A new Fidelity report examines how private equity is reshaping the M&A landscape and increasing options for independent advisory firms.
Fidelity Clearing & Custody Solutions released the Insights on Sources of Capital and Independence report, which finds that established firms with demonstrated track records of consistent growth have been receiving the bulk of capital funding.
According to Fidelity, this results in the formation of unique “ecosystems,” as platform firms and strategic acquirers increasingly use this capital to fund and acquire smaller firms. In the first quarter of 2018, strategic aggregators were responsible for more than two-thirds of M&A transactions, which is up from 47% in the first quarter of 2017.
As external capital providers are increasingly drawn to larger firms, assets are further concentrated at the top, according to Scott Slater, vice president of practice management and consulting at Fidelity Clearing & Custody Solutions.
“Those large firms are then investing in smaller ones, often using a model that keeps the owners involved as the business grows and develops,” Slater said in a statement. “That’s a significant shift in attitudes, and is opening up new opportunities for small firms who are open to embracing this more collaborative perspective.”
There are two predominant ecosystem models through which private equity capital is making its way down from providers: the direct investment model and the intermediary model, according to the report.
In the direct investment model, investments are made in a platform firm that uses the funds for organic and inorganic initiatives. For example, private equity firm Lightyear Capital acquired equity positions in large advisory firms, including Wealth Enhancement Group, Advisor Group and HPM Partners. The large advisory firms then made smaller firm acquisitions, which helped them to build significant scale.
In the intermediary model, a strategic acquirer uses private equity funds to support a network of affiliated firms through M&A. For example, an investor group led by private equity firms KKR and Stone Point Capital took a majority stake in Focus Financial, a strategic acquirer. Focus Financial then helped one of its partner firms, Buckingham Strategic Wealth, close more than 30 M&A deals.
In the report, which is based on interviews with leading acquirers, including members of Fidelity’s M&A Leaders Forum, Fidelity identifies four best practices for finding and working with private equity partners.
1. Advisory firms need to understand which strategy and partners best align with the firm’s interests, according to Fidelity. Advisory firms should begin by assessing their own objectives to determine the best funding option for their business. Factors to consider include growth expectations, priorities and the level of control desired. Alignment around philosophy, vision and beliefs is also important.
2. Firms should also tap outside expertise to expand options. According to Fidelity, outside experts — such as investment bankers and transition consultants — bring knowledge and support to the selection process to help firms make better-informed decisions. Fidelity says these experts can provide a wide range of expertise, from helping determine a realistic valuation and model financial scenarios, to evaluating the firm’s strategy and identifying best fit options.
3. According to Fidelity, firms should plan for a successful transition and ongoing growth. Post-acquisition, firms need to achieve ongoing business success to be positioned well for additional funding. Things like dedicated onboarding teams and a focus on identifying and implementing best practices may help firms be successful.
4. Lastly, Fidelity suggests that firms leverage experience of capital partners to encourage continued growth. Ongoing collaboration with capital partners may help firms improve business metrics, refine managerial processes and develop strategies around critical initiatives like organic growth and succession planning.