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Success in Succession Planning
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Three Factors for a Successful RIA Merger

A similar investment philosophy, culture and geography are key to getting a deal done.

In times of economic uncertainty, fee-only wealth managers receive increased attention from a wide range of acquisition-minded financial services firms, including other wealth managers.

Principally, these suitors want to offset macrosensitive volatility from the likes of investing, trading and deal-making gone wild with the recurring cash flow streams from advisory-centric wealth management firms. And when they find willing targets that can supply the billable AUM they seek, they tend to come to the table and compete.

The third quarter of 2020 set a new record for RIA deal flow, with 55 firms changing hands, according to the boutique investment bank Echelon Partners. Although much of this activity is in keeping with long-term consolidation trends in the RIA space, and some of it was undoubtedly pent-up from delays in the first wave of coronavirus lockdowns in Q2 2020, it also reflects a recession-fueled trend for buyers to seek recurring revenue businesses.

Despite headwinds from the pandemic, Echelon says RIAs purchased in the first half of 2020 averaged $1.7 billion in AUM, setting a pace for transferring 19% more in assets through acquisitions this calendar year than in 2019.

Separating Grain From Chaff

In another sign of buyers’ ongoing attraction for RIAs focused on wealth management and financial planning, transaction multiples keep rising. Specifically, multiples on “EBITDA” — earnings before interest, taxes, depreciation and amortization — paid for RIAs have increased on average from mid-single digits a few years ago to high-single digits, or in some instances, low-double digits today.

So, amid all these indications of interest from wooers, how can an RIA owner know which buyers belong on their short list of suitable partners?

In my experience, finding the best buyer — an entity, remember, that may soon double as a long-term partner for the next phase in an owner’s career — starts not, as many believe, with the amount of money on offer. Even deal structure is dwarfed by other considerations.

To many of my clients, what’s most important when it comes to evaluating the right “fit” with a would-be acquirer are the following three factors:

  • Like-mindedness
  • Cultural affinity
  • Geography

By and large, a firm owner contemplating a sale does so with continuity in mind. Most RIA owners think they’re on the right track when it comes to client service. So, to their thinking, a buyer they perceive as having a similar approach to client service and engagement becomes a must-have. That’s why identifying prospective buyers with similar business processes is important.

You Can Read My Thoughts

To be sure, a strategic buyer may go in search of new synergies. For example, a white-shoe investment-management firm might wish to add financial-planning capabilities, or another pillar of service it may feel it lacks. But, more typically, sellers look for buyers that can help them apply an existing service model to more customers.

In short, they want “scale” as a remedy against fee compression. Scale is shorthand for smooth growth predicated on a planned and consistent alignment of staff, processes and technologies — and it becomes particularly prized as asking prices for pure investment advice trends are down under pressure from passive strategies. In a recent survey, the consulting firm Advisor Growth Strategies found 28% of RIA principals deemed the pursuit of “scale” as a good reason to sell a firm.

The same survey found interest in factors closely related to scale. For example, 31% of RIA executives faced challenges “managing technology” and “operational processes.” Advisor Growth Strategies reckons balancing the time and effort required to operate at scale is especially challenging for RIAs with less than $1 billion under management — unless they find a suitable buyer or manage to maximize scale-building efficiencies organically through outsourcing.

Culture and Investment Philosophy

Cultural affinity is a vital but widely misunderstood ingredient for a successful merger. To what extent? Well, I’ve seen deals crumble to dust at the last minute, snagged on disagreements over investment philosophies. For many buyers and sellers alike, a good merger depends on the firms involved having similar approaches to leadership, internal coaching, succession and mission-critical offerings such as financial planning and investment advice.

In one case I recall, it became clear late in the sale process the would-be buyer would require the seller to abandon its proprietary investment management process, a successful approach built up over decades. But the seller thought its track record of success in its niche was the most valuable thing about it. Under pressure from a prospective buyer to jettison that, the seller ended up walking away.

There’s more than pride or avarice involved in such decisions. Many firms develop and grow in consultation with their clients. These firms aren’t so much imposing investment philosophies as providing a transparent and well-articulated bundle of investment services to a cadre of like-minded investors. Abandoning this sort of consensual approach for a sale — even if it solves for significant business issues — is simply unthinkable to many RIA owners.

Geography and Real Estate

The importance of geography and real estate to specific mergers varies in the best of times, and it’s easy to think the pandemic is changing this equation even more.

We’ve all learned lessons about remote working this year, and consensus seems to indicate that it works pretty well, by and large. And as long as it’s backed by distance-shrinking communications tools and e-document-storage technologies, it’s even a boon to wealth-firm owners, who can now conceive of de novo firms without physical headquarters and have a boundaryless client-engagement plan.

This consideration may affect M&A activity in the RIA space, either in the teeth of the pandemic or long after it’s gone. In this light, an acquisition may coincide with plans to downsize physically, perhaps by freeing staff at the acquired firm to work from home, share office space, or combine these approaches on a rotational or “as needed” basis.

But it still may be the case that an acquirer sees an M&A target as a beachhead in a new market, all the better to establish a presence in a region. In those cases, an office may be helpful — though the point might be made with a small office or a berth or two in a shared workspace on the WeWork model.

That said, post-COVID-19 considerations about office space may not surface in deals already in the works, but they may when leases come up for renewal. In short, it’s starting to look like RIAs may require less physical space to operate in the near to medium term.

First Things Last

Every business sale is different, but the commonalities for success outlined above can help prospective RIA sellers think through a new and unfamiliar territory called M&A. When both parties can agree they have a similar outlook for the business in question, when they have a compatible approach to investment philosophy and service, and when they understand and agree on the role of geography and real estate for the united firm, it’s very likely that the price for the business and the structure of the deal will fall into place.

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

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