“Many of you are exactly in that position where you have borrowed money to buy the equity of the firms … and if that’s the case you’re looking at a difficult personal situation,” Palaveev said in a webinar on March 18. “The partners who have borrowed money to be owners of this business are very often your top contributors, your rising stars. … And we can’t really let them suffer too much. … We can’t ask them to spend every dollar and every cent trying to hold on to an equity position. It won’t work very well for them and it may create a disastrous situation between the firm and its owners.”
DeVoe said that after the financial crisis, valuations for RIA firms fell from their pre-crisis highs and took a few years to come back. “Multiples of cash flow had expanded into double digits for large firms,” he said. But cash flows are likely to compress and nobody’s sure how long that will last. For those advisors who were hoping to sell, deal structure, including the down payment, is going to be more important than valuation. “Rather than wait around for two or three years … let’s structure the deal so that you’re able to grow and grow even faster, run a better business within the shelter of [an acquirer’s] tent.” If you’re selling to a sophisticated buyer, he said, one that has calculated the ways it can help you grow, those firms will pay for a higher valuation than a neighbor firm down the street.
Cooper said that even though lower valuations can help junior staffers buy in, it’s a difficult call to make.
“In general, founders do not want to buy themselves out, at a discount, with their own money," he said. "This means they don’t want to carry the note, take a significant discount on the price because it’s a minority purchase or the buyer claims their ‘sweat equity’ is what helped create the value, then have the note serviced by the cash flows attributable to the equity purchased, which they would have collected anyway. The icing on the ‘I don’t like this deal cake’ is if the founder is forced to carry the note, they are doing all the above and carrying 100% of business risk they carried before the transaction.”
He also said that junior staffers are not likely the risk-takers that founders are and may not want to go out to get a loan to buy a minority stake in a risky business. The pandemic has shone a light on firms that aren’t actually growing, he said.
“Most small firms weren’t growing beyond the market for the last several years anyway," he said. "This market pullback has the potential to expose a lot of firms that weren’t adding new clients and weren’t adding new AUM attributable to new clients.”