Smaller RIAs are combining because consolidators have deep pockets and are actively looking for RIAs to buy. Money management teams are breaking away from brokerage firms and banks, with many of them joining established RIAs. All in all, the mergers and acquisitions of RIAs continue at a brisk pace and are likely to increase in the near future.
The serious flaw in the RIA mergers and acquisitions model is that the combined entities need to be more successful than they would be separately. There are a number of ways to achieve more success. Cost reductions are often touted when justifying combinations, and enhanced capabilities are another regularly cited rationale. What is clear is that without increasing relative profits, many of these combinations will prove impractical. They will fail.
To date, generally rising markets have provided cover for what will turn out to be many bad RIA acquisitions and mergers. With rising markets, client investment portfolios go up, spinning off higher fees. But what will happen if the markets stop rising or, worse yet, seriously fall? Revenues at these firms will suffer, and, depending on the precise nature of the deals, incomes for advisors will deteriorate. The valuations of firms will plummet.
The only logic behind combining or buying RIAs is for the new entity to be more profitable. The most powerful way for that to happen is to generate greater organic growth. While expense reductions will contribute to greater profits, this approach will only go so far.
For combined entities to enable their partners to be more successful, firms require organic growth, which can happen in a number of ways. For example, if an acquired RIA has more capabilities to offer clients and prospects, greater revenues are very possible along with a higher company valuation. If the acquired RIA can benefit from the well-established and potent brand of the acquirer, for instance, greater revenues are very possible, along with a higher company valuation.
The most effective route to organic growth is usually through bringing in more assets to be managed. If the business development activities of the advisors in the combined entity are no different than before the acquisition or merger, the feasibility of the entity being very progressively successful longer term is increasingly unlikely.
With relatively few RIAs growing at a respectable rate due to them sourcing new clients, the idea of buying books of business and calling it an increase in assets under management can be quite appealing. But this strategy is not inherently contributing to the bottom line. Moreover, many expenses are often involved in acquiring a firm and they need to be recouped. There is the time and effort of all involved as well as a variety of outlays for lawyers, accountants and the owners of the acquired RIA.
RIA acquisitions and mergers, without increases in the bottom line ,are probably going to stagnate with a sizeable number of them failing. Organic growth is the most powerful way for the combined entity to deliver higher incomes to the owners and thereby increase the value of the combined firm.
Russ Alan Prince, president of R.A. Prince & Associates, is a consultant to family offices, the ultra-wealthy and select professionals.