Why exactly private equity firms are dumping money into IBDs at a time when many are going bust

After reading this article, Dan Seivert sent along these thoughts as a concise cheat sheet:

PE firms are investing in the IBD space because the following conditions exist:

1. The current business model is distressed meaning low cash flows and low valuations despite strong revenues.

2. Because the space is distressed and cash flows are low valuations are also very low.

3. Any meaningful improvements to the business model can have a significant impact to profitability and valuation.

4. The reason most BDs don’t make these improvements is they don’t have the cash so they find themselves stuck.

5. PE firms do have the cash and it makes it relatively easy for them to work firms out of this chicken n’ egg scenario.

There is the false premise that private equity firms have sufficent insight and know how to capitalize upon the vulnerabilities of wirehouses and that independent broker/dealers afford superior advisory services support. Neither are correct. The industry is going through a metamorphisis from sales with no responsibility or accountability to advisory services affording both accountability and reponsibility to a fiduciary standard in the consumer’s best interest.

Large scale institutionalized support for fiduciary standing is the opportunity because it presently does not exist.

Private equity firms can play a critically important role in making advice/fiduciary standing safe, scalable and easy to execute and manage, affording a preemptive advisor value proposition and far superior economic metrics to conventional commission sales. This requires the creation of prudent processes, technology, work flow management, conflict of interest managenment and expert advisory services support for each of the ten major market segments advisors serve.

If private equity firms can get more engaged in what is required to create an expert preemptive advisor value proposition that is sacalable and easy to execute in support of fiduciary standing that outdates the conventional brokerage model—its a home run. Otherwise, they are simply trying to turn lead into gold.

SCW

Always good to ask the basic contrarian question — is this a bearish indicator? Probably.

As marketers, we see business problems as symptoms of a demand dropping problem. If you are selling something people are demanding, there’s no problem. Throwing cash at dropping demand is usually tragic, but predictable. It’s human nature to support the status quo, we know.

In the comment: “ making advice/fiduciary standing safe, scalable and easy to execute and manage, affording a preemptive advisor value proposition and far superior economic metrics to conventional commission sales.” This is a wish list. Any one of these is pretty much impossible to achieve right now.

Investing in old business models may be less profitable than investing in new models more in tune with emerging demand — whatever that is.

Elmer,

As a marketer, can you cite one instance where the best interest of the consumer has not prevailed in the free market? Are there any consumers who prefer their adviser NOT to act in the consumer’s best interest? Is there any better indicator for demand?

Because of consumer demand, I do not cede the point that advisors want a safe business environment in which to work and acknowledge they actually render advice and have an onpoing fiduciary responsibility to act in the consumer’s best interest. You are correct that is not presently possible in any brokerage formate, but that does not mitigate the consumer’s demand for an advisor to actually act in their best interest and acknowledge fiduciary status?

Under Dodd-Frank’s universal fiduciary standard which makes advice safe, scalable and easy to execute and manage as a business you cite as being a wish list could not be further from the truth. You may not be aware that presently there exists (a) enabling prudent processes (asset/liability study, investment policy, portfolio construction, monitoring and management) authenticated by statutory documentation and confirmed expert opinion letter, makes advice/fiduciary standing safe for brokers and advisors to acknowledge and execute, (b) access to advanced technology which supports continuous comprehensive counsel and transparency in cost and compensation necessary for fiduciary counsel is finally made available to retail advisers and clients, (c) work flow management tied to a functional division of labor (advisor, CAO, CIO) makes advice scalable and easy to execute and manage, (d) conflict of interest management, not just disclosure which perpetuates conflicts, makes fiduciary standing possible and, (e) expert advisory services support for each of the ten major market segments advisors serve. This makes advice safe, scalable, easy to execute and manage, has far superior economics in terms of pricing, earnings and earnings multiple to commission sales and affords a far superior advisor and consumer value proposition.

As for old versus new business models, I refer you to Harvard’s Clayton Christensen Innovators Dilemma which confirms through many examples that the biggest mistake established industry’s make when faced with industry redefining innovation is to look at innovation in the context of their existing business model when a new business model is in order. To be clear, the brokerage industry is evolving to an advisory services business model where brokeras are actually accountable for their recommendations and responsible to an objective, non-negotiable fiduciary standard of care based on statute, case law and regulatory opinion letters.

I am sorry you do not view accountability and responsibility for recommendations as being germane to sales and marketing or influencing demand, but the reality of the marketplace sdays otherwise.

SCW