There's no reason, wealth industry figures say, why there won't be more busy M&A activity affecting the RIA space. So far this year there has been a burst in transactions, then a drop, followed by a recovery. What's driving deals, and where is this sector headed?
After a burst of activity in January, followed by a subsequent slump in transactions, M&A activity has picked up again, although 2021 may be the first year in the past seven that doesn’t set yet another record for the number of deals.
All the usual suspects propelling the interest in RIAs and rising valuations remain in place however: sticky clients; asset-based fees that produce a predictable, recurring revenue stream; attractive margins; low capital expenditures; aging owners; low interest rates; consumer demand for services and an increasing need for scale.
“There’s no reason [why] the merry-go-round doesn’t continue,” said Charles Ruffel, chairman at Kudu Investment Management, a prominent minority investor in RIAs, said. “There are a lot of things that make RIAs attractive to a lot of people.”
A well-run advisory firm is a “growth and income play,” said Matt Crow, president of Memphis-based M&A valuation firm Mercer Capital. “There are not many of them out there.”
Mercer Advisors leads the way with nine transactions through mid-June, according to data compiled exclusively for Family Wealth Report by DeVoe & Co.
Beacon Pointe Advisors and Wealth Enhancement Group followed with six deals, Captrust bought five firms and big-spending Canadian newcomer CI Financial and publicly-traded Focus Financial Partners completed four acquisitions apiece. MAI Capital Management (partially owned by Wealth Partners Capital Group) signed off on three deals and Hightower Advisors and Creative Planning each added two firms to their growing rosters.
Who needs capital?
That’s easy - everybody.
Marty Bicknell, CEO of Mariner Wealth Advisors, long eschewed bringing in outside capital. But he threw in the towel earlier this year, selling a minority stake to Leonard Green & Partners. Similarly, Peter Mallouk, CEO of Creative Planning, frequently touted his independence as a badge of honor. No more. In February, Mallouk sold a chunk of his RIA to private equity firm General Atlantic.
Captrust was yet another holdout, but sold a 25 per cent stake to private equity firm GTCR last year. Mercer is now on its third capital provider and equity stakeholder, Oak Hill Capital. Earlier this month, Steward Partners, the fast-growing, $23 billion firm founded by former Morgan Stanley managers, received a $100 million investment from the Pritzker Organization.
And just last week, taking advantage of continued low interest rates, Focus Financial took on an additional $800 million in debt to fund more M&A activity this year.
Is CI Financial to blame?
Acquiring 14 US RIAs in the past 20 months has been unprecedented. “The industry has never seen a buyer acquire with such velocity in such a short period of time,” according to David DeVoe, principal of the eponymous San Francisco-based RIA consultancy and investment bank.
There’s little doubt among CI’s rivals that the Canadian asset manager is pulling off major deals by simply outbidding everyone else. “They are not price sensitive,” said one competitor.
Another M&A adversary, Focus Financial CEO Rudy Adolf, told analysts on an earnings call last year that “there are some amateurs in this industry who seem to be paying multiples that are just absurd.” Just to make sure everyone knew which buyer he was talking about, Adolf added “foreign buyers, they wash out; it’s only a question of when.”
CI Financial is not always the highest bidder, according to CI Financial CEO Kurt McAlpine. But McAlpine acknowledged earlier this year that he is “very comfortable with what we’re paying for the quality we’re getting.”
Forced to raise more capital to compete, other RIA buyers are decidedly not comfortable with what CI is willing to pay.
Who’s getting squeezed out?
Mid-sized firms and NextGen advisors.
RIAs with assets of less than around $10 billion or so who want to grow inorganically are having a harder time keeping up with CI Financial, which has over $230 billion in assets, and other well-funded aggregators who are amply backed with private equity capital.
“It’s much more challenging now for a mid-level RIA to compete with professional buyers,” said Carolyn Armitage, the former managing director for M&A consultancy ECHELON Partners who is now head of Thrivent Advisor Network.
NextGen advisors who might have hoped to buy in and become equity-sharing partners in growing firms are also in for a “rude awakening,” according to Armitage.
The valuations that RIAs are commanding on the open market, which may reach in the high teens as a multiple of EBITDA for the biggest and best firms, means that internal succession is now “way more difficult” for younger advisors, Armitage said.
The financial rewards of selling to an external buyer for a premium price, versus the hassle of finding, hiring and onboarding a potential successor - and then helping them finance an equity purchase - are “so robust,” Armitage maintained, that it is often “simply not in a founder’s economic interest to pursue a succession plan.”
If it’s a seller’s market, why is David DeVoe worried
about too many sellers?
He fears that there are not enough sophisticated buyers to absorb a big influx of sellers.
To be sure, there is currently a “reasonable” balance of buyers and sellers, with sellers having the upper hand, DeVoe said. But he points out that in the last five years, the number of sellers has doubled, while the number of active buyers has only increased by 40 per cent.
The economics and demographics of the RIA M&A market, DeVoe argued, strongly indicate that the current rate of around 160 reported transactions per year should double. Ideally, he said, additional supply should come on the market at a gradual, upward rate of around 30 per cent annually.
But if the pent-up supply comes on the market too quickly and too soon, there would be a “constraint on the number of transactions that can take place with the given buyer pool, [where] fewer buyers are getting more deals done,” DeVoe said.
Qualified buyers simply don’t have the bandwidth to absorb a big influx of firms coming to market at once, DeVoe maintained. Such a scenario would result in an “unhealthy” M&A market, he said, characterized by “suboptimal” partnerships and valuations that could “drop dramatically.”
What should keep the big buyers up at night?
Black swans in the form of a market crash, a revived pandemic outbreak, natural disaster or a geo-political crisis would obviously not be welcome news.
But in the business world of the moment, major RIA players should be looking over their shoulder at potential market disruptors like Amazon, Goldman Sachs or a yet-to-be-determined well-capitalized entrant willing to take a page from the CI Financial playbook and ramp it up even further.
If a digital behemoth like Amazon with nearly unlimited capital and plenty of intellectual firepower turns its attention to wealth management, “things could get pretty unsettling pretty quickly,” DeVoe observed. Goldman Sachs, meanwhile, has yet to unleash a full-frontal assault on the RIA market as currently constituted.
The venerable Wall Street firm, so memorably characterized by Matt Taibbi as a “great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money,” is still absorbing its purchase of United Capital firms and has just signed up Steward Partners as an anchor client for its nascent RIA custody business.
The investment bank’s push to go down market also includes its Marcus digital business, which some observers believe may be the tip of the spear for a rebranded, costly and aggressive marketing push - possibly accompanied by more acquisitions - into the advisory space.
The sleeping giant has not yet stirred.