Consolidation among the most prominent players in the RIA space is “very possible,” according to a managing director for private equity firm Lightyear Capital.
Max Rakhlin said the return on dollars aggregators spend finding smaller affiliates still makes that route attractive for the industry’s most significant firms. But those circumstances won’t persist forever.
“At some point, that calculus will change, particularly when the larger firms will no longer grow at the same pace they’ve been growing at,” he said. “I don’t think any one of us can predict right now when it’ll happen.”
Digital Privacy & Protection CEO Mark Hurley also expected consolidation at the top, predicting the industry will evolve to include 30-50 “mega-firms” with $500 billion to $1 trillion in assets. But he said these big firms will look less like aggregators and more like Schwab or Fidelity.
“They’re going to own other ancillary business lines,” he said. “But no one knows who the winners are. We think it’s going to be an existing aggregator because there are so few mid-size firms to buy.”
Private equity’s impact on consolidation in the RIA space and whether the M&A “music” will continue to play have been constant touchstones during discussions at RIA Edge, part of Wealth Management EDGE at The Diplomat Beach Resort in Hollywood Beach, Fla., this week. According to Marshberry Managing Director Kim Kovalsi, 68% of 2023’s deals were completed by PE-backed buyers, and of the 108 announced transactions this year, PE buyers made up 75%.
Hurley said PE money is mainly coming from sovereign funds, which are getting wise to the interest in the space, so he expected firms to be “disintermediated” at some point.
But Rakhlin doesn’t believe the field of PE-backed firms and rate of dealmaking is too crowded, noting there is $60 trillion in investible wealth in the U.S. (set to double by 2030), with 15,000 independent firms (approximately 10,000 of which had less than $100 million in assets).
“There’s plenty of options to choose from in order to ensure that the firm the smaller RIA is affiliating with meets the client demand, is a good home for their employees and has the right service level,” he said. “I firmly believe we’re probably in the early to middle innings of consolidation, which is not that surprising.”
But as aggregators consider deals to grow ever larger, Hurley predicted more leadership changes at the top. In the five months since he released a report on the state of the industry, Hurley noted significant turnover in management at firms, particularly among the aggregators.
“I think this is because, quite candidly, the people who built these businesses are not the right people to take them forward,” he said.
To Hurley, the skill set for running a business with 10% market increases per year differs from one where firms feel pressure to compete for clients and aggressively grow. The pressure would only increase as the most significant firms grow more prominent through consolidation.
Other speakers sounded (measured) alarms about PE’s continued encroachment in the space. Earlier this week, Rise Growth Partners CEO Joe Duran said PE firms (and the demands they bring) could sometimes make large, PE-backed RIAs look more like wirehouses.
During a breakfast-as-hot-wings conversation early Wednesday, industry gadfly Michael Kitces said PE funding could make a firm more successful. However, the “worst-case scenario” involved companies cutting customer support “to the bone” to boost profitability at the expense of client relationships.
“By the time anyone notices how downhill the company is going, they’ll have sold it for a really nice multiple, and it’ll be someone else’s problem,” he said. ‘From the external end, it is really hard to tell which is which.”
It’s even more challenging for a firm’s founder, mainly because a PE firm may have done as many as 100 transactions (or more), while it’s likely a firm founder’s first time having that conversation. So it becomes far harder to know what to look for (and look out for), Kitces said.
“My real challenge to it is our industry is only so large. We’re not a thing where if you put money in, you can make the next multi-billion dollar unicorn company because 50 million people adopt it,” he said. "I worry a lot that PE is trying to squeeze more out of the industry’s companies than they actually can."