Fidelity Custody & Clearing’s 2016 Wealth Management M&A Transaction Report discovered that advisory firms acquiring other RIAs are getting “much more selective,” says David Canter, but there remains a “gulf between what the sellers think” their firms are worth and what buyers think those firms are worth.
Canter, executive vice president for practice management and consulting at Fidelity Clearing & Custody, said in an interview that larger RIAs looking for acquisitions are “getting better” at transactions, talking to more firms before buying and knowing “what they’re looking for” in an acquisition. What they’re looking for are similar client service abilities and human capital, “not just firms with recurring revenue and profitability,” he reported.
That greater selectivity among prospective buyers, and their interest in acquisitions to meet their business growth goals, should send a message to prospective sellers, suggests Canter. “Be very vigilant,” he said, on “what kind of talent” you have at your firm if you’re considering selling.
“Buyers are skeptical of buying firms without talent that can help them grow,” he said, plus those buyers now conduct a “detailed analysis of the book of business,” including the demographics of the firm’s client base, what percentage of clients are in the decumulation phase and the “relationship the firm’s advisors have with the next generation” of clients.
As for actual wealth management M&A activity in 2016, Fidelity said there was “healthy activity,” counting 104 transactions representing nearly $67.1 billion in assets under management. Strategic acquirers accounted for 37 of those transactions, with RIA acquirers accounting for 31 deals and banks doing nine deals.
The Fidelity study doesn’t just count the number and size of transactions, but also uses the insights of its M&A Leaders Forum, blue-chip individuals who are leaders of acquisitive firms such as Savant Capital and Mariner Holdings, so-called rollup firms like Dynasty Financial and United Capital, long-time wealth management investment bankers like Mark Hurley’s Fiduciary Network and independent broker-dealers like Cambridge Investment Research and Ladenburg Thalmann.
At a Forum meeting in November 2016, its members identified four major trends in RIA acquisitions, according to the Fidelity study:
- Acquirers are increasingly prepared, well capitalized, and sophisticated, yet are experiencing increased competition for a relatively small pool of attractive target firms.
- Unlike in the past when AUM “rollup” was the primary M&A objective, acquirers today are using M&A as means to pursue strategies such as talent acquisition, scale, improved advisor productivity, and growth.
- The advisor community is largely unprepared for M&A and lacks awareness on the right time to sell. Too many desire to maintain independence and lifestyle elements while failing to see the forces driving increased industry consolidation.
- Acquirers demonstrate greater interest today in understanding and addressing seller motivation as well as understanding the specific challenges each advisory firm seeks to solve through M&A.
Since the global financial crisis, Canter said Fidelity has seen “steady growth in the number, size and scope” of larger RIA firms—those with $1 billion or more in AUM—buying other RIA firms. In 2016, 26% of RIA acquisitions were conducted by those larger firms.
Canter said “we hear there are a lot of deals in the pipeline” but that some active M&A firms “took off 2016 to digest prior acquisitions.” However, Canter believes M&A activity “is going to pick up,” partly because as an independent RIA firm owner, “you only have four choices.” You could buy other firms, you could sell, you could “internally transition the business” to existing employees, “or the business fades away with the founder.” Canter says if you believe “behavioral economics dictates a rational outcome,” selling activity among RIA firm owners will increase because “there’s not enough Next-Gen talent groomed to succeed the founders” of those firms.
Based on existing trends, Canter suggested that “we may see a few other firms—a handful—start with a base of large, regional RIAs” and do some additional acquisitions, perhaps funded by private equity, along with “existing well-known firms and” even family offices. Those family offices see the value “from a creditor perspective; from a coupon perspective,” since they would gain cash flow from those acquisitions, along with the longer term benefit of holding equity stakes in those firms.
In addition, Canter said “we think there will be a lot more broker-dealers entering the space,” particularly those already invested in fee-based wealth management.”
(Source: Fidelity Clearing & Custody)
There are three other major issues that may affect the pace of RIA acquisitions in the near future, Canter said. The first is pricing pressure, which he said “could create anxiety among sellers.” The second, related issue, is the amount of competition in a firm’s specific geographic area. The third issue is the cost of capital, Canter said, including “to what extent will increased interest rates affect valuations” and access to capital.
For many advisory firms, pricing and margin pressures suggested that “even if you can grow, your revenue per client won’t be going northward.” So for those RIA firms that want to grow, options include the better use of technology to serve more clients, which will drive down the cost of servicing those clients. Another path to growth will be “better definition of services delivered to specific types of clients.” The bottom line? “for the next 10 years, advisory firms will have to professionalize,” either internally or through an outside acquirer. Firms not making changes in their pricing and ‘professionalization’, he said, “may not worry about it until it’s too late.”