Among the other ways the coronavirus has hurt the economy, it has hurt the valuations of financial advisory firms. Falling asset values have a domino effect on RIAs: falling stocks mean falling AUM fees, falling revenues, falling profits and, finally, the falling worth of RIAs themselves—and at the worst possible time when many advisors were thinking of selling as they look toward retirement.

“I believe multiples will come down a little,” said Marty Bicknell, CEO of Mariner Wealth Advisors, in an email reply. His Overland Park, Kan.-based company is an acquirer of RIA firms. “If the range was 6-9 times EBITDA, I think it’s 5-7 now. That’s for firms $2 billion and below. Firms $10 billion and above are still mid-teens, 15-17.”

But a 30% drop in the S&P 500 doesn’t mean your firm has lost 30% of its value. For one thing, many firms had a balance of stocks and bonds to blunt the pain.

Echelon Partners, a firm focusing on wealth management M&A, uses an example of a $1 billion portfolio (as of December 31, 2018) that’s invested 60/40 in stocks and bonds and is charged a 0.18% quarterly fee at a firm with fixed costs of $1.26 million. The valuation multiple for the firm is 8.0. A mixed portfolio that Echelon calculated saw a 12.7% decline in the first quarter of 2020, but the three previous quarters saw growth. The rolling four quarters of EBITDA on March 31 of this year would be down only 1.8%, and valuation for the rolling four-quarters is based on a similar number (and not on an annualized quarterly drop in the valuation multiple, which would have been a huge 29.9% decline).

“Emotionally you’re in one place, but I think cognitively you should be in another place,” said Dan Seivert, Echelon’s CEO, in a recent webcast.
“Eighty percent of the time there’s a general agreement that buyers and sellers will use the four quarters prior to the close,” Seivert said. “Quarters are much easier to use than months are. In our industry, there’s a high inclination to want to close at a quarter end.”

But there’s going to be compromise, and it’s likely that buyers in the future won’t want to look at your past when considering whether to buy your firm. They are going to look at your future. Do you have a strong middle management? Do you have a young clientele that’s going to build assets rather than start scraping them off? Can a buyer keep your clients when you leave?

“When the markets are great, the sellers tend to want to be looking backwards at four quarters worth of performance,” said Mark Bruno managing director of Echelon Partners, in the webcast. “When the markets are falling as they were for a period of time now … you see how it tips in the buyer’s favor to want to use a more forward-looking time frame to assist with the valuation.” It’s about finding a compromise, he added.

Matt Cooper, the president of Newport Beach, Calif.-based Beacon Point Advisors, a firm that’s been acquiring RIAs, says he’s not totally comfortable looking at things like a target firm’s trailing-12-month measures, which assumes there will be a V-shaped recovery.

“We aren’t buying the past 12 months, we are buying today and into the future,” he said. “What if three of the best advisors left the firm and took clients and team members, permanently impairing revenues and earnings? What if the markets are hampered and down for several quarters?”

He says it’s for that reason he prefers to use a discounted cash flow of future expected cash flows that results in a multiple of the most recent quarter of adjusted “run rate” EBITDA.

Run rate is part of a more sophisticated measure of value that has emerged as M&A activity has become increasingly giddy in the past few years. According to a KPMG report called “Prove It: Show Me the Money,” run rates reflect the effect of investments in the business that don’t appear on the financial report—things like revenue gains from planned price increases, “or the savings from cost-cutting measures initiated in the past 12 months, or the contribution of an acquisition that has not been executed.”

“With run-rate adjustments, the seller paints a picture of the value a buyer may realize post-sale—and seeks to be paid for all or part of this upside,” the KPMG report said.

These metrics are where buyers and sellers are likely going to stop seeing eye to eye.

“The big picture here is that the pandemic and the resulting market volatility dramatically changes things for a lot of people,” said Pete Dorsey, managing director of institutional sales at TD Ameritrade Institutional. “The state of the marketplace will work in favor of buyers and against sellers. We’ve seen a big shift, an inversion, in the M&A environment from recent years, when demand outstripped the supply. Now the supply is likely to outstrip the demand.”

Scott Slater, vice president and a mergers-and-acquisitions specialist at Fidelity Custody & Clearing Solutions, says that RIA earnings are clearly going to be affected by falling asset values, and that’s going to affect the multiples that advisors are asking for their firms.

Up until now, “we had an awful lot of upward pressure on multiples,” Slater said. Many advisors knew they were in a period of peak valuation by the end of 2019, and that there’s been an arms race for talent, especially as private equity comes into the space. Those factors haven’t changed, he noted, and he expects the activity will accelerate again after the merger lull prompted by the Covid-19 pandemic.

What’s almost more important is that deal structures will likely change, Slater said. Buyers will not pay as much cash up front, as they have been lately.

According to Fidelity’s report, “M&A Valuation and Deal Structure—Insights from Leading Serial Acquirers,” the median up-front payment since 2017 had recently risen to 45% from 35% five years ago. “Looking deeper, 43% of firms mention that for the majority of the deals conducted since 2017, up-front payment (cash and/or equity) is over 50% … with 9% of firms paying over 90% percent up front.” Not coincidentally, sellers were also asking for shorter earn-outs periods.

That’s all going to likely change in a buyer’s market.

“Structure is where you can bring more control from a buyer’s standpoint to managing the risk that’s involved,” Slater said. “There’s still plenty of capital available. So it’s not going to be for lack of that.”

He added that the buyer’s questions are now: “How much do we pay up front? How can I reduce that? How can I tie the subsequent payout to earnings overall? How do I put the motivation back on the firm that’s selling?”

There’s a range in multiples, Slater said, and those sellers who can sell at the higher end of the range are going to be easier to integrate into an aligned model of a buyer.

This type of firm “already has their data in good shape for the clients and how they operate," Slater explained. "It is able to demonstrate that they have good processes. It’s not going to be that the buyer has to come in and do a lot of work to bring them up to speed. There are a lot of firms out there that have underinvested over time in their platforms, and while there are going to be buyers out there for them, if they haven’t kept up they aren’t going to be attracting the same kind of multiples and the same kind of interest from some of the better buyers out there.”

Ron Carson of Carson Wealth in Omaha, Neb., another acquirer of RIA firms, said how much you fetch in a deal depends on how single-dimensional you are. He noted that he offers much less for one-trick ponies who do only one thing like portfolio management.

“It goes back to what are you getting when you buy,” Carson said. “Are you getting an advisor who held himself out as a portfolio advisor PM, or are you getting a real capable firm that does taxes, estate planning, tax planning, income planning, legal documents, asset management … all of that stuff. That’s where the market has gone. People want to have an Amazon-easy experience.”