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RIA firms likelier buy targets if owner stays put

FWR Staff

16 January 2007

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 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 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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