The effect of these combined forces may also cause some acquirers to consolidate or divest their holdings, so don’t be surprised if a firm that was once acquired by one buyer ends up with another. Once again, we saw this in 2008 when some of the most active acquirers actually left the advisory market and sold their holdings to other consolidators or back to the original owners.
Interest rates have helped valuations tremendously, but that may not always be the case.
Available Credit
Credit has also been readily available to acquirers and internal buyers. Today, firms can rely on many lenders who are willing to extend millions toward internal succession or the acquisition of books of business. This has allowed thousands of employees to become owners at favorable terms and has allowed founders to put some money in the bank. It has also fueled the feeding frenzy for books of business, where services such as FP Transitions report 50 buyers or more for every seller.
Fifteen years ago, almost every single transaction I observed was seller-financed, i.e., the retiring owner had to become the bank. Today, firms not only have access to credit, but they can also shop lenders. I frequently hear our clients scoff at the rates offered by specialized lenders since they receive even better terms from small local banks.
If the credit capacity shrinks, we will witness a contraction in demand. And once again, our good friend Adam Smith would suggest that lower demand means lower prices.
Growing Markets
The growing markets have also helped advisories a lot up to this point. When assets under management are growing by 22% or more simply by virtue of the markets, firms don’t really need to grow in any other way. Also, the growth created is pure gravy—it does not require any additional effort in managing client relationships or enhancing client service.
Indeed, the good markets have actually disguised the fact that most firms are not growing their client base very well at all. The organic growth rate has not been very impressive (net new client additions equal 6.1%), and the strategic focus for many firms has shifted to acquisitions, where the results have been very lucrative.
In a virtuous circle, growing markets also tend to make investors more optimistic and therefore more likely to invest. In fact, the best business development years in terms of adding new clients tend to come on the back end of recessions when investors approach the market with renewed confidence. A little turbulence like we experienced in 2020 seems to be the best condition for investors to consider an advisor. First, it creates the sense that “things can be a bit scary, so perhaps I need help.” At the same time, it encourages investors to think, “Things always seem to work out well in the end, so I should be investing. Just look at those 2021 returns!”
Finally, growing markets make it much easier for clients to pay their fees. When they have a 26% return (the S&P returned 26.7% in 2021), it isn’t very painful for them to accept a 1% fee. Investors have been very happy to collaborate with advisors and have mostly appreciated that collaboration.
Low-Maintenance Relationships
Call your favorite airline during a snowstorm, and you are likely to be greeted with the dreaded “due to extraordinary call volume, we are experiencing longer than usual wait times” message. Every business staffs to normal levels of service, not to emergency levels. Advisory firms are no different in this regard. The typical firm in the industry has 96 clients per professional and about 45 clients per staff member (advisors and support). The service model behind these numbers assumes firms can schedule client communications normally and not field many emergencies.
Imagine a scenario where all clients are calling at the same time and seeking a meeting or a phone conversation. The sheer number of hours and people needed to respond would be daunting, and most firms are not able to handle such “peak demand.” Thankfully, emergencies have been rare, and we have come to assume that they won’t happen. As a result, most firms would admit they have pushed a bit too far the limits of how many clients they can handle.