By all measures, 2021 was the most prolific year ever in the history of the wealth management industry in terms of RIA mergers and acquisitions, with no signs of slowing as we head into 2022. Indeed, year-to-date (YTD) our industry recorded 165 acquisitions with a record breaking 64 transactions occurring in Q3 alone, the most in any other quarter ~ ever. (Includes all transactions where Seller had a minimum of $100 million in assets under management. “Third Quarter 2021 DeVoe & Company RIA Deal Book”)
The factors that made up the deal storm in 2021 continue to accelerate and will have a dramatic impact on the shape and direction of the wealth management space for years to come. Chief among these have been the entrants of more and more buyers pursuing dwindling baby-boomer era seller-founders. (Baby-boomer era represents those born between 1946-1964 and are currently 57-75 years old.) According to DeVoe and Company, the number of RIA buyers has skyrocketed to 88 doubling in just 5 years, and that number is climbing as more PE backed RIAs and financial buyers seek to enter the RIA roll-up market (Source: DeVoe & Company’s Third Quarter Deal Book).
Indeed, in 2013, 36 RIAs were sold to a small handful of buyers, and since then another 1,000 RIAs have been bought by a much deeper buyer bullpen. Advisors now report that they are being solicited at least once a month to sell their businesses, while larger RIAs are being hit up twice a month from cold call outreaches.
As a result, deal pricing has mushroomed as the buying frenzy increases. Most notably, asset managers looking to replace their commoditized money management business with the more predictable and sticky wealth management businesses have become the primary drivers as they bid up pricing. These legacy asset managers are leveraging their aging, commoditized and declining asset management revenues to go all-in on transforming their firms into wealth managers, a high-risk strategy that is not for the faint of heart. Some of these well-known asset managers are paying stupefying purchase multiples, apparently choosing to win the business at any price and thus price-out their competition.
This is a dangerous strategy as pricing beyond perfection carries significant risk barely tolerable in a bull market, let alone a bear market. These buyers are driving pricing up so high, we are now approaching “price convergence” on near-scale, or at-scale sellers. Specifically, the purchase multiple paid for the seller asset is nearly the same as the buyer’s selling multiple.
This strategy of “price convergence” they are playing is designed to push buyers out of the market as they pay premiums on deal values so that it no longer makes economic sense for buyers to pursue inorganic strategies. For example, much of the M&A activity in the RIA space has been to arbitrage the EBITDA multiples from larger firms acquiring smaller firms with lower EBITDA multiples. Larger firms are able to capture that EBITDA multiple difference to create incremental business value. However, when pricing becomes too high, it no longer makes sense for buyers to deploy their capital in this manner and they are better off focusing on organic growth strategies instead.
The upshot here is that culture matters now more than ever. With this many suitors, the wise advice is to be careful who you date. From my experience in doing 12 deals this year and over 55 deals in the last five years, cultural fit is an absolute must. While the temptation to take the higher price is there, what firms are now telling us is that those who did choose money over culture are regretting it tremendously. Those deals did not go as they had thought, promises made were not kept, and they are now part of a larger entity that isn’t aligned with their clients, staff and their ultimate role in that firm. Further, unwinding these deals and breaking up with their acquiror will ultimately destroy more value than they had received in exchange for the higher price—so they feel trapped—a cautionary tale and not the reward these selling principals had hoped for in exchange for their life’s work.
Another key theme playing out in the deal landscape this past year is the cost of waiting. Is this seller’s market going to last forever? The equity markets are at all-time highs despite recent pull-back. As we all know, markets are cyclical in nature and there will be a market break most likely sooner rather than later. Looming inflation, continued Covid variants, supply chain issues and the like are all unknown variables that can rapidly contribute to market volatility. Recent history has shown that after a prolonged recession or market correction, deal prices can plummet dramatically. In fact, after the financial crisis of 2008-2009, pricing fell by over 40%.
Additionally, industry data shows that the majority of firms are not materially growing net of market appreciation, so if you are thinking about selling in the next couple of years, you are taking on “uncompensated risk”—e.g., there is no benefit for waiting so there is no better time than now to start the process.
Other developments that are contributing to deal volumes this year are the rise of “hybrids” coming to market. Dually registered RIA/BD firms are looking to accelerate bridging their legacy commission business to advisory revenues and its predictable, recurring nature wrapped in a desirable fiduciary duty service model. However, in order to do that, they need to enhance their firm’s muscles in terms of middle and back-office support, which they don’t fully have and which is expensive and time-consuming to develop. Sellers want to offload these time consuming and expensive activities and focus on what they do best, service existing clients and winning new ones. As a result, hybrids are looking to well-capitalized firms that have an institutionalized infrastructure and technology footprint that can not only take over all middle and back-office functions, but also enhance the client value proposition by delivering a full-suite of family office services to help hybrids become more competitive.