Deal flow in wealth management mergers and acquisitions has remained strong, valuations have yet to drop, and all signs point to the status quo continuing into 2023, according to a panel of M&A experts.

The panelists—Mark Tibergien, former CEO at Pershing Advisor Solutions; Raj Bhattacharyya, CEO at Robertson Stephens; and Peter Nesvold, partner at Republic Capital Group—shared their perspectives in a webinar earlier this week, moderated by Scott Slater, vice president at Fidelity Institutional.

They agreed that while 2022 might have individual investors losing sleep over market dips and swirls, it’s a great time to be a financial advisor.

“This is the time when people in this business earn their keep, that’s for sure, but the business of wealth management couldn’t be better,” Tibergien said. “Whether you choose to remain independent of corporate or passive ownership, or whether you intend to merge or acquire, it’s a dynamic industry to be in.”

The economic uncertainties that stress investors these days pale by comparison to 2008, when it seemed the future of the entire financial system globally was at risk, or even to the technology bust of the early 2000s, added Bhattacharyya.

“What’s important to remember is that in every one of these situations, a properly constructed portfolio, managed by an advisor, that takes into account the client’s wealth plan, has stood the test of time,” he said. “The fiduciary relationship we have with our clients in the RIA space is extremely important. It is these markets that test the RIA model, and I think the model comes out even stronger when the markets are challenging and when our clients most need us.”

Even under the strain of the Covid economy, financial advisors had plenty of opportunity to branch out and take on some personal risk, as seen in the more than 500 RIAs that opened doors in 2020-2021, Nesvold said.

“That’s pretty remarkable, because if you walk down Madison Avenue you can see how devastating the pandemic was to small businesses. And RIAs are small businesses,” he said. “And yet in terms of numbers, RIAs have been able to thrive despite what we’re seeing in the financial markets. That’s testament to the resiliency of the RIA model and why it really is a terrific business.”

Deal Flow Is Strong

According to Fidelity, the number of completed RIA deals is up 25% over the last year, with transactions for firms with assets under management under $250 million and those between $250 million and $500 million seeing the strongest activity, Slater said. Meanwhile, assets under management are off by only 10%.

This is another sign of industry resilience, Nesvold said.

“When you look at M&A globally for all industries, M&A volume was down 30% year to year in the first half of 2022, but up in wealth management,” he said, adding that he expects to see continued strength in 2023. 

The reason? First, he said, the amount of private equity money that’s come into the industry has created a cadre of professional buyers who are disciplined enough to ignore market timing and focus on acquiring attractive business regardless of the markets. And second, there’s a strong population of advisors aging out of the business.

“If you were a 55-year-old advisor during the Great Financial Crisis, you’re almost 70 now,” he said. “These deals are going to happen simply because of demographics.”

Valuations Remain High

For many of those advisors ready to retire out of the business, valuations remain high, the panelists said, but some of the terms are changing. Much of the data here is put together informally, they admitted, as while there’s reasonable transparency for deal volumes, valuation data is hard to come by.

“It’s very opaque, there’s no transparency,” Bhattacharyya said of the advisory industry. “But what we’re seeing personally is mid-teens EBITDA multiples. And that’s for several billion in assets, the right geographic regions, a young management team and real firm growth.”

EBITDA—earnings (net income) before interest, taxes, depreciation and amortization are deducted—is a common way for potential buyers to look at a company’s profitability.

While sellers would love for pricing to be tied to revenue, “that’s not relevant,” Tibergien said. And sale multiples can appear to be all over the ballpark, he continued, because different advisory practices will be priced differently as buyers factor in future prospects.

“If it’s a small advisory practice with no capacity and with old clients, it’s going to be priced differently than if it’s a more dynamic firm that has organic growth. We’re talking about professional investment here in people who advise clients for a living,” Tibergien said. “The buyer has to understand what the growth potential is in any of their businesses, and what the likelihood of continuity is.”

With that in mind, he said, he’s seeing EBITDA multiples in a range of low- to mid-teens.

“Beyond that, we’ve heard people talking about 20 times EBITDA, but that’s with a 5% required rate of return, which is hard to justify unless you can achieve some sort of synergy within the business,” he said.

