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.