Over the past two years, many owners of RIAs with $200 million or more in assets have become accustomed to being approached by financial or strategic partners with acquisition offers.
And there's no end in sight to the M&A consolidation frenzy. Last year, deal volumes hit record highs, and with the entry of more private capital than ever into the independent wealth management space, these records could well be broken by the end of 2022.
But as roll-up consolidation trends intensify, we're starting to see some exciting alternatives to change-of-control transactions.
Increasingly, successful RIA owners who are confident their businesses are well positioned for future growth are choosing to simply sell a minority stake in their firm.
When To Say No—And When To Say Yes
To be clear, the minority stake sale is not an approach that works for everybody, nor is it ubiquitous in the industry—only when right opportunity arises.
Indeed, for independent financial advisors who are ready to move towards retirement in the next few years, a traditional full acquisition and roll-up structure could be the best possible decision.
But RIA owners with a high growth firm, a solid brand, scalable infrastructure and a 10–20-year runway are potentially a great fit for a minority stake sale.
This is especially so for RIA owners whose goals are to attract fresh capital that can be deployed primarily for growth, such as acquisitions of smaller books or taking some of the proverbial chips off the table with a partial liquidity event that diversifies their personal finances by monetizing some of the equity in their business.
Let's Talk Deal Structures And Proceeds
But establishing that your goals and business broadly align with a minority stake sale structure is just the first step. Beyond identifying the right strategic minority partner, there are a host of considerations related to deal structures and proceeds.
First, consider that a typical minority M&A partner will take a 20-25% stake in your company. In exchange for giving up that equity stake, RIA owners need to clearly determine what the best use is for that new capital, as well as the value they will be receiving from their new strategic partner.
One of the most effective ways for RIA owners to use the proceeds from such a sale is to pay down legacy debt to improve their financial standing. A close second is to retire relatively dormant equity partners from the business.
Why? Because a clean balance sheet and clear ownership lines are mission critical for RIA owners when they decide to pursue further growth of any kind that requires further financing, as having a “clean” balance sheet and equity cap-table can make facilitating future transactions easier.
Lastly, we mentioned “taking-some-chips-off-the-table” earlier. This is important for many advisors, as a vast majority of their net worth is the equity in their business, and those advisors might value the liquidity to meet their personal financial goals.
'Tag Along' Rights
Perhaps one of the most significant levers of value creation for RIA owners who sell a minority stake in their business to a larger firm is the concept of "tag along" rights.
Here's what it means in plain English: If the larger firm that acquires a minority stake in a smaller RIA is sold, the smaller RIA's owner can economically benefit from the deal, should they choose to do so. This is usually in the form of a “tag along” right that allows for the RIA owner to participate in the larger multiple that the parent firm would garner in the event of a sale.
The tag along value is typically set between 75 and 95% of the total value of the revenue they contribute to the sale of the larger firm, which is most likely considerably more than the RIA owner would get in a stand-alone sale.
It’s a “win-win” for both firms in that the larger firm gets the multiple arbitrage on their minority stake and the smaller firm gets tag along rights if the larger firm sells, which are economics they would not be able to participate in otherwise.
Towards A Higher Growth Future
How does a $500 million RIA become that $2 billion success story? It’s not easy, but a strategic partner can be invaluable in helping an RIA owner realize the full economic potential of his or her business,
Partnering with a larger firm gives RIA owners access to deeper management experience, guidance and resources. Ideally, such a partnership will include sourcing growth opportunities in the form of client prospects and potential acquisition targets.
Selling a minority stake in an RIA remains relatively less popular than being bought outright as part of a roll-up consolidation play.
But it's an approach that will almost certainly continue to proliferate as capital continues to come off the sidelines and new entrants seek other avenues of growth in the wealth management space.
Dan Newhall is the chief development officer and managing partner at Perigon Wealth Management.