave or sell to someone else, that is not a true partnership.
Some firms allow you the opportunity to buy equity in the firm after a period of time where they get to make sure you will be a good partner first. Then you get to purchase equity at a price they determine which is just an investment not necessarily a partnership.
The fairest and partner-like equity is the one that gives you a significant stake in the firm for taking the risk to join them at the founding price with the same class of stock for everyone. Laidlaw and Company, a 175-year-old investment banking firm which has recently launched an RIA — Laidlaw Asset Management — offering advisors a significant equity stake with the same price and class as the founders. This gives you all the upside, aligns interests and is a true partnership to grow the business as equals. Laidlaw Asset Management also has transparent liquidity of these private shares in the unfortunate case that you pass away or once the shares have vested.
Bottom line: The car may be fast — but make sure you know what’s under the hood!