Search for profitable, growing practices makes buyers turn to smaller firms. Last month Pershing's Advisor
Solutions group released a study of
mergers and acquisitions in the registered investment advisor (RIA) space. The
point, says Pershing, is to help independent practitioners decide whether it's
best to hold on to their firms, sell them outright or enter into
business-building partnerships with other firms.

"Many advisory firms continue to grow rapidly and generate high levels of
profitability, which has caused many advisory firm owners to ask themselves
whether it is better to sell and cash in, or retain ownership and continue to
increase the value of the firm," says Pershing Advisor Solutions' COO John
Iachello. "The Real Deals study reveals an interesting paradox that
many owners would rather be acquirers and are not necessarily looking to sell
today."

The study, conducted by Seattle-based consultancy Moss
Adams, looks at M&A deals in the
RIA industry between January 2000 and July 2006, when there were 228 separate
deals involving firms with at least $1 million in annual revenue worth, in
total, more than $1.5 billion.

In addition to a fairly healthy market for advisories, the study uncovers two
clear trends in the marketplace.

RIA practices are comparatively profitable, which make them attractive
acquisition targets.

The average profitability of advisory firms is around 19.5%; asset growth
averaged 22% in 2005.
RIA owners -- whose average age is 51 -- may want to unlock part of their
businesses' value, but they also want to see their businesses grow.

There are five primary RIA acquirers: banks, trust companies, consolidators,
accounting firms and other RIAs. Acquired RIA firms tend to be wealth- or
investment-management specialists.

Permutations

Banks, trust companies and accountancies wade in mainly to bolster their own
wealth- or investment management offerings. RIA-on-RIA acquisitions are done
primarily in the interests of growth. Such deals seem to be on the rise. They
made up 30% of all RIA deals in 2005 and 36% in 2006 - most often as equity
exchange mergers.

Banks, for example, want firms that can integrate with their client base to
add investment and wealth management services to their existing product suite.
"In a typical deal of this type, banks will acquire a controlling share (usually
90%) of targets with average revenue of $3.7 million for a valuation of 3 times
revenue, or $11.1 million," says the report. "In reality, the deal's potential
value can range from a minimum of 2.1 times revenue to much greater than three
times revenue, depending on the appreciation or depreciation of the bank's stock
and the remaining seller's interest."

Consolidators, on the other hand, want to see a steady stream of earnings
that looks likely to keep groing. In the sale of an RIA to a consolidator, the
valuation is typically at around five times "EBOC," or "earnings before owner
compensation" -- around $7.5 million.

Real Deals gets past the idea that firms are valued wholly on the
basis on revenue multiples. "Acquirers focus on profitability and cash flow,
with agreements structured to ensure that the acquired firms continue to grow
and generate profits for the acquirer," according to the report. "The deal
values often published or discussed are merely notional, as the ultimate
valuations remain high only if certain targets are met."

It follows then, that the likeliest acquisition targets have strong growth
and profitability potential. For such firms, it's a seller's market. It's
tougher going for buyers, however. More than 90% of firms Moss Adams surveyed
for Real Deals weren't interested in selling, not at the moment anyway --
shades of those high profitability rates mentioned above.

The fact that so many advisors are in their mid forties to mid fifties is
another part of the puzzle. If they can keep at it for another 10 years or so,
increasing numbers of post-career baby boomers seem likely to make it worth
their while. Interestingly though, firms with principals who want to remain
active in the business are stronger acquisition candidates than those whose
principals plan to fade away.

As a result, acquirers are looking deeper and longer at smaller firms. The
Pershing study suggests there will be more deals in the future where firms with
less than $500 million in assets under management are acquired. Other key
attributes - such as profitability and growth potential - are likely to remain
the same.

These deals are frequently designed to keep the principals motivated to
remain active and lead the charge to further growth; at least for a few years.

To sweeten such deals, buyers typically offer owners a sound succession plan,
a chance to use the larger firm's know-how, infrastructure, economies of scale
and sometimes capital to grow the smaller firm. Principals get an equity stake,
independence to make client-related decisions and fairly attracive growth
incentives.

"Mergers or acquisitions can be a strategic way for RIAs to grow their
businesses," says Moss Adams senior manager Philip Palaveev. "A key
opportunity for RIA firms to become acquirers is in their ability to capitalize
on the greater cultural compatibility they have with other advisory firm owners
and to create an infrastructure that ensures future growth and profitability."

The study unearths some interesting factoids.

52% of all acquired firms had over $500 million in assets under management
Banks formed 50% of all acquirers in 2005 alone, and have in general been
the most active buyers in the market
Consolidators grew as buyers as well, forming 11.5% of all deals in the time
period under study
The "median price" was pegged to revenue -- on average, around 2.75 times
the revenue value -- but it was wholly conditional on continued growth and
profitability

The report says the busiest U.S. markets for RIA-related M&A activity are
New York, Chicago, Florida, Southern California, Washington, D.C., and
Philadelphia.

Real Deals is free. You can email Michael
Geller in Pershing's marketing
department to request a copy. Pershing is a unit of the Bank of New
York. -FWR

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