Has the RIA industry been overfished? A rapid spate of deal-making has seen giant firms gobble up other large prey, leaving the industry with more whales and fewer minnows.
Rather than go hungry, the predators are now snapping up smaller prey. A recent report from TD Ameritrade found that 58% of all industry deals in the first half of 2019 were focused on firms that manage between $100 million and $500 million in assets.
“In no previous year has this size range accounted for more than half of deal activity,” noted the authors of the report.
But you’d never know about this down-market trend by reading industry headlines. For example, Focus Financial, a prolific acquirer of RIAs, has made three high-profile acquisitions in 2019. But RIAs that are owned by Focus have made more than 30 deals on their own—the kind of deals that don’t necessarily generate buzzworthy press releases.
The stepped-up pace of deal-making for smaller to mid-sized firms is the rare confluence of aligned interests. Buyers are ready to spend as they bulk up their base of advisors and clients to achieve scale economies.
And there’s surely no shortage of motivated sellers. And many share a common trait: a lack of succession plans.
“Succession has emerged as a primary motivator for advisors as the workforce ages,” says Ed Louis, senior analyst at industry consultant Cerulli Associates. He adds that 40% of all advisors “will be transitioning out of the field in the next decade.”
Brian Hamburger, CEO of Market Counsel, thinks that may spell trouble ahead.
“Most advisors will exit the business without a succession plan,” he says. That means they’ll fail to generate any proceeds from the businesses they’ve built, and also may mean they are leaving their clients in the lurch.
In fact, three out of every four advisors lack a formal succession plan, according to a 2018 study by the Financial Planning Association and Janus Henderson Investors. That may be because there are not national regulatory requirements to do so, though around a dozen states mandate that a plan be in place and on file with state regulators.
“Just like many planning clients, advisors don’t want to think about things like estate planning,” adding that “a lot of advisors wait too long until a sale is no longer easy to pull off.” Hamburger cautions that “a good internal succession plan “can take five or 10 years to pull off successfully.”
And if advisors wait too long to figure out the succession path, “they’ll secure less value for their practice, or turn their clients over to a buyer that fails to show the same level of care to their clients,” says Hamburger.
Louis Diamond, executive vice president at industry recruiter Diamond Consultants suggests aging advisors need not fear a mass simultaneous rush to the exits that floods the markets with practices for sale.
“There is a perceived oversupply (of planning practices) for sale, but we see a lot more buyers than sellers,” he says.
Still, any advisors that have begun thinking of selling their practices may want to start to think about taking the initiative, suggests Tim Welsh, who runs industry consultant Nexus Strategy.
“This is a great time to sell. Valuations are full and older advisors have client books that will only get older,” says Welsh.
Settling on the right price can prove tricky as buyers and sellers often have vastly different views of a firm’s value. Sellers shouldn’t necessarily pay attention to recent headlines around deal multiples. The recent high-profile industry transactions have often been coming with double-digit Ebitda multiples.
Smaller practices rarely sell for a lofty multiple. “Sellers often over-estimate their firm’s value,” says Greg Friedman, CEO of California-based Private Ocean, a $2 billion RIA that has grown through both organic and acquired growth.
Friedman, co-author of “The Financial Advisor M&A Handbook,” notes that sellers “always want to show the highest level of after-purchase profit potential, and their forecasts are rarely realistic.”
And some practices may simply fail to attract a reasonable offer, let alone a generous one.
“Not all offers are flattering, usually because it’s not a very good fit or the buyer is opportunistic - some acquirers are only looking to buy below market to sweeten their internal rates of return,” says Carolyn Armitage, a managing director at Echelon Partners. “When sellers aren’t represented by an investment banker, they may not know any better as the buyers are seasoned professionals who do this full time and can be very convincing, while sellers only go through a sale once in their lifetime.”
Once you’ve made the decision to sell, patience can be a virtue, says Friedman. He says that sites like Succession Link “create a lot of first dates, but few are worth a second date.”
