Kevin Casey: M&A, Valuations, and Deal Structures | Next Gen

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I think we will see 3 to 5 RIAs start to look like the Big Four in accounting. If you add the top 5 or 6 RIAs, we're only a few hundred billion. I think in 5 to 10 years, you're going to see that shift.

Welcome to Barron's Advisor: The Way Forward, Next Generation, a special series spotlighting the emerging leaders shaping the future of financial advice. Twice a month, we'll be digging into the strategies, insights, and game-changing moves that will help you take your practice to the next level. I'm your host, Allison Tucci, and today with me is Kevin Casey, Managing Director of Pathstones Corporate Development and Strategy Organization.

Today we're going to be talking about inorganic activity and how that can spur organic growth. Thank you for being here. So you have a little bit of a different background than some of the other guests that we have, and you have a different role. So corporate development. At Pathstone. Can you describe really what your role entails, what you do, and how you got there?

Yeah. So I started my career in strategy consulting. Thought I wanted to advise, you know, big corporate clients, be on the strategy side of the business. And while I was there, I got recruited by a firm called Focus Financial Partners, who I'm sure a lot of folks in the industry are very familiar with, going through a lot of change right now. But it was an incredible experience for me who didn't know what an RA really was, right? In my mind, the gold standard of wealth management was Merrill Lynch, UBS, Morgan Stanley, the big banks, broker-dealers. And I didn't understand what this independent world was. So I was recruited there as a consultant. And their model really was recruit consultants and bankers. The consultants would work with the existing firms, the bankers would execute the deals, and then you would kind of learn the other skill set over time. So I spent about 5 years there, got to work with firms that span from your kind of mom-and-pop, you know, RA working with a $500,000 account all the way up to the $20 billion firms working with $100 million families and everything in between. So I got to understand the good, the bad, what drove growth, what didn't. Ended up working on, you know, over 40 M&A transactions. And through my travels there, ended up meeting Matt Fleissig, our CEO at Passstone. Very fortunate meeting. And after speaking for, you know, 6 or 8 months, he really sold me on what we were building from a value creation perspective, sold me on the integrated model, the fact that we were really pursuing a strategy that solely focused on the ultra-high net worth., it sold me. They had done a couple of deals, and I think for me it was really critical to join an organization that understood that M&A is really difficult. I didn't want to be the first person to execute a deal at the firm, so they had some experience, and they really wanted someone to own that process. So I joined about 3 years ago. The role is interesting. I describe it kind of in 3 parts. The first part is really, you know, the sourcing of acquisitions. So I spend a lot of time speaking with advisors, speaking with firms, Speaking with investment bankers, just being in the flow of knowledge and keeping PASSTO on top of mind, sharing our story. The second part of the role is actually deal execution, which is the fun part, right? So working with our board, our investment committee, working with our teams to figure out how we can bring these two businesses potentially together. And then thirdly is integration and firm strategy. So probably the hardest part of the role. Integration is really difficult in our industry. So really spending a lot of time thinking about, again, how we bring the best of both organizations out through a combination. And strategy, firm strategy, anything from pricing to compensation to growth initiatives. It's, it's a fun role because it spans the entirety of the business.

So how do you think about growth from your role and what do you prioritize?

First and foremost, organic growth is everything in our industry. Actually, I think it's fascinating to go back when I started my career in the space and see what drove valuations. At the time it was scale. And it was the ability to execute M&A that drove, you know, significant valuations in our industry. Fast forward, there's a lot of big firms. There's a lot of firms that know how to execute M&A. So what drives value now is organic growth. And there's that kind of beacon number out there of 10% that everyone's chasing. If you can grow at 10%, you're going to trade at X value. So for us, organic growth is everything from a value standpoint, but also from a business, you know, health and continuity standpoint. So it allows us to pay for promotions, invest in the business. Career pathing for people. So we leverage M&A as a way to propel organic growth. If there's not an organic growth kind of thesis behind an acquisition, we're not going to pursue it. So, you know, we've done this, you know, 14 times over 15 years. It's been very selective, but ultimately the strategy is to ultimately drive organic growth of the underlying firm.

Where are you targeting in terms of, you M&A versus organic growth?

