Much has been written about sellers seeking liquidity or succession solutions, but the real story of the day is the amount of money chasing after a small pool of advisory firms and broker-dealers. According to the “Real Deals Third Quarter 2011 Update” produced by Pershing Advisor Solutions, deals done by private equity firms and serial buyers are increasing.
When we look at the transaction cycle over the last decade, the uptick in advisory firm buyers seems to predict the market: The more money courting advisory firms, the more likely the market will swoon. That’s tongue in cheek, of course, but oddly not entirely off. The bigger implications arise when dollars, especially from passive investors outside of the business, start chasing a small number of potential sellers.
As we all know, demand tends to inflate prices beyond common-sense valuations, making deal structures more aggressive and creating an environment in which more prudent buyers are disadvantaged because potential sellers believe their practices are worth more.
Financial Buyers Emerge
The recently published “Real Deals” report, available on Pershing.com, revealed only a slight increase in the number of mergers and acquisitions among retail-oriented financial advisory firms, though these firms were larger on average. The report also showed that after being absent for much of the past year, private equity firms or serial buyers acquired more than 70% of the assets of the firms acquired in the third quarter.
For many years now, we have been hearing of sellers seeking buyers who will pay cash on the barrelhead rather than considering a sale to their own employees, for whom the purchase would have to be financed over time. While that makes financial sense for the seller, it raises the question of whether the business will have the staying power to support the purchase price.
Bigger firms have larger staffs with greater capacity, but if a transition plan is not in place, buyers could find themselves holding the bag with respect to client service after the deal. Smaller firms have the advantage of serving a number of clients that could be assimilated by the buyer, assuming the buyer has a team of professionals able to perform this role.
Buyers considering pouring money into this market should ask several critical due diligence questions and current owners of advisory firms should be prepared to answer them: