The third quarter was “unexciting” as far as advisory industry mergers and acquisitions were concerned, and the quarter may be setting up the industry for a down year overall, according to DeVoe & Company.

The decline is a natural reaction to world economic events and does not indicate any systemic weakness in the industry, DeVoe & Company said in its "Third Quarter 2023 RIA Deal Book," which was released today. However, without a dramatic change, 2023 will be the first down year in M&A activity in nearly a decade, the report said.

Although deal numbers are down, "it's a great time to sell a firm -- valuations are high, deal structures are fair, and the buyers are typically strong orgasnizations," said David DeVoe, founder or DeVoe & Company. "Its a more challenging time to be a 'new buyer.' You are comp[eting with buyers that have done tens of transactions and have strong value propositions. So you should take it very seriously and stay on the sidelines." 

“RIA M&A started the third quarter at a solid rhythm,” the report said. “Activity in July and August was above last year’s pace—and then the music stopped. September yielded a scant 15 transactions, compared to 22 transactions in September 2022, erasing the previous months’ gains and resulting in another quarter of decline.

“With Q3 being yet another down quarter, the likelihood of 2023 being a down year is calcifying into a reality,” the report concluded.

Third quarter deals were down to 65 compared to 68 for the same quarter last year. RIA M&A activity was down by 9% at the end of three quarters of the year, with 185 deals in the books compared to 203 for the same period last year. The second quarter of this year saw an even bigger drop in deal numbers compared to 2022 with a 15% decline.

“One could argue that the last two years have not been exciting, as the activity has steadily tilted from a plateau to a slight decline,” the Deal Book said. However, “one can see seeds being planted that will soon take root.”

The report added, “These seeds include new capital infusions to major acquirers like Mercer, CAPTRUST, Wealth Enhancement Group, Prime Capital and others; the changes that will occur at Focus Financial Partners with a new owner; and mega-deals like Creative Planning’s acquisition of Goldman’s Personal Financial Management business. Changes like these will likely lead to greater activity” for next year.

Despite the quarterly decline, RIA M&A activity is still at a healthy level because it is steady and 2024 will likely see an increase over this year, DeVoe said.

For firms that have moved, the buyers are concentrating on large firms of $1 billion or more. “With private equity flowing back into established consolidators, a growing number of buyers are flush with capital. And these buyers prefer to ‘buy big,’ so they are targeting the large and mega RIA spaces,” DeVoe said.

One problem pointed out by the DeVoe research on which the Deal Book was based is that less than one-fifth of advisors believe their next-gen advisors can afford to buy out founders, which underscores a growing succession challenge the industry faces.

This scenario will also tend to boost the number of M&As that are on tap for the future because firms are going to be forced to sell externally. In many cases the next generation of advisors within a firm cannot afford to buy out the founders when they are ready to retire.

“The affordability challenge is real,” the report noted. The high external valuations paid to RIA sellers in recent years have raised the economic bar for younger advisors to buy out founders—especially for mid-size or large firms.

“The significant increase in interest rates since the beginning of 2022 [also] has pushed financing costs up dramatically. Planning early is an ideal way to combat it. Starting equity migration early is critical, as RIA valuations have been increasing faster than compensation, and the distributions can help fund future purchases,” DeVoe & Company advised.

DeVoe also counseled that those firms that are envisioning selling internally need to set up talent management programs to enable younger advisors to take over in the future.

“Firms investing in management coaching and leadership development can gain exponential value to the organization. Even if next-gen advisors cannot afford the whole firm, these actions almost universally make a firm stronger and create a more valuable company,” the report noted.