From a geographic standpoint, we have 22 offices around the country. Some are larger, some are smaller. And I think, you know, 2024 and 2025, our message to our team was very much let's scale our existing geographies. We've found that when we become the predominant RIA in a region, and I'll use an example of our Washington, D.C. presence, which was a combination of a legacy firm called Convergent and a firm called Dyson Capital Advisors. One's in Rockville, Maryland, one's in Alexandria, Virginia. So we kind of encompass the whole D.C. DC market. We're the largest player there, and we have seen that be our strongest organic growth opportunity in that market. So really investing in our existing geographies. And from a capability standpoint, so Passstone's a little unique than a traditional RIA. So we have a 14-page services matrix that we engage clients with in a fully unbundled manner. So we'll take on reporting, administration, bill pay, tax, accounting, and not have to manage the money. You know, there's some debate whether insourcing is a great idea or not. We've become obsessed with insourcing. We want as much resource and capabilities internally as possible. That's why we pursued an M&A strategy. So my goal is to take that 14-page services matrix and make it, make it 25 pages, whether that's a law firm, additional resources in tax and accounting, business management services, trust services. We actually went and we acquired a trust company back in 2022. In Jackson, Wyoming, which has been incredible for our clients because we feel when you refer a relationship out, you lose control of the client experience and there's risk in that. You know, you don't have to always use our services internally. But that said, we want to control the client experience and control that outcome. So the more we can offer internally, the better.

Where did that strategy come from and originate from?

I think it came from our clients and just the trend that we've seen in the fact that clients want to have a single phone call, and they want Passstone to be their single phone call and coordinate and be the financial quarterback of their entire life. And we've seen it through our combinations, right? More of the combinations that we have done have been investment-oriented. Hall Capital was an investment-only firm, and there was demand in their client base to do, you know, bill pay, do tax, do accounting, etc. And we're not here cross-selling or mandating to anybody that they need to offer these services to their clients. It's fascinating. Clients raise their hand and say, hey, I want to avail myself of these things. So in the first year post-combination, we generally see a pop in the consumption of services. And then from an organic growth perspective, going back to that, you know, the team members now have a new value proposition to go to market with. You've gone from just selling investments and performance to now, hey, look what else we can do for you. And by the way, we don't have to manage the money. It's a much more conflict-free and a softer sell.

That's a great strategy overall, and I like the idea of expanding your services. What is really that focus on that expansion?

You know, I think the world of accounting and tax is getting more complex, and clients have different needs, so we continue to bolster our resources and our expertise there. We've talked about a law firm, right? We have a team of 12 or 14 attorneys internally that are basically taking the ball to the 1-yard line and drafting with attorneys alongside of them. So, Laws are changing, potentially, in Delaware, Arizona, and Utah, so it could be fascinating to own a law firm internally at a firm. We've talked about business management, like I said. Our clients are a little boring. We have, you know, we were founded on the family that invented the powder-free latex glove. We have, I would say, more or less the industrial-type families, a lot of private equity families, etc. We don't have a lot of entertainment and athletes. That could be a new market to break into. Travel has been one that's been brought up quite a bit. There's a lot of risk in that given the fact that—

I would say.

Yeah. Flights get canceled. Hotels screw up the booking. But we're advising on it already. So, you know, having an expert internally that we can refer to would be very nice.

Healthcare concierge, is it on the docket at all?

It could be. So, we went to all of our managing directors, our board, and some of our rising leaders with a survey last year and polled them of what resources they would want to have internally. And what I just spit back to you in terms of tax, accounting, travel, you know, additional trust services and other geographies, those were top of the list.

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Welcome back to Barron's Advisor: The Way Forward, Next Generation. Let's get back into the conversation.

There's probably a lot of listeners right now that are advisors, that are folks that are either going to try to lift out from a wirehouse, bank, broker-dealer, etc., or they're an independent advisor that owns their own, you know, $4, $5, $6 billion firm. They're thinking about selling. What are the first steps that they need to take to ready themselves for a conversation with Pathstone?

Understanding who you seek to serve and who your core client is can really inform the firm that might be a fit for you. So understanding who your core client is, understanding the demographics and what you're seeking to solve for within your business is very critical. I think understanding the, the players in the market as well. You know, it's fascinating to me when folks say, hey, I'm going to do a bilateral transaction and you haven't spoken to anybody else. It's good to hear what other folks are doing throughout the industry. And I think, you know, if you are in our case seeking to serve the ultra-high net worth and you're speaking with a firm that delivers family office services or things beyond investments, what does that platform really look like? Are you able to deliver it at scale? Is it a combination of insourcing and outsourcing? What does that client experience go back to? And I think lastly is investments, right? The integration process. I think there has to be a convergence of thought generally on the investment platform. But the reality is, as much as we can be aligned, we're probably going to have different positions, different tilts, different managers. But the overall thesis should generally align, and those will converge over time. When we've done combinations, you know, particularly on the investment side, it's always about the next new client and what that experience and what the investment platform will look like. It's really difficult to say to a firm, a person joining us, or a client joining us, you know, hey, it's great I'm joining Pathstone, but, you know, your fees are going to change and your investments are going to change, etc. So the message has always been same advisory team, same fees, same investments, just more.

