First Republic

Tax Reform Could Make RIAs More Attractive to Corporate Buyers

Corporations suddenly have new incentives to buy registered investment advisory firms, says a new DeVoe & Company report.

Under the new tax code, the corporate tax rate will drop to 21 percent. The Trump administration’s intention was to create more after-tax income for these companies to hire more people, pay their employees better and invest in machinery. But many analysts expect corporations will use that money instead for acquisitions, said David DeVoe, managing partner at DeVoe & Company.

“Those corporations that were contemplating acquiring an RIA in the past—and this RIA would then fall under their corporate tax structure—they suddenly have a new layer of incentive to execute those transactions versus 2017 or before,” DeVoe said. 

DeVoe’s latest RIA Deal Book report, released Monday, explores the implications of tax reform on RIA M&A deal activity. The new law could have the unexpected benefit of making RIAs more attractive to corporate buyers, the report said.

Banks would be one of the more likely institutions to fall into this category. In 2017, banks acquired RIAs at more than twice their usual pace—8 percent versus 3 percent historically.

DeVoe said banks and other large financial services companies that are structured as corporations could use that additional after-tax income to acquire RIAs. 

There’s also an arbitrage opportunity. Corporations are now taxed at the lower rate, while the typical RIA is taxed at a maximum marginal rate of 37 percent. But if the corporation were to fold the RIA into their business, the RIA would be converted to the corporation status, and its after-tax cash flows could be higher.

“When these corporations acquire a highly taxed RIA, seemingly as they roll under the new 21 percent corporate tax rate—post-transaction—there will be more after-tax income from that organization than there would’ve been if they had acquired them before this tax change,” DeVoe said.

The vast majority of RIAs are structured as S Corps and LLCs. And although these entities received a tax cut, a carve-out in the tax code treats certain LLCs and S Corps as personal businesses.

Some RIAs, including Brent Brodeski, CEO of Savant Capital Management, are lobbying against this carve-out, arguing that not all RIAs are small, personal businesses.  

“The logic there is that this is someone who’s a CPA working by themselves,” DeVoe said. “It’s really their income, etc., whereas Brent’s argument is, ‘Wait a sec. Some of these firms have $10 or $20 million in revenue. It’s not one single person’s income.’”

For now, RIA firms fall into the tax code almost the same as they did last year. And because the tax code hits their income as well as any proceeds from a sale, it doesn’t change the equation much in terms of offering an incentive to sell or not.

Overall, while RIA M&A activity reached another record high in 2017—with a total of 153 deals—the trajectory of growth is flattening out, DeVoe said. That’s just 6 percent higher than 2016, whereas M&A activity jumped 42 percent from 2013 to 2014.

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