Before the coronavirus gave the market a cold, consultants say that advisory firm valuations had reached nosebleed levels.

Andrew Altfest, whose firm Altfest Personal Wealth Management has been tentatively seeking merger targets, said that in many cases the firms he was looking at were often too rich for his blood. “It has to be a fair rate of return to buyers to compensate for the amount of time and investments, and I think some of the valuations were high.”

But now the calculus has changed with the coronavirus, the market downturn, self-quarantines and the shutdown of much of the economy. Those RIA firm valuations are going to come down.

“I believe this sudden and aggressive down move in the markets exposes the vulnerabilities of most RIAs, particularly smaller RIAs,” said Matt Cooper, the president of Beacon Pointe Advisors, a Newport Beach, Calif., firm that’s in acquisition mode. “Most [firms] bill as a percentage of AUM, and with asset prices falling across the board, RIAs are [going to see] an almost certain drop in revenues. Because a large percentage—my guess is well more than 50%—bill quarterly in advance, we are a week away from pegging values for [second quarter] billings and revenues.” (Cooper made the comments last week, as April 1 loomed.)

The owners paying advisors a fixed salary “are shouldering all the risk of the reduced revenues,” he said.

But just as the stock market decline itself leads to opportunities (if you are in the position to buy), so too do reduced valuations for RIA firms. One silver lining: Junior staffers are now in a better position to buy into the firms they have helped build, say consultants, because lower revenue means lowered valuations.

“A second silver lining is that the loans for these purchases—the interest rates are going to be better, that’s another benefit,” said David DeVoe, whose firm DeVoe & Co. consults with advisors on M&A activity. “The third thing is the shock to the system will hopefully jolt many advisors into putting these plans in place. We’re still an industry that has 70% of advisors that do not have a written succession plan.”

But consultants say the process must be thought out carefully. DeVoe said he recommends separating equity from compensation. There’s a reward for labor and there should be different rewards for being shareholders.

Philip Palaveev, a consultant with the Ensemble Practice, said in mid-March that a healthy firm that’s profitable with good teams won’t have trouble going through the crisis, especially if they hold onto relationships with clients. Firms with little debt, good capital reserves and 25% profit margins are going to be in better stead to get through the crisis, he said, as they got through the crisis of 2008. But he said advisors very often don’t look at their own P&L sheets and that’s going to make it hard when revenues decline.  

Palaveev said it would be tempting, but a mistake, to use the capital cushion if times get tight for advisories trying to pay their bills. However, he said it is a more defensible use of capital reserves to help partners who are buying in by making disproportionate distributions or to make a second loan to them.

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