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Questions From New RIA Owners About M&A: Part 1

It’s advisable to keep a pragmatic and open mind to help avoid suppositions—particularly around valuation—that may impair your ability to effectively prepare for and execute an eventual sale.

Selling your brand-new RIA may not be top of mind yet, but it’s hard to ignore merger and acquisition activity around independent wealth management firms for very long.

Every quarter, consulting firms with expertise in the field provide running tallies of M&A activity that has risen steadily since the early 2000s, as a variety of buyers attracted by recurring revenue in a growing financial-advice channel make their moves.

Meanwhile, RIA prices are on the rise. In 2019, multiples paid for RIAs increased 29% over the 2015–2018 average of 5.1 times “EBITDA” (earnings before interest, taxation, depreciation and amortization) to 6.6 times EBITDA, according to consultancy firm Advisor Growth Strategies.

In an effort to help newly minted RIA owners make M&A preparation a cornerstone of their business planning, we offer answers to the most penetrating M&A questions we’ve received in recent years from RIA owners and entrepreneurs.

But first let’s talk about the best attitude for M&A preparation.

It’s advisable to keep a pragmatic and open mind to help avoid suppositions—particularly around valuation—that may impair your ability to effectively prepare for and execute an eventual sale. In short, you can’t just count on your firm selling easily at a high valuation because other firms seem to be doing that. Just like they undoubtedly did behind the scenes, you’ll have to work for such an outcome.

  1. How do I get “M&A ready” after launching my independent firm?

At some point after your RIA has opened its doors and you and your team have transitioned your clients’ assets, you’ll probably start thinking about inorganic growth. This may lead you to wonder how best to add assets from other firms. You may, for instance, consider attracting experienced advisors who can bring clients along with them. Or you may mull tucking in smaller RIAs, or agreeing to take over the books of retired sole practitioners.

And of course you’ll have an eye out for an eventual sale—maybe to another RIA, a rollup or to private equity, or perhaps to the next generation of talent—even if you don’t see that happening for a decade or more.

The first thing you need is an effective operating agreement, which will cover when and how equity in the RIA is shared and transferred among current and future owners of the business.

Next up is an accurate valuation, which should be recurring and part of a regular annual business review. After all, when you know what your RIA is worth today, you can make measurable adjustments to improve its valuation in the future.

In general, front-loading basic preparation for M&A shows the kind of maturity and flexibility that attracts buyers and sellers alike.

  1. Is my operating agreement set up to accommodate acquisitions?

Such arrangements can be as nuanced as you like. If maintaining personal control of the RIA after a sale is a priority, you can build equity classes so that you can share the economics of a practice without having to cede control. You could, for example, confer economic participation on advisors from a particular date—when they started or when the agreement went into effect—without loosening your grip on the reins.

  1. What resources are available to help me structure an M&A deal?

First, the RIA owner has to be able to look past the sell side, which tends to be their focus, and think as well about sources of buy-side support. Even if selling is the ultimate goal, having to forgo interim opportunities to increase the firm’s value through acquisition can be a costly oversight.

This can be remedied by working with consultants now to have the necessary structure in place when M&A opportunities arise.

Being open to inorganic growth through acquisition makes even more sense when you consider that the average RIA deal involving firms that manage at least $1 billion in end-client assets now involves firms with $1.8 billion to $2 billion in AUM, according to Echelon Partners' 2020 Q4 M&A Deal Report. As a result, smaller firms are having a harder time finding firms to partner with.

So, whether you’re looking to buy or sell, it’s worth making sure the financing and structuring support you need is just a phone call or email away.

  1. What are some capital alternatives for RIA owners looking to make acquisitions?

There are multiple types of capital solutions available for M&A deals involving RIAs. At root, however, your choice may come down to strategy based on considerations of cost and control.

If it makes more sense to exchange equity in your RIA for cash to fund an internal or external transaction, you will, in most cases, be giving up a portion of your ownership stake.

In this light, using traditional sources of debt funding for acquisitions might seem like a good way to protect your stake. But you may find that today's attractive (read: low) rates are offset by requirements for personal guarantees and performance covenants.

At Dynasty, we’ve developed a hybrid approach that enables RIAs to pursue acquisitions without diluting ownership or requiring onerous personal guarantees or performance outcomes. For example, RIAs can receive capital today in exchange for a percentage of their firm’s and their M&A target’s revenues over a fixed period of time—without their having to give up ownership, encumber personal assets and with easily achievable covenant terms.

Harris Baltch is head of M&A and capital strategies for Dynasty Financial Partners.

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