A new report produced by Advisor Growth Strategies and sponsored by BlackRock examines the driving forces of price and terms in advisory firm mergers and acquisitions. The core of the analysis provides a window into successful deals, including which buyers are prevailing and which sellers are optimizing transactions.
Entitled "The RIA Deal Room: New demands and realities in M&A," the study busts some common myths that circulate in our industry. For example, the so-called multiple is not the same regardless of firm size and client characteristics. Nor are all deals cash deals.
Industry professionals with experience in transactions know that economics do contribute to the price. Terms are defined by other factors as well, however, such as who is assuming the risk, the proclivity of clients to move to the new firm, the organic growth potential of the business and the demonstrated history of solid financial performance.
Much to the dismay of many prospective sellers, 30 years of advisory experience alone will not command a premium price. They also must have an enduring business, depth in their team, a process for generating new business and a balance of older and younger clients who are accumulating wealth.
Furthermore, cash is not always king. Transactions driven by the liquidity needs of a seller tend to result in a lower total payment.
An analysis of the data showed that the median multiple for practice sales in the 2015-2018 period was 5.1 times EBITA. The same methodology applied to free cash flow found it to be roughly the same — without meaningful balance sheets, there isn't much of a difference.
So, what does change the overall multiple? Brandon Kawal of Advisor Growth says, "It's likely to be a flip in the supply-demand equation. More sellers = picky buyers = lower multiples." He added, "When Cerulli estimated there are $2.4 trillion of assets in motion in the next decade, it will become a demand-supply equation instead."
The researchers did find a material change in deal terms over the past few years, with structure often being defined by the size of the firm being acquired.
As an example, the typical financial terms involving RIAs with under $200 million of assets under management were 55% cash, 38% equity and 7% contingent on certain performance elements. On the opposite end of the spectrum, RIAs with between $500 million and $1 billion of AUM were paid 33% in cash, 45% in equity and 21% contingent.
What Does It Mean?
While the authors did not explore the reasons for this swing, several key ideas emerged from their study.
First, in smaller firms, the owner likely will ride off into the sunset; the transaction is more like a purchase of his assets than an acquisition of his business. However, the equity in the combined enterprise helps to ensure that the seller remains interested in the company for a period after the deal is done to ensure continuity.
In the case of the bigger firms, buyers are acquiring a growth business and the larger equity component effectively transforms the sellers of the old firm into partners in the new firm. The contingent component mitigates risk and ensures that their new "partners" stay focused on driving client retention and growth. The larger risk in the big firms also means that shifting more of the terms to the sellers makes sense.
Advisor Growth observed that large acquisition brands have been setting the pace in recent times. Firms such as CAPTRUST Financial Advisors, Mercer Advisors and HighTower have a great history with mergers and acquisitions as well as integrating firms into their own brands.
Many of these players are on the road to creating nationally-branded wealth management firms under an RIA charter much as Schwab, TD Ameritrade and E-Trade have done as brokerage firms. This sets up an interesting battle for clients at all wealth levels in the coming years.
