Is RIA M&A Recession Proof?
I read with great interest the Mercer Capital article “What’s Driving RIA M&A?” The firm noted how their previous prediction about the RIA M&A space (and likely one many of us would have had if we were pressed for an opinion) was that it would slow down with the high cost of capital. Yet, surprisingly, RIA deals only declined about 1% year-over-year in 2023, while general M&A activity declined more than 30%.
Why is there such disparity between RIA and ‘general’ M&A activity?
The Mercer team suspects, and I agree, that RIA deal activity is strong for four primary reasons:
1. The RIA industry is highly fragmented. With more than 15,000 RIAs in the U.S., according to Investment Adviser Association’s 2023 Industry Snapshot, there are a lot of opportunities for consolidation, as larger RIAs look to acquire smaller ones, to expand their scale and reach.
2. The RIA industry is aging. The average RIA owner is 56 years old, and according to J.D. Power, 20% say they are five years away from retirement. This creates a need for succession planning (read our piece, Why Ignoring Succession Planning Could Cost You Millions) and many RIA owners are choosing to sell their businesses to larger RIAs or private equity firms.
3. The RIA industry is growing. Total assets under management (AUM) of RIAs grew from $20.26 trillion in 2000 to over $114.1 trillion at the end of 2022, according to Statista. Assets have increased in 18 of the past 21 years. This growth is driven by several factors including an aging population, the rise of the middle class, and the increasing popularity of self-directed investing.
4. The RIA industry is seeing an influx of private equity investing. Private equity firms are attracted to the RIA industry because of its high growth and recurring revenue model.
By any measure, M&A transactions within the RIA industry have experienced significant growth rates far outpacing the overall M&A market. The question now facing buyers, sellers and their advisors is how long will this fast pace continue, and what happens when the market begins to rationalize?
The Eye on Private Equity
None of us have a crystal ball, but Private Equity activity in the RIA M&A space may be a bellwether of future transactions.
As Mercer points out PE is “beholden to their PE backers,” with obligations to put capital to use in pursuit of attractive returns. For such firms to continue raising funds to fuel additional RIA acquisitions, actual investment results will be questioned. If returns do not justify the risk, or successfully compete with other opportunities, then funding sources will slow, leading to a more selective deal environment.
Deal Performance Matters
Those of us on the outside of RIA M&A deals can’t really track the actual results of a particular acquisition. This is essentially a private-to-private market. We get the M&A deal headline but not the details. We see the numbers of transactions but are the buyers happy with the deals?
One thing I learned years ago is that excess capital tends to lead to over-paying, weaker deal terms and, in turn, potentially poor investment results.
When buyers realize they overpaid for a RIA, and/or sellers realize that joining a bigger platform wasn’t what they expected, they will act. Buyers may want to recover some of their investment. Sellers may want their independence back. We call this the “disenchantment dance.”
Years of consolidation within the financial services sector have demonstrated several trends: Buyers got bigger, and sellers got richer. There have also been a large number of well-documented deal failures leaving both buyers and sellers looking for an off ramp.
Tightening Terms May Slow Activity Down
Right now, despite the high cost of capital, we’re still seeing firms going for high multiples, but deal structures have changed. Two and three years ago all-cash deals were common, now we see a portion of cash paid up front, and a balance paid in installments over subsequent years. Revenue retention payments are made after a few years, and more equity is given as part of the transaction. This can still net out into strong deals for RIA sellers — but these new structures ensure sellers maintain the strong business that attracted the buyer to begin with.
Mercer says that “an elevated level of (M&A) activity is here to stay,” and while we agree one must question how long this pace will continue at high valuation levels and relatively attractive deal terms. Do trees actually “grow to the sky?”
Be Prepared
Our message is simple: All RIA participants must carefully monitor market conditions and be prepared to address changes as they arise. At the end of the day, the question is: What is most important for your firm? Don’t let industry trends dictate when you act. I believe firms should always be prepared for action. These times require a well-articulated business strategy that will grow your firm’s enterprise value. Actively evaluate your options, be nimble and informed. When you decide to be a seller or buyer, you want to be sure it’s on your terms, no matter how many transactions have been completed this year.
This article was written by David Selig, founder and CEO of Advice Dynamics Partners.
An edited version of this article was originally published in Citywire RIA in October 2023.
David has over twenty years of experience in M&A, management consulting and financial services. He has authored two white papers on the subject of mergers & acquisitions for Fidelity Institutional Wealth Services and Schwab Advisor Services, and he is a regularly featured speaker on mergers, acquisitions, and succession at conferences and industry events around the country.