No Substitute for Organic Growth, M&A Experts Warn

What You Need to Know

M&A activity can be beneficial, but it needs a foundation of organic growth for long-term success.
In pursuit of any deal, a focus on successful cultural alignment and integration has to start from the first discussion.
The key to successful deals is that, as one expert puts it, something more has to be accomplished beyond merely acquiring assets or clients.

The pace of mergers and acquisitions in the registered investment advisor industry remains impressive in 2023, despite some significant headwinds driven by economic uncertainty and rapidly rising interest rates, according to a panel of M&A experts convened Wednesday in New York City by the communications and marketing agency JConnelly.

However, while many RIA firms and capital partners are pressing ahead on M&A transactions that are slowly but surely reshaping the wealth management landscape, the experts warned repeatedly that inorganic asset gains accomplished through M&A transactions can never replace the critical importance of organic growth and a sound overall client acquisition and retention strategy.

The speakers on the panel included Brandon Kawal, a principal with Advisor Growth Strategies; Marc Cabezas, executive director of mergers and acquisitions at Hightower Advisors; and Raj Bhattacharyya, CEO of Robertson Stephens.

As the trio emphasized, RIA leaders cannot look at M&A and organic growth as being interchangeable if they hope to see their enterprises thrive in the long term. The panel agreed that a firm’s M&A strategy should be supplemental to the organic growth strategy.

“That’s a fundamental truth that we need to emphasize early and often in this discussion,” Kawal said. “M&A should not be the foundation of the growth strategy or the basis of your expectations of success over time. If a firm has a strong foundation, then M&A can be highly beneficial, but without the organic growth and the right foundation, it’s not going to deliver those stellar outcomes.”

According to the panel, the key to successful M&A activity is that “something more has to be aimed at and accomplished beyond merely acquiring assets or clients,” as Bhattacharyya put it.

“M&A needs to be more than a financial transaction,” he said. “Something has to be happening. For example, maybe you feel you need something in terms of new talent or new client services capabilities, and you are going after that. Or maybe you feel you have some special capability that others could benefit from.”

Whatever the specific case, the panel agreed, this vision about achieving a sustainable improvement in the firm’s approach must guide the M&A process from start to finish, from the initial introduction through the exploration process to the negotiations about prices and multiples.

No Such Thing as a Passive Partner

The three M&A experts said 2022 saw robust M&A activity despite the challenging markets and concerns about interest rates, and a big reason why is that there was a lot of capital held by parties highly interested in investing in and acquiring RIAs. They expect the same for 2023 and beyond, with the potential for only a slight cooling in the pace of deals.

“Being acquired by a larger entity or taking on outside capital can be a really powerful thing,” Kawal said. “But it is also important to understand that, when you are joining up with a new partner, it’s never all rainbows and pie in the sky. When you take on a partner, things will change with your firm and your process, so you need to think about this carefully.”

As the panelists pointed out, many RIA leaders are in the position of running their own RIAs precisely because they wanted to gain more control of their client service and business management processes.

“We’re an industry formed by entrepreneurs and independent thinkers,” Kawal said. “You need to ask yourself before any deal, are you really ready for this change? Frankly, there is no such thing as a passive partner. Whatever type of firm or entity you are working with, they will come to the table with a view of how to do things and what success means that you need to be ready for.”

Cabezas and Bhattacharyya agreed, but they also emphasized that no two parties are going to come to the first discussions in 100% agreement about process or success, and that’s OK.

“It’s very important for both sides to ask themselves, who is our ideal client, and what is the ideal client experience?” Bhattacharyya said. “If these two things don’t align, say, 75% or even 80%, that’s a red flag for both parties. Other considerations may be, how much do you believe in the power of tech versus traditional approaches? What is your investment philosophy? There needs to be some basic alignment from the very start when it comes to the most successful deals.”

One Deal or Many?

According to the panel, some firms in the marketplace pursue one-off deals that allow them to solve a specific challenge or access a specific new market or service area. This type of M&A activity can generally be handled without too much long-term disruption for a firm and its people.

Firm Culture Matters Most

While the trio of M&A experts agreed that defining a firm’s “culture” is in itself a subtle and somewhat messy exercise, doing this work is of fundamental importance to success in the pursuit of inorganic growth.

“The focus on the potential for successful cultural alignment and integration has to start from that very first discussion,” Cabezas said. “Getting this right can really create momentum, and getting it wrong can be really painful.”

According to Bhattacharyya, firms with positive cultures that tend to have an easy time getting along and integrating their approaches have a few things in common.

“Culture for an RIA firm is made up of many things,” he said. “But broadly speaking, positive cultures tend to be associated with broader equity ownership, caring about being a fiduciary, caring about organic growth and caring about the client’s ongoing experience.”

Stepping back, the panel emphasized the importance of firm leaders talking in significant detail about what life will look like for the acquired party after the deal.

“Where will things stay the same, where will they change a little bit, and where will the biggest changes come?” Bhattacharyya asked. “All this must be clear before the deal is signed.”

To this end, one common issue Cabezas sees is a hesitancy among firm leaders who are considering M&A to bring lower-level stakeholders into the due diligence process.

“Of course confidentiality is key early on,” Cabezas said. “However, we also see firms make a mistake and wait too long to bring their middle managers and even staff into the process. A whole lot can be learned about how the cultures may align this way.”

Bhattacharyya applauded that comment and echoed Kawal’s perspective.

“This is such an important point for a successful deal,” he warned. “With any transaction, your employees lives are going to change, either a little bit or a lot. The sooner they are able to understand what is happening and why it is happening, the better. You can’t just drop this on them a week before close or even later. If you take that approach, you can end up in a disastrous situation.”