Funding a transaction also requires careful planning. Diamond says that sellers often require 50%-60% down at closing, with the remainder paid out within a few years. Part of the subsequent payment may be tied to an earn-out for sustaining cash flow or revenue targets.
Even if the price is mutually agreeable, buyers should be open-eyed about the prospects for cost savings. John Langston, founder of M&A advisor firm Republic Capital Group, says that “if you’re buying a $100 million to $200 million practice, they are likely already quite lean, and there aren’t a lot of opportunities for cost synergies.”
Buying for growth can make tremendous sense depending on a RIA’s goals. For many, though, inheriting the book of business of an aging advisor holds limited appeal. Instead, M&A offers a way to bolster staff and lay the foundation for organic growth in coming years. And in the RIA business, organic growers are rewarded with higher valuations longer term.
Langston suggest his buy-side clients focus on firms with at least $400 million in managed assets, if that’s their goal.
“That’s where you can truly achieve synergies and also be able to more quickly expand the multiple for your firm,” he says.
Armitage agrees, noting that “demonstrate consistent growth, ideally organic, grow to receive maximum consideration.” She adds that firms with sustained robust growth are also better-positioned to attract high quality advisors and employees.
Even as sales prices (in terms of sales and cash flow multiples) have been expanding, it’s not clear that the trend will continue.
“While there are more buyers than ever before, we see firms fairly priced in this marketplace,” says Armitage. “Firms are being fairly valued based on their future income streams, and astute buyers are pricing in normal market cycle fluctuations so that they don’t overpay.”
That doesn’t mean the recent run-up in prices for practices will reverse course.
“There’s no question that valuations are strong,” Langston says. “But the industry now has much more predictable and sustainable cash flows as advisors and clients have become much stickier, along with the fact that industry demographics are very favorable.”
Indeed, a favorable demographic tailwind remains in place. Many Baby Boomers are wrapping up their careers and need savvy retirement planning. And they’re also on the receiving end of a massive inter-generational wealth transfer through inheritances.
Who’s buying? While many smaller RIAs will merge or sell out to other smaller RIAs, some larger national firms have a clear interest in acquiring small practices.
Mercer Advisors, for example, has cobbled together a $16 billion (in assets under management) business by gobbling up small to medium-sized RIAs. Mercer’s private equity firm, Genstar Capital, has recently put the RIA up for sale, portending yet more deal-making in the private-equity segment of the industry.
Minneapolis-based Wealth Enhancement Group, which oversees more than $11 billion in client assets, has also shown a predilection for tuck-in acquisitions. Those two firms pulled off a combined seven acquisitions in the first half of 2019.
That pace of deal-making only trails the level of activity pursued by Focus Financial Group, which has a seemingly insatiable appetite for M&A.
At a glance, deals appear to be about numbers. But many strategists stress the importance of a mutually shared culture around client service and leadership style.
Armitage recalls a merger completed last year that was beset by clashing cultures. “CEOs that have a hard time giving up control in a new entity can create real disruption,” she cautions.
In response to that challenge, Friedman says, “you need to ask yourself if you’re OK with losing control and are OK with becoming part of something bigger.” He adds that “I’ve found sellers that think they’ve figured that out in advance, but they haven’t.”
And getting the contracts signed is often just the first step in what can be an arduous process. In addition to what Friedman calls “the normal chaos and disruption that M&A brings to a firm,” a smooth integration of disparate technology platforms is essential.
Shaun Kapusinski, director of operations at Sequoia Financial and Friedman’s co-author of the M&A guidebook suggest a deep dive on how the respective firms utilize their tech stacks.
“The risk (of merger integration) is so much greater if you don’t spend the upfront time with advisors to see how they use technology and deal with their clients,” he says.
And Kapusinski stresses that any sort of integration disruption can “lead to death by a thousand cuts” for the advisor-and client experience. He says that “client retention can be the biggest challenge for any mergers that aren’t seamless.”
While this is a golden age for M&A, an economic slowdown or bear market could change things in a flash. As such, RIAs looking to make a deal, may want to act sooner than later.
David Sterman, CFP, is President of New Paltz, NY-based Huguenot Financial Planning