Just smoothing that integration process, just enhancing your already existing value proposition if you're a financial advisor and really focusing on that next stage of just growth and scalability potentially. Correct. So in terms of, you know, you're talking to founders, you're talking to advisors, I'm assuming they, they have misconceptions about their worth. Yep. You saw this all the time. What are some of the most common misconceptions that you see when founders say, you know, it's my turn. I want to be purchased and I'm worth XYZ.

The key driver of valuation is organic growth. And I think what we've seen with firms is they've gone through a period where it's been rapid growth and it's been up and to the right. And over maybe recent years, growth has flattened. And that's— they've probably reached some semblance of critical mass or a point of inflection where they needed to invest in the business. And quick handily, that dampens valuation, right? Because if you made those investments, the value would have gone up. From an earnings standpoint, I think there's quite a few firms that founders might treat the business like a piggy bank. They give themselves a very small compensation number and it inflates profitability. From our perspective, we look at a normalized EBITDA number and put a multiple on that. There's a little bit of back and forth there in terms of what does a normalized P&L look like. Then lastly, folks look at the big numbers in the news for the big platforms., and they see 20, 21, 24 times. And I think the joke is, you know, you tell me the EBITDA, I'll tell you the multiple. There's some of that as well, but there's also the fact that, you know, platforms— and it is a fact— platforms trade more than mergers. That's why the M&A math ultimately works. So I think there's coming to grips with that, hey, you are a tuck-in acquisition. There's going to be some, you know, multiple arbitrage and accretion when ultimately joining a platform.

And I'm assuming you're having these really tough conversations with founders, and it can be quite emotional. A lot of these folks, you know, they built the business themselves or with a colleague, a father, a mother. Some family member normally is involved in the building of the business. How do you help these founders really emotionally detach and view the worth of their business? They can have a, you know, a financial conversation about the sale.

Yeah, I think we try and show them that we are also a founder-led organization and that we appreciate, you know, the fact that they built this business and that our job is to preserve that legacy within Passstone and ultimately celebrate it by continuing to grow. So it's less about value extraction and more about, you know, what does this mean for my clients and for my team and for my brand, which might not live on necessarily the same way it did before, but within a larger organization.

So, continuing on the thread of talking to someone who is trying to sell their firm, what type of deal structures should they look for, look out for, or you've seen, if you don't want to get into the details of the deal structures that you put together, that you've seen to be more common?

Equity payouts, et cetera? Yeah, I mean, I think there's always, I think about consideration really in 3 ways. There's the upfront consideration, and that's a mix, you know, based on percentage of overall consideration based on business dynamics. There's retention consideration in mergers, right, because we want to incentivize businesses to come together. And then there's growth consideration because we want to share in that upside with our new partners. So those are really the 3 buckets. And then in terms of the components of that, obviously there's cash and equity. You know, I'll debate industry investment bankers all day long what the appropriate mix is there. We have a belief in over-equitizing people, right? And, you know, we generally think about these deals somewhere around 50-50, 60-40 in either direction in terms of cash equity. Probably a little bit more than most in the industry. But we want that alignment, and we particularly want that alignment with the next generation. So in each of our transactions, we've gone out of our way to make sure that we are equitizing the second generation, because when they're making that phone call to their clients saying, you know, hey, we're going to join PASSTO and this is a great deal for us as a firm, the clients always ask, what does this mean for you? And for them to be able to say, I'm an equity owner in this new organization, it means a lot. So we've gone out of our way to make sure that that gets done.

And how are you thinking about earnouts and specifically in this market environment where, you know, organic growth for individuals might not be seen as so easily obtained as it was in the past couple of years?

Yeah. You know, we take the approach that growth earnouts should be exclusive of market performance, which maybe is, again, a little bit different than most in the industry. But true organic growth, you can control that. You can't control market performance. So we basically strip out the market by saying, who were your clients in the beginning of the day and who are the clients when we measure the earnout? Have they contributed? Have they withdrawn? And what new clients have you added? We think about it on a total revenue standpoint. It kind of isolates folks from that short-term market risk.

If you were going to sell your firm, let's say now your hat is you're a founder, what is something that you wish you knew in that situation?

