The registered investment advisory industry is changing in many ways. The efficiency increases not only through technology, but also through mergers and acquisitions, so-called M&A.
And M&A activity in the industry is on the rise for a number of reasons.
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Smaller consultancies with assets under management not exceeding $ 150 million (AUM) often struggle to achieve profitability. High fixed costs include compliance and technology, and the total cost of doing business can be challenging for small businesses.
Selling to a larger organization can lower some of these costs and save time. Many consultants who are ready to retire also do not have a successor to buy and run the company.
These are pretty common scenarios that lead to a sale.
“We have seen an increase in deal flow over the past few years and we expect it to continue for the foreseeable future,” said James Fisher, M&A director at FP Transitions, a financial advisor consultancy based in Lake Oswego, Oregon.
Fisher attributes the increase in transactions to a number of factors. Given the widespread industry consolidation, buyers and sellers see M&A as a growth path.
Traditionally, the seller would leave the store after a transition period. That’s no longer the norm, says Fisher.
In 60% to 70% of the external transactions that FP Transitions enables, the seller works for the buyer’s company for two to seven years, he says. This agreement can provide a gradual retirement path for the seller while reducing the burden of compliance, back office management, and technology. This also gives the seller the opportunity to further expand their business.
Another big trend is the acquisition of talent. “Buyers see the value of the acquisition not just in the assets and customers, but also in the seller’s advisory team and staff, most of whom already have close relationships with the acquired customers,” says Fisher. “This enables new owners to leverage institutional expertise and skip the time and cost of training new professionals.”
The story goes on
[Read: Building the Next Generation of RIA Professionals.]
Early RIAs for sale
Max Schatzow, investment management and securities attorney at Stark & Stark in Princeton, New Jersey, says many companies currently for sale are part of the first wave of independent RIAs. These were founded by owners who broke up with broker-dealers years ago, before the RIA movement was as big as it is today.
Schatzow says some of these firms have never scaled much or created internal succession plans. “These are companies with one to three partners, all in their late 50s or early 60s, who want to move on,” he says.
Greg Sloan is a certified financial planner and CEO of Go Beyond in Atlanta, a software platform that helps consultants make hiring decisions and retain customers. In a previous role, Sloan helped facilitate consulting acquisitions.
According to Sloan, the M&A trend predicted years ago has finally arrived.
“Many RIA founders grapple with the fact that they don’t have the technical expertise or venture capital to invest in next-generation leaders and owners,” he says.
Of course, sellers always hope to get the highest price. According to Sloan, valuations for smaller businesses are high relative to profitability. “I’m not sure if this is the case with larger companies,” he says.
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Evaluation methods can change
The consulting industry is still focused on sales at multiples of sales rather than the most widely used formula of earnings before interest, tax, debt, and amortization known as EBITDA, Sloan says.
“We are still in the early stages of consolidating the RIA division,” he says. “At some point I see the EBITDA formula creeping down on lower AUM companies, but that could take a decade depending on the pace of this consolidation era.”
Schatzow says the RIA ratings are higher than he can remember.
“There’s a lot of institutional demand for established companies and they all seem to be seeing the same handful of salespeople,” he says.
He adds that relatively low borrowing costs also drive business.
Financial institutions are also buying RIAs, according to Leila Shaver, a securities attorney and founder of My RIA Lawyer in Atlanta. These include banks and insurance companies that have increased the median of acquisitions in 2020.
“We’re also seeing boomer-aged consultants retiring and moving on, so small to medium-sized RIA sales have skyrocketed,” she added.
Take the time to benchmark
RIA owners interested in selling their businesses must take the time to evaluate their current practice, Fisher says. This includes an assessment of internal talent, position in the market and company value.
FP Transitions carries out many of these benchmarking studies for its customers. “We can help design and implement a plan to achieve set goals such as growth, internal or external succession,” says Fisher.
“The bottom line is, know where you are, know what you want, and be strategic and realistic using the right guidance and tools,” says Fisher.
According to Shaver, the RIA industry is only at the beginning of a ramp-up phase.
“The RIA space is incredibly entrepreneurial, with the ability to create multiple revenue streams and lines of business that can be sold to the retail investor,” she says. “A consultant can wear multiple hats and sell broker, advisory, and insurance products to one client under one roof.”
As the number of transactions increases, Shaver expects closer government scrutiny, particularly over various standards and the way advisors are compensated. All of this is already confusing to consumers, and business-to-business transactions can blur the lines even further.
Shaver says, “In the meantime, it’s open season.”