In for the kill: Private equity firms swoop on the advice sector

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Pension freedoms and regulatory change are driving private equity investment in the advice sector, but experts have raised concerns over what this means for the future of the profession.

As private equity firms circle distributors and providers, some are warning their interest heralds further consolidation and more vertically integrated models for the advice market.

So what has sparked the interest of these investors? What is their end game, and where will it leave the advice industry?

‘The game’

Private equity firms set up a fund from wealthy individuals and institutional investors, promising returns of 10 to 15 per cent, which they use to acquire equity ownership in companies.

Over a five to seven year investment period, they build up the companies in preparation for a sale or flotation.

An industry consultant close to the private equity sector says: “The statistics show that for every 10 businesses, eight will tank, one will do alright and one will shoot the lights out. So for a private equity firm, all of the businesses in a fund have to have the potential to shoot the lights out.

“They are also looking for firms with elastic cash flow so they can pump it full of debt and leverage the business to achieve high returns. On top of that they want exit strategy options. That is the game.”

Independent regulatory consultant Richard Hobbs adds: “The classic private equity model is to buy an underperforming business, shake it up and sell it on at a profit.

“Sadly, when these firms look at distribution companies they see a grossly inefficient business. If the advice industry has aroused the interest of private equity firms that is because they want to shake it up – this should not be viewed as a benign investment.”

Opportunities

Among the biggest deals in recent months is the acquisition of financial planning business Towergate Financial and mortgage broker John Charcol by Palatine Private Equity in March.

Palatine bought the businesses from Towergate for £8.6m and committed to invest a further £5.4m into their IT and back-office systems.

Towergate Financial, which is subject to an FCA investigation for past advice, has since rebranded to Wren Sterling. The liabilities linked to the FCA investigation have been retained by Towergate Financial’s former parent.

Palatine typically invests between £10m and £30m in transactions including management buyouts, shareholder restructurings and buy and build strategies.

Palatine partner Tony Dickin says: “Wren Sterling and John Charcol were both non core to the Towergate group as it is an insurance group, so they were relatively underinvested.

“We thought there was an opportunity to release the businesses from those constraints and invest heavily in staff and systems.

“The pension reforms have created a great opportunity for financial advice, while the MMR has increased the focus on advice in the mortgage market.”

Just last month private equity house Equistone, the former buyout arm of Barclays, backed the £50m management buyout of Wealth at Work.

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Liverpool-based Wealth at Work offers financial education, retirement income planning and regulated advice to employees. Palatine retains a minority stake in the business.

Equistone partner Dominic Geer says: “It has become fairly common to buy a business from another private equity firm.

“Palatine delivered a return for its investors, but businesses move through different phases in their development. Following the pension reforms the management team at Wealth at Work is keen to go again with a new plan for the changed market.”

He says while Equistone has a history of investing in financial services, the investment in Wealth at Work is its first in the advice sector.

“What got us interested is the pension freedoms, which we feel have the potential to grow the market for managing savers’ money over the next 10 to 20 years,” Geer explains.

Providers have also peaked investors’ interest, with Permira investing in Just Retirement in 2009 and Cinven taking a 77 per cent stake in Partnership in 2008.

Both businesses have since floated on the London Stock Exchange and last month announced plans for a merger, after they took a hammering following the Government’s pension freedoms Budget bombshell.

Permira partner and head of the financial services team James Fraser says: “We saw Just Retirement as a business with a fantastic product in annuities and an opportunity to grow that market.

“The pension freedoms were a surprise to everyone but Just Retirement has done a great job of responding to that and expanding its product range. The mainstream media seems to have forgotten the average person has a pension pot of only around £30,000, and for those people a guaranteed income for life is still a great product.

“We think the pension market will continue to grow in the long term and we are always interested in growing businesses which have good products and a strong market position in their specialty.”

Vertical integration

Many argue that an increase in investment in the advice sector should be welcomed as a driver for innovation which will help to grow the market.

EY senior adviser Malcolm Kerr says: “Private equity firms now recognise that the market for financial advice and wealth management is set for significant growth – particularly in the age 55 to 65 segment.

“They also recognise that most firms and advisers are more professional than they were five years ago. That means better governance, reduced conflicts of interest and less conduct risk.

“In addition this market is relatively inefficient and offers scope for consolidation. In theory at least this could create more profitable firms. It’s a tempting prospect. We are also seeing interest in fairly small firms as well as the larger players.”

However, others are concerned that a further drive towards consolidation could reduce the availability of advice, while some argue investors’ focus on a market event could leave areas like customer service neglected.

Threesixty Services managing director Phil Young says: “Private equity investors are not interested in sustainable growth, no matter what anyone says.

“They are looking to make their money from a small number of big events and know very little about the advice sector. All they are interested in is the returns.”

Hobbs says: “My counsel to firms looking for investment is ‘be careful what you wish for’.

“You need to find out what private equity firms want to do with a business – they usually target firms that are not doing very well and need major changes.

