Only 18% of top management at registered investment advisors with more than $100 million in assets under management think those next in line could afford to buy the firm, a steep drop from 38% just two years ago, according to a new report by DeVoe & Co.
This finding inspired David DeVoe, founder of the San Francisco-based investment bank and RIA consultant, to lead with the bad news in his 2023 Annual RIA M&A Outlook report, which polled 102 RIA leaders on their thoughts about succession and transition planning.
“Unfortunately, more and more, the value of RIAs exceeds the buying power of their staff,” he wrote. “This affordability gap has accelerated dramatically in the last several years, and the industry may now be at the onset of a succession crisis.”
The polling question was a simple one—Is the NextGen of your RIA able to buy out the founders?—with only three response options. But in each case, the percentages continued to trend in the wrong direction, he said.
The flip side to that drop to 18% from 38% of participants saying their NextGen could afford to buy the practice was a marked increase to 45% from 30% of respondents saying the NextGen definitely could not afford it. And in the middle, 37% are not sure, compared with 32% two years ago.
DeVoe acknowledged that firm valuations, which have hovered around all-time highs since 2020, are partly to blame, as are higher interest rates that dampen NextGen’s appetite for borrowing. But he also pointed a finger squarely at the RIA founders themselves. “When RIA founders procrastinate promoting their future leaders to partner, it makes it harder for them to afford the firm,” he said in an interview conducted by email. “The sooner a future leader becomes a shareholder, the better, because their ownership stake will start throwing off profit distributions—which can then be re-invested in additional shares.”
But without internal buyers waiting in the wings, founders looking for liquidity had to turn to an external sale last year. Indeed, 57% of sellers said liquidity was a driving force behind the sale, up just 44% in 2022. Hand-in-hand with liquidity, succession as a driving force also saw a big jump, to 45% last year from 38% in 2022.
And even though growth declined from the number one reason to sell a firm in 2022, it came in second last year with 49% of sellers indicating its importance.
That drew more finger-pointing from DeVoe, as he called the inability to grow organically a “self-inflicted wound.”
Devoe is hardly the only professional in the advisor world to call out the profession's organic growth problem. “Advisors have an extremely strong value proposition, arguably the best solution for hundreds of millions of U.S. families to best chart their financial future. The RIA ecosystem has a veritable workshop of growth tools not kept in a pantry for advisors,” he said. “Yet complacency and procrastination are yielding an inappropriately low average organic growth rate of 3%.”
Six years ago, organic growth was at 9%, but years of above-average market performance led to complacency and a corresponding pullback in investment for growth. Key areas that were slashed included marketing and business development expenses, which were cut by 50% at respondents’ firms.
“Once you lose momentum and muscle memory, it becomes challenging to get the growth machine humming again,” DeVoe said.
Looking ahead to the year, the report said that M&A should remain healthy, and trend up over the next five years.
“Large, medium, and small RIAs can all serve clients extremely well—perhaps even better than other business models,” he said. “The attractive economics and low barriers to entry can create a fertile environment for well-run RIAs of all sizes to maintain success and prosperity.”