Waltham, Mass.-based independent broker-dealer Commonwealth Financial Network has introduced a number of financing options to assist the firm’s advisors with succession planning and growth. The offering includes three loan options and an equity-based financing structure.
“Part of what drove us to create not just the expanded loan portfolio, but much of this equity-based funding, was due to the competitive nature of some of the products that certainly brought the big RIA aggregators to market,” said Matt Chisholm, Senior Vice President, RIA Services and Practice Management. “So for [our advisors] Knowing now that we are there on their side of the table to help them solve something they knew they would have to deal with at some point is very comforting and fueled by great interest.”
Chisholm said the firm launched the offering in response to requests from advisors for capital to accomplish one of three things: to monetize or de-risk an existing practice at current market values and multiples; facilitating succession and the transition from a founder to a next-generation advisor; or to facilitate growth acquisitions.
For many years, Commonwealth offered traditional credit to its advisers, but only on an ad hoc basis. This more formal offering, called The Entrepreneurial Capital program, offers the advisor flexibility and includes traditional, bridge and jumbo loans, as well as the equity financing option. (Chisholm alluded to the financing offer when Commonwealth launched its business advisory services last year.)
Due to the long-term lower cost of capital, the company has dispensed with one of the credit products whenever possible.
“The cost of capital over the life of it – it’s arguably always cheaper to get a loan because it’s a fixed term and you’re not giving up any of the equity value, which obviously has an associated benefit,” Chisholm said. “For our equity investments, on the other hand, we would only go beyond the limit of equity-based financing after we have exhausted a loan solution.”
One of the advantages, Chisholm said, of using Commonwealth as opposed to an outside lender is the convenience and speed of deployment. Commonwealth performs a quick credit check and processes a loan request within 48 to 72 hours. For the traditional and bridging loans, the company does not need to look at the advisor’s financial data. For jumbo loans and equity financings, the IBD looks at the company’s income statement (P&L) for the prior year to get a picture of the company’s health.
The traditional loan is a five-year debenture with an interest rate of 2% plus prime. For the bridging loan, consultants receive financing in exchange for interest-only payments at the grand prize plus 2% with a term of 18 months. These loans have no prepayment penalties and no subscription fees. In the case of a jumbo loan, a consultant receives up to 100% of their company’s earnings and repays it at the best rate plus 3% over a period of seven years. There is a 2% subscription fee for this loan.
The jumbo loans are most commonly used to ease the down payment for a type of buyout, where the advisor pays a certain amount up front and the rest over four or five years, Chisholm said.
The company’s share offering is somewhat different from others in the market as Commonwealth does not take controlling interest or ownership of the consultant’s practice. Rather, the company creates a right to a portion of the revenue for the use of its capital. The IBD begins this process by evaluating the consultant’s business based on both the revenue multiple and the revenue multiple.
If the consultant is still interested, Commonwealth will refer this assessment to an external third party such as FP Transitions and will cover the cost of this assessment which will serve as a basis for the value of the practice. IBD will then invest up to 40% of that value and convert this into a function of sales.
“Once we make the investment, we don’t look for reports,” Chisholm said. “We then try to distance ourselves from the way the business is run; We create this equation or switch to revenue, which then defines how our distribution goes on, so we can essentially get a return on our capital while allowing the advisor to use that capital with as much freedom and flexibility as they do be able.”
So far, Commonwealth has been using its own money to fund the options, but it has begun exploring relationships with other banks to raise more, and possibly cheaper, capital than it does today. This will be done by traditional lenders rather than those specializing in the wealth management industry.
“All of this is done in the spirit of trying to find ways and means to help our advisors grow and/or transition,” Chisholm said. “This is not a profit center for us. But we recognize that to the extent that we can capitalize on our advisors to grow and thrive, and we retain them, that is how we earn our returns on many of our services.”