Deals involving the biggest RIA firms are dominated by private equity firms. But being owned by a PE firm comes with challenges.

PE investors are attracted to the RIA space for its high returns—which are far higher than they are for other businesses, said Dan Seivert, chief executive of Echelon Partners, at the firm's Deals and Deal Makers Summit in Newport Beach, Calif.

Average returns for PE firms have fallen to about 10% per year, Seivert said, but RIA deals have been producing returns in the 40% to 50% range.

In fact, about 61% of $1 billion-plus RIA deals are being done by private equity firms, said Carolyn Armitage, managing director at Echelon Partners. “That's pretty dramatic.”

(That number excludes an outlier—Principal Financial Group's acquisition of Wells Fargo's $827 billion-in-assets retirement plan unit in April.)

Private equity firms have the most resources, but also put the most financial restrictions on the RIA firms they buy, warned James Gold, chief executive of Steward Partners Global Advisory.

There are some good private equity firms entering the space, but a lot don't yet understand the industry, added Larry Roth, managing partner at RLR Strategic Partners, a consulting firm.

RIA firms considering a sale to a PE firm need to be prepared to see ownership changes when private equity players look to liquidate after five years.

But that five-year plan can become four years or sooner if a PE firm finds a buyer, Roth said, and “they prefer a three- to five-minute hold,” he joked.

Meanwhile, an RIA portfolio firm may find it difficult to make longer term investments in the business if PE owners are a few years away from selling out, Roth added.

Although private equity continues to dominate the deals over $1 billion, the number of deals made by RIA firms acquiring other RIAs also continues to grow. RIA acquirers dominated overall deal volume through the second quarter of 2019, according to Echelon, with 36 RIA-to-RIA transactions. If the trend continues, this category will see a year-over-year increase of 132%.

In total, 2019 could see 200 RIA transactions by year’s end, a record volume for the wealth management industry, Echelon says.

Driving the higher volume is the better availability of financing, the increased number of peer-to-peer deals, more PE owners encouraging portfolio firms to make acquisitions, and historically high valuations, Seivert said.

On that last point, though, Seivert added this warning: A 20% drop in the stock market could cause a 70% drop in RIA valuations as revenues, margins and valuation multiples all fall.

That risk could be weighing on potential sellers. Over the past year, Seivert said he's seen a “very meaningful change in the mind-set of sellers,” who are now more serious about finding a buyer. These aging RIA firm owners have in many cases been unable to establish internal succession plans, he said, so they are willing to consider a third-party buyer.