Private equity firms love the RIA industry.
Industry investment bankers and M&A experts have been saying this for the past few years—and the influx of billions of dollars in growth capital over the last decade seems to prove their point.
The entrance of private equity to the independent advisory space was the subject of Cerulli Associates’ latest report, which delves into the reason PE firms are so bullish on RIAs, the impact they’ve had and which firms are most attractive.
RIAs are attractive to private equity firms for a number of reasons, Cerulli found, including the fee-based, recurring revenue model, stickiness of their clients, potential for growth and wide pool of opportunity.
“Private equity interest in the RIA channels is a perfect storm of market opportunity, fragmentation and revenue,” wrote the report’s authors. “Newcomer consolidators are accessing PE capital earlier in their lifecycles and Cerulli expects this trend to continue as more firms explore M&A activity.”
Cerulli estimates more than $3.7 trillion in client assets will be available for acquisition over the next five years between advisor retirements, new breakaway advisors, and RIAs seeking growth and scale. Eight out of 10 RIAs have less than $500 million in assets, and, as growth stalls for many, analysts expect they will be looking to partner.
“RIAs that are currently struggling with growth challenges kind of need that operational support and guidance to move forward, to grow faster and to grow better,” said Cerulli Wealth Management Research Analyst Stephen Caruso.
PE-backed firms offer M&A expertise, as well as capital needed for purchases, and can provide marketing and operational support, according to Cerulli, but potential sellers should approach partnerships deliberately.
“The key piece is understanding what the objectives of the private equity firm are, why they're investing in your firm and what the growth goals of your firm are—and making sure that they're aligned,” said Caruso. “You still have the duty to your advisors, to your clients, to those relationships to keep growing, keep providing the services that they need.”
Caruso said it’s also important to identify what needs the firm is trying to meet and what the investor has to offer.
“I think a lot of the value for private equity comes in that value-add, that M&A support, that business model support and helping a firm go from $5 billion to $15 billion,” he said. “What does that look like? It might be that you shift into more formalized roles, adding vice presidents of marketing and heads of technology—functional business areas that you might have not considered at $2 billion.”
Also crucial, he said, is understanding potential investors’ timelines and expectations for growth.
Private equity first entered the space in a real way 10 years ago, said Caruso, when Centerbridge Capital Partners II took a $216 million stake in Focus Financial in July 2013. Later the same year, United Capital raised $38 million in funding from Sageview Capital, Bessemer Venture Partners and Grail Partners.
The added money has allowed firms to introduce new services for clients, such as tax and trust, and new affiliation models attractive to advisors. Private equity partners have been behind much of the innovation and rapid consolidation in the RIA space over the last decade, according to Cerulli.
PE firms tend to take one of two approaches, said Caruso. They either invest in a large acquirer with an established platform to support continued dealmaking or buy a smaller “enterprise” firm with between $1 billion and $5 billion in assets and strong growth to build out an acquisitive model.
There is still opportunity in the marketplace to buy a piece of a large aggregator, like Focus, that exercises minimal control over its subsidiary firms, but investors have been gravitating toward a different model.
“Where I think we've seen more private equity dollars going is into those larger platform-based firms with more asset and local market share capture opportunities like Mercer Advisors and Creative Planning—firms that are more highly centralized and have more overarching control over their underlying affiliates,” said Caruso.
Caruso is intrigued by the $200 million stake Crestview Partners took in Modern Wealth Management earlier this year, before the firm had any assets to speak of. Noting Modern Wealth was founded by former United Capital and Goldman Sachs executives, he said he looks forward to seeing how the firm develops.
“You kind of have that alumni effect where folks have experienced the acquisition trajectory, understand the pipelines, understand the players in the space,” he said. “And we can see some early investor behavior impact the growth of a new consolidator, which I think is awesome.
“We’ve seen a lot of folks start that platform from within the RIA and then get investment after, whereas I think having investment at the start gives you greater opportunity and greater flexibility to acquire firms and be strategic in your decisions without having to balance that underlying business ahead of time.”
While Cerulli analysts expect private equity inflows to move down market due to an “inflection point” created by the growing number of investors and aspiring acquirers, Caruso said that will be temporary as acquired firms experience capital-infused growth rates. He expects the market will eventually stratify, driven by new affiliation models and the desire to capture more assets, but the bulk of capital investment is likely to accrue to firms with acquisitive affiliation models.
Dozens of acquirers have taken private equity capital in recent years, including Cerity Partners (Genstar Capital, Lightyear Capital); Carson Wealth (Bain Capital); F.L.Putnam Investment Management (Emigrant Partners); Mariner Wealth Advisors (LGP, Penfund); and Sanctuary Advisors (Azimut Group, Kennedy Lewis).
“This is what's happening. It's an inertia that can't be stopped,” Echelon Partners Managing Director Michael Wunderli said during last year’s Deals and Dealmakers Summit. “I think there are still those out there who have a little bit of a negative association, but private equity has been great. They've supported the industry and have created deal structures for advisors to really excel. I think that people are seeing this and they’re seeing the wealth creation that you get ... you sell your business, but you're still running your business. Now, you just have all these tools at your disposal and all these programs to create more wealth.”
“Institutional capital, they love this space,” said Advisor Growth Strategies' Brandon Kawal, speaking on a panel at Wealth Management EDGE last month. “Private equity and family offices, they love the independent wealth management space. So, they're going to do new and unique things around platforms they invest in and the types of business models they're trying to create and, I think overall, it’s very, very healthy.”