Many RIAs are spending time taking care of their clients and employees while assessing the financial impacts of COVID-19. As the industry gets used to working remotely and adjusting to market volatility, new questions about macro RIA trends have surfaced.
There were 139 M&A transactions in 2019 compared to 97 in 2018, according to Fidelity Investments. At the beginning of 2020, the RIA industry appeared poised for another banner year in M&A, as Fidelity reported 13 transactions in January. Everything seems to have changed in a matter of weeks.
No industry participant has a crystal ball, so the best approach is establishing verifiable truths about the RIA M&A market and building a reasonable case on how to best position for the months ahead: The capital options are more diverse than ever before; there are more acquisition brands competing for opportunities; and the succession problem isn’t going away.
A Chance to Prioritize
Deal volume is likely to slow considerably in the coming months. Buyers will evaluate deal structures, and sellers will consider the timing of the transaction. Late-stage transactions may proceed as planned, but deals in the early stages will likely pause. The length of this volatility is a key concern, and the impact on deal flow may be felt for the next one to two quarters.
Suppressed deal flow presents a good opportunity for potential buyers and sellers. RIAs should take the chance to consider how M&A efforts perpetuate the broader objectives of an advisory firm. The firms that are playing long-ball will continue evaluating M&A for access to talent, capabilities, and geographic expansion. The coming months provide an opportunity to get educated and position for the future.
Adjusting Deal Structures
Our inaugural release of “The RIA Deal Room” research showed that deal structures were emphasizing down payments with over 60% of cash consideration paid at closing. Our upcoming 2020 release will show that deals in 2019 followed a similar trend. This market is likely going to tilt structures away from cash guarantees and put emphasis on shared risk/reward.
Valuations will be impacted due to the decrease in cash flow and tempered growth assumptions. Many transactions make explicit assumptions in pro forma financials that have been generally accepted in good markets. Pro forma earnings before interest, taxes, depreciation and amortization can be more than 30% higher than operating EBITDA in the average transaction.
Transaction models likely will factor more conservative growth assumptions, and heavily adjusted financials will receive greater scrutiny. Decreasing valuations is rarely a good news story, but participants emphasizing long-term outcomes are positioned to win.