Valuation? I wish I knew how fast these firms are growing and how fast the value creation has happened. It's fascinating. Like, we, we bought out one of our founders, 75% of his equity in 2019. Oh, wow. And then 25% of it in 2023. The fascinating part is that the 25% was worth more than the original 75%, just based on the growth of our organization. We've compounded that, you know, north of 50% a year. When we have these conversations around equity roll, it's trying to educate them around what the equity means, particularly for the second generation who maybe don't have a great experience or know much about equity because they can't eat it, right? They're familiar with cash or familiar with payouts, you know, the equity component and what that pays from a dividend perspective. But ultimately, when we have these liquidity windows with our private equity sponsors every 3 to 7 years.

And that's such a fascinating thing that you said. So the 75%, the 25%. And candidly, I thought very much similarly of, I wish I started an RIA firm back in the day. I'd be probably retired at this point in time. But joking aside, thinking about equity and empowering that next generation to actually buy out the folks that are retiring is a topic that a lot of firms I see really struggling with or trying to approach in certain ways. They think that that next generation doesn't have liquidity to be able to buy out. Those individuals. How are you all approaching it? And are you kind of leaning more on your institutional capitals for that? Or are you thinking about, you know, extending, as an example, equity to additional partners, maybe principals further down into the organization to gather that liquidity to purchase out the team?

Yeah. So within Passstone, we have really 3 on-ramps to equity. There's equity roll through a business combination. So if you were an owner previously, you can roll equity into Passstone. There's the opportunity to buy equity. We have an annual buy-sell, but candidly, there's very few sellers and a lot of buyers. So the supply and demand doesn't necessarily always match up. And then we have the management incentive unit program, which is a feature of a lot of private equity-backed firms. That is a massive, massive opportunity for myself, my teammates, my partners. About half of our colleagues are shareholders within Passstone, and the vast majority of those were granted via this profit interest program, which is really a fast way for folks to create tax-advantaged upside within the organization. In terms of combinations, you hit it on the head. There's always the gap where the second generation could figure out financing, pay cash, whatever it might be for a few percent. It could be the 2%, 5%, even 10%. But when it comes to buying those larger chunks, 25%, 35%, 40% to really move the needle, that's where the the challenge enters. So that's where we step in as Pathstone and say, hey, we're going to provide the liquidity to the founder that he or she requires, and we're going to hopefully redistribute some of those proceeds to the second generation, or we'll arrange financing for them, backed by Pathstone, to buy additional equity and get equity in their hands. So we've done that, and it's been a feature of almost every single one of our deals.

For someone who is also maybe a strategy consultant or looking at more of a, a breadth and they're thinking about focusing, what's some advice that you would give them for how they can grow their career?

Yeah, I think identifying mentors and folks that you want to model your career after. I look at my early mentors at Focus and they all had strategy consulting, investment banking backgrounds, and I felt myself wanting to glean insights from them and then meeting Matt and Kelly and their advisory background made me really appreciate their combination of IQ and EQ, which I think is unique in the advisory space. So really, I don't say hitching your wagon to a handful of mentors, but really modeling your career and taking the best of what you've been able to experience throughout your career to kind of model your own path.

I love that. And in terms of really how you're thinking about the next 10 years, what would be an outlandish or big bet that you would make about the industry or the landscape? I mean, I've heard everything from fees being subscription-based, which I think actually would probably happen a little bit sooner than 10 years. But what would be really your big bets in terms of how it transformed the landscape?

I don't think it's outlandish, but I think we will see 3 to 5 RIAs start to look like the Big Four in accounting or the Big Five, whatever it used to be. I think scale will continue to matter, and there will still be room for the mom-and-pop RIAs or the RIA on Main Street. But in terms of value creation and brand, we will start to see a few independent brands emerge. At that point in time, maybe the banks and broker-dealers will start to wake up. I mean, they have trillions and trillions of assets. If you add the top 5 or 6 RIAs, we're only a few hundred billion. So we're a microcosm in terms of the entire industry. I think in 5 to 10 years you're going to see that shift.

Fantastic. Well, thank you for coming today.

Thank you. The production team for Barron's Advisor: The Way Forward: Next Generation is Ellie Ismailidou, Rebecca Bisdale, Paul LeBlanc, Kinga Rojek, Joseph Lesby, and Alexis Moore. Melissa Haggerty is the executive producer. Jenna Mathis is the director of programming for Barron's Advisor Programs. Greg Bartalis is the editor-in-chief of Barron's Wealth and Asset Management Group. We'll be back soon with another episode.

Thanks for listening. This podcast was brought to you by Wells Fargo Advisors. Looking for a firm your clients can't outgrow? Wells Fargo Advisors offers financial advisors full balance sheet solutions with wealth planning, investment products, banking, and lending that meet the needs of affluent to ultra-high net worth clients. Build your practice your way and on your schedule with independent and employee model options designed to meet your needs today and tomorrow. Learn more at joinwfadvisors.com.