Mergers and acquisitions among registered investment advisors has cooled over the last 18 months as interest rates have risen, declining from a high of 76 in the fourth quarter of 2021 to 57 in the second quarter of this year, according to San Francisco-based consultant and investment bank DeVoe & Co.
At 2023’s midpoint, M&A activity has registered a 11% drop from the same period last year, with just 120 transactions compared to the 135 in the first half of 2022.
The firm also noted that the 18-month slump follows nine consecutive years of record M&A activity in the RIA industry.
“Given the slow start of M&A activity for the year and expected persistence of the macroeconomic conditions, it is unlikely that 2023 will be another blockbuster year,” wrote firm founder David DeVoe in his Deal Book Q2 2023 report. “The first annual M&A decline in nearly a decade may be upon us.”
Whether or not that plays out remains to be seen, DeVoe said today in an interview, but he noted that RIAs who are not identified as consolidators are increasingly taking more of the deal flow in completed transactions this year.
Year-to-date, RIA acquirers account for just over 28% of deals done, compared with 26% for all of 2022 and 23% for all of 2021. Reasons for this include the eroding effect of interest rates on consolidators’ capital positions, which in turn has slowed their deal pace as they spend more time on due diligence, Devoe says.
“The under-$500-million deals has been a very active sector,” DeVoe said. “And geography is a big part of the story. A lot of RIAs started with a footprint in a major city, and now that they have that established presence in a major market, we’re seeing an uptick of activity in second-tier cities.”
For example, the entire state of Minnesota rarely saw more than one deal a quarter until the second quarter, when seven firms sold to other RIAs.
Small firms, with $100 million to $500 million in AUM have seen the most activity, with 57 deals this year. There have been 34 deals involving large firms with AUM in the $1 billion to $5 billion range being acquired by buyers with more than $10 billion in AUM, DeVoe said.
It was mid-size firms, with $500 million to $1 billion in AUM, that were sitting on the sidelines, with just 16 deals inked this year. By contrast, 62 deals were completed in all of last year.
For both sellers and buyers, valuations bring good news, DeVoe said, as they have neither risen nor declined significantly.
“We have about three years of very consistent, high valuations in the industry,” he said. “Prior they had steadily marched up from a low in 2008.”
DeVoe put current valuations at 12 to 18 times cash flow for companies with $1 billion in assets, and “smaller firms in the high single digits.”
“That said, we sold a firm with $350 million in AUM for 17 times cash flow,” he said. While DeVoe & Co. represents both buyers and seller, DeVoe said that he’s been completing more sell-side transactions lately—14 in the last year.
Terms, meanwhile, have shifted somewhat, in what DeVoe said was a “reasonable and constructive way.”
“The major terms tend to be how much of the valuation is paid up front, with how much you get over time depending when you demonstrate retention of clients or growth,” he said. “In the past you’d see down payments of 40% and that’s jumped to 75% or 80%. We even did a deal with 100%.”
Buyers remain disciplined in their acquisitions and, of course, looking for growth, he said, which seems to be getting harder and harder to find.
“Right now the industry has a problem with growth,” DeVoe said. “Five years ago, firms were growing 9% a year organically. That’s stripping out growth by the stock market or by M&A activity. Slowly and methodically, that has deteriorated down to 3% to 4%.”
The reason, he continued, is that five years ago the stock market was doing well ,and firms grew complacent. Their organic growth efforts stagnated, and they cut their marketing budgets.
“It’s kind of a tragedy, because that’s a self-inflicted wound.”