The merger and acquisition market in the RIA industry remains strong, but volatility in the economy and markets is having an impact on deal-making, industry executives say.
“It’s a super-dynamic market. Choppy deal structures are evolving,” said John Furey, founder and CEO of Advisor Growth Strategies in Phoenix, as he introduced the firm’s RIA Deal Room 2023 survey and a webinar panel of M&A-focused professionals from Captrust, Savant Wealth Management and Mariner Wealth Advisors.
For Marty Bicknell, CEO and president of Mariner, headquartered in Overland Park, Kan., much of the market looks similar to the way it’s been over the last 10 years, and it’s only in certain areas where differences are starting to emerge that might end up developing enough to set the tone for the next 10 years.
“Some things haven't changed. The pipeline, the number of opportunities, look about the same. Seller expectations haven’t changed,” he said. “Multiples are still strong for those firms that have a differentiated offering. Something special, like layered next-gen talent. But some sellers don’t really have anything like that to offer the buyer, and they may have missed the top of the market.”
Bicknell said while Mariner has not yet changed its deal structure, he is seeing more buyers putting deals in place that are back-end weighted with requirements for seller performance.
The downturn of 2022 and subsequent volatility is beginning to have an impact on RIA M&A, agreed Rush Benton, senior director at New York-based Captrust.
“With the decline in the financial markets last year, and the increase in interest rates, I think private equity has gotten more nervous than they were, and which means they have increased scrutiny on the properties that are being bought, and under what terms,” he said.
The best firms will continue to be desirable, he continued, while second-tier firms will find established buyers like Mariner, Savant and Captrust making lower offers, he said.
“If you’re a bit of a marginal firm, with nothing to differentiate you, you’ll still get offers. You may get good offers. But I don’t they’re necessarily going to be from really good buyers,” he said.
Looking at the buyer side, Brent Brodeski, CEO of Savant in Rockford, Ill., said there is a level of discomfort among private equity firms that were focused on using financial leverage and cheap debt in the run-up to 2022, and for them the deal environment has really changed.
“There was a variety of more traditional private equity-funded players who were just buying everything they could buy, paying too much in some cases and not really integrating them,” he said. “That debt’s not so cheap anymore if they’re just going to buy a lot and play the multiple arbitrage game without really trying to add a ton of value around improving their partners. I think a lot of them in our world are hurt right now.”
Brodeski said looking forward he expects in 2023 and beyond that different players will emerge in the industry, which remains very attractive in its potential growth and opportunities for consolidation.
Deal Structure Edges Out Valuations
These observations are in line with the findings of The RIA Deal Room 2023, which collected data on 2022’s deal flow and surveyed more than 20 of the industry’s most active buyers. In all, there were 225 M&A deals of RIAs last year, representing more than $60 billion in seller assets under management and more than $1 billion in total valuation.
While 2022 started off strong, the rise in interest rates and market pullback took a toll on deals.
Between sellers and buyers, sellers were the ones to first show a disconnect with the new reality. The levels of private capital and demand for deals were still strong, but sellers’ expectations didn’t adjust as quickly to changing economics, the survey found.
“Deal structures quickly become a focus as acquirers sought to remain competitive in an uncertain market,” the report stated. “This transition created tension, since many anchored to the high watermark financials of late 2021. Expectations recalibrated as the market transitioned toward more balanced deal structures to maintain momentum.”
As a result, RIA M&A continued to set records in valuation multiples and volume—225 deals were completed—but total valuation decreased. The median-adjusted EBITDA multiple increased 11% from 2021 to a 10x multiple, but the deal valuation dropped because firm was lower in 2022.
For example, a hypothetical RIA in 2021 might have had $3 million in revenue, $1.05 million in direct expenses, $1.20 million in overhead expenses and $750,000 in profit, yielding a valuation at the year’s 9x multiple of $6.75 million.
The same firm in 2022 would have had $2.54 million in revenue (a 15.3% drop), direct expenses of $889,000, overhead expenses of $1.02 million and profit of $635,000. Even with the higher 10x multiple, the valuation would have been $6.35 million.
Aside from the decrease in valuations, the pace of EBITDA growth decelerated for the fifth year in a row. From 2019 to 2020, for example, the increase was 21%, and from 2020 to 2021 it was 12%.
“Many RIAs exploring a transaction would have to grapple with market returns plus traditional client withdrawals while negotiating a valuation,” the report stated. “Fluctuating revenue and cash flow meant deal structures had to become the focus to reconcile valuation expectations.”
The survey found that last year buyers were working with sellers to get them their desired valuation, but in return the buyers insisted on better risk alignment through deal structures and long-term growth incentives. The most common reasons buyers gave for passing on deals were poor cultural fit, poor business/operational fit and lack of growth.
Those structural changes included a reversion from some of the seller’s-market upsides back to more traditional structures. For example, retention payments switched to growth payments, and “earn more” incentives (which focus on current profits) reverted to traditional earnouts (which focus on future profits).
In addition, structures edged away from the cash-heavy trend of 2019-2021, also reflecting more of a “we’re in this together” mindset. Looking at the three financial components of a deal, the survey said cash represents the certainty, equity the shared outcomes and the contingent the shared risk. In 2021, 77% of deals were cash, 21% equity and 2% contingency. Last year, however, cash represented just 67% of the deal, equity 25% and contingency 8%.
“There is still a fantastic transaction out there for most prepared sellers, but buyers may require more time and performance to achieve the desired results,” the report said.
Younger Advisors Want To Partner For Growth
One trend Brodeski said he’s seen recently is younger advisors looking to sell. Whereas the typical seller used to be the older advisor looking for succession planning and to monetize the business, he’s been seeing younger, G2 sellers who are looking for something else.
“They don’t need to do a deal. They’re making good money. But they’re looking at larger firms like ours that have specialists, that have technology, and it’s hard to compete,” he said. “Both organic and inorganic growth can build brands. Ant they’re saying they don’t want to sell, but they want to merge, to be bigger, better, cooler, together.”
With just such a seller in Atlanta, the oldest owner was 52 and the youngest was in their mid-30s. “They’ve all got 15-year runways,” Brodeski said.
Regardless of the kind of firm that wants to sell, the age of the advisors or the desired deal structure, the panel had some advice for financial advisors looking to sell or partner in 2023.
“Covid? It’s over,” Benton said. “Get on a plane and go see the people you're thinking about partnering with.”
Zoom calls are great for an initial meeting, he said, but advisors have to meet face to face and spend time with the entire team.
“If you're just taking a spreadsheet and looking at the numbers from perhaps eight different offers, then you’re not doing right by your clients, who you say are your number one priority,” he continued. “And I don’t think you’re doing your employees right either. I don’t think you're doing justice to what you're trying to do by partnering."