As the economy emerges from the financial crisis, the RIA business is recovering faster than most other industries. But that rebound in revenues and assets has not translated into higher valuations for RIA firms or an increase in M&A activity.
Advisors are three years older than they were in 2008, and as one acquirer notes, age isn't working in their favor. The older the advisor, the more likely buyers are inclined to make lowball offers, reasoning that the seller is holding a lot of high cards.
Another factor hamstringing merger activity in the RIA space is the absence of several former classes of buyer. Banks, the acquirers with the deepest pockets, have spent the last three years licking their wounds and repairing their balance sheets from the ravages of the housing bubble.
Roll-up firms also have curbed their activity. Memphis-based WealthTrust has encountered financial difficulties, and sold some of the RIA firms in their network back to the original owners. Last year, Focus Financial Group was forced to raise a second round of capital, diluting the original investors and advisors who affiliated with them before the financial crisis. In some other cases, there are reports of squabbling and looming cramdown battles for controlling equity interests between senior lenders, mezzanine lenders and private equity investors as the entities wrestle with problems caused by excessive leverage.
Meanwhile, Mark Hurley's Fiduciary Network reportedly is profitable. But it is only making two to four investments per year, so it hardly represents a solution to thousands of RIAs wrestling with succession issues.
Some observers think the RIA business simply is not conducive to the roll-up model. Private equity firms and lenders don't have a lot of experience dealing with businesses where most of the assets are intangible, one observer explains.
Another expert sees it the same way. "Roll-up firms are rarely successful in people businesses," Pershing Advisor Solutions CEO Mark Tibergien says. "You need to get to critical mass quickly to establish credibility. And you need to get to that liquidity event fairly quickly, say within five years."
Negotiating each deal with individual RIA firms is an arduous undertaking that often takes six to nine months. After all that, the two parties frequently end up deciding not to complete a transaction.
The questions advisors must ask before entering a deal are multidimensional. "What price does the stock have to reach to be worth giving up the cash flow to fund the parent?" Tibergien asks.
The value of the parent's equity is partially determined by the quality of the other firms in the consolidator's portfolio. "If it's a portfolio of old advisors who are no longer in a growth phase, that's what you have stock in," Tibergien says.