“Interest in distribution firms has increased in the last few years, but some liken it to the locusts turning up.

“The investors may achieve their financial objectives and leave a more efficient business behind, but it will be a smaller business. That just worsens the issues around access to advice which the Government is seeking to address through its financial advice market review.”

The anonymous consultant adds: “The two main strategies for distribution businesses are consolidation and vertical integration.

“When the FCA changed the independence definition, a number of IFAs dropped the label. The profile of financial planning is also increasing, meaning independence has become less important.

“At the same time, investors look at listed, vertically integrated firms like Hargreaves Lansdown and St James’s Place and say ‘wow, look at the value in those businesses’.”

But Permira head of the UK Philip Muelder denies that private equity traction is a sign of inefficiencies in the market.

He says: “We have been following the wealth management sector for at least five years and believe there are opportunities to deliver growth in excess of 10 per cent in that sector. That is driven by changes in regulation and demographics. We think regulation is making it more difficult for certain businesses to operate which leads to consolidation.

“We look for backable management teams that have a clear vision and have created the right customer and regulatory culture.”

Permira bought wealth managers Bestinvest and Tilney in 2014 and merged them to create Tilney Bestinvest.

Muelder says: “The management strategy for Tilney Bestinvest is to build a leader in terms of scale, customer service, range of products and national footprint.

“They are making good progress with £10bn of assets and 15 offices today. We are keen to pursue further M&A – I think there is scope to double the size of the business through M&A alone over the next three to five years.”

Tilney Bestinvest chief executive Peter Hall denies that having a private equity backer means there is excessive pressure on revenue targets.

He says: “We set the targets together and we all care about hitting those targets.

“When there is a fall in the stock markets, I have found private equity backers to be much better at taking a longer term view. When I have run wealth management businesses in banks, they were much more short termist.”

Investor pressure

Others warn of the impact of taking on private equity investment on business owners.

The anonymous consultant says: “Private equity deals can be wonderful, but there are not many examples where that is the case. The biggest problem with consolidators is they cannot achieve the numbers they say they will because there are not enough quality businesses around to acquire.

“You’ll have the investor breathing down your neck asking why you haven’t spent their money yet.

“Taking on private equity backing means you lose your autonomy. You have to follow the business plan, and if you screw it up or do something different they are going to come down on you like a ton of bricks because they don’t like surprises.”

But Dickin says Palatine looks for strong management teams and does not want to be operationally involved in the businesses it invests in.

He says: “We will always work towards an exit but we don’t need to set out in advance what form that will take.

“It is relatively unusual for us to float a business, but we will sell to a trade purchaser or to management with a new private equity backer. We grow it to a certain point and sell it onto people who are capable of taking the business further.

“The exit should not be interpreted as a negative thing, as we are used to allowing management to stay invested in the business.”

Adviser views

Tom-Kean-MM-Peach-300.jpgTom Kean, director, Thameside Financial Planning

The move towards consolidation and vertically integrated models represents a gradual chipping away at the IFA business model. There is still a lot of fallout to come in the small adviser space with changes like the sunset clause, and I imagine private equity firms will be trying to position themselves to make the most of that.

BasiMichael Basi, managing director, Basi & Basi Financial Planning

Private equity investment can only be a good thing because it drives innovation. For any industry, all consolidation does is open up market gaps that new firms can exploit. The advice sector has needed a shake up for a long time and private equity investment is the way to do that.

Expert view: Private equity firms will crack the whip

Phil-Young-700x450.jpgPrivate equity investors are looking to make their money back from a small number of big events. Most are hoping to achieve a market event within five to seven years.

Usually that means building the firm up to a significant size and flogging it through a flotation or sale. The idea that they are investing either for the good of growing the business or are interested in pedestrian returns is a myth.

Most business owners that take private equity on board say they do not enjoy the experience, because there is a lot of pressure to deliver results.

For a lot of IFAs, theirs is a lifestyle business which allows them to come and go as they please and to work from home, but all that changes radically if you take on private equity investment.

Events like the RDR get everyone excited about M&A activity. If there are likely to be small businesses available on the cheap and the ability to consolidate and drive costs out, then private equity will be interested.

But asset management is seen as the sexy part of the industry where all the margins come from. The advice part is unattractive and private equity firms are unlikely to invest in a distribution business unless it has the potential to generate revenue from asset management.

Private equity investors are also more likely to be interested in vertically integrated businesses. Any IFA would need to either demonstrate the potential for a vertically integrated business, or accept the fact that it might happen further down the line.

To attract private equity investment you also need to have a decently sized business in the first place, as it is generally not worth their while to do deals worth less than £15m.

A lot of advice businesses are stuck without a capital injection like this. The business may be worth a quite lot, but you need to spend a lot more to increase the value to a point where you can sell it. Banks are not interested in lending to IFAs and there are limited other sources of finance.

But beware that private equity investors will crack the whip. You can safely assume that absolutely none of them know anything about the advice sector in any great detail. All they are interested in is the returns.

Phil Young is managing director of Threesixty Services