Nesvold said he agreed that valuations haven’t started to drop yet, but he is perceiving a cooling, seen mostly in the level of aggression among buyers.

“We still are seeing that high bid in a process coming in at, or near, historical highs. I’m just not seeing three of them anymore. Maybe I’m seeing one or two,” he said. “What ends up happening in downturns is that sellers are backward-looking, saying, ‘Well, I was worth X just a couple of months ago,’ and buyers are forward-looking, and they say ‘Yeah, but you’re worth Y now.’ So there is a bit of a split there, and that evidences itself more in deal structure.”

Shifting Deal Structures

Nesvold said that deal structures are now including more earnouts, more deferred compensation, to incentivize the seller to hit future targets.

In addition, Bhattacharyya said, other deal terms are shifting away from “the seller’s market” where they were a year ago, and there is better risk alignment between buyer and seller on many of the points that used to be very much in the seller’s favor in the past.

One area of notable difference, he said, are the kinds of stakes buyers are acquiring.

“Buyers don’t need control of the business. It’s the advisors who control the business. It’s whomever is servicing the client. That’s where control really resides. And so we’re seeing more deals for minority stakes of 25% or 30%,” he said. “In minority deals, there will be more minority protections—at least information rights, maybe a board seat, and the right to say no on a number of things. But surprisingly on valuations, not a massive discount.”

In one sense, buyers have been becoming more selective—not because they’re not seeing quality firms coming to market, but because deal flow is so good that many of the bigger consolidators have as many as 15 or 20 firms in the pipeline for letters of intent, Nesvold said.

“When you have that kind of deal flow, it does force you to become more selective. We’re not seeing busted auctions, to use a banking term. Everybody is still finding a home. But there are certain buyers that are taking a step back,” he said.

And as interest rates change and credit tightens, the more highly leveraged buyers might need a little time to adjust to those higher rates and work out just how much credit the lenders are willing to put on these businesses, he said.

Does that mean that advisors who have been thinking of selling but haven’t need to move quickly? Not at all, the panelists said. Especially if that advisor has a couple of more years before wanting to pull the trigger.

Sprucing Up For A Sale

As buyers have gained experience as integrators and might be slowing down acquisition rates, this is a good time for sellers to reflect on what it is they want out of a sale. There’s a “right” buyer for every seller, the panelists said, where the seller is looking to spend another 10 years growing the business or wants nothing more out of a deal than a financial transaction and a retirement party.

“More and more, buyers, even the ‘serial acquirers’ are probably very focused on that fit, in order to create better value. Aggregation for aggregation’s sake isn’t going to happen for much longer,” Bhattacharyya said. “So if you want to stay in and grow your business, don’t necessarily go for the highest dollar. Go with the party that will grow your business best. That’s the better deal.”

In Tibergien’s discussions with RIAs, he said he’s observed that many tend to compare themselves only to other RIAs, forgetting that there many other institutions—from the advisor’s custodian to the big wirehouse next door—that are all competing for the same type of client.

That question of differentiation is as vital today as ever, and Tibergien said the two most common areas where differentiation can take place are in targeting a niche and in developing technical expertise.

“If you’re going to be a niche-focused firm, it’s not enough to say we’re working with clients with $10 million. You have to look at what’s the source of their wealth, what’s the family structure, where are they in their life cycle, what are the characteristics of that individual, so you can create a community of clients,” he said. “An example of that would be business owners in transition, which is a great niche market. Or professional practitioners, like lawyers or accountants, or widows, or people going through a divorce, and so forth. But the idea is creating a community of clients.”

Technical expertise, he said, might be catering to people who have a philanthropic orientation, an interested in ESG, or who are in need estate planning.

“Firms that are able to position themselves clearly as an expert in a technical area, or an expert with a certain type of client, tend to be growing faster than those that look at anybody who can flog a beer as a prospect,” Tibergien said.  

Figuring this out now for a sale down the road will increase an advisory firm’s value no matter what the market.

“It’s not inevitable that you’re going to sell,” Tibergien said. “But it is inevitable that if you don’t do something about building continuity in your business, the business will die with you.”