RIA merger and acquisition activity is in the doldrums, DeVoe & Co. reported Monday. With 63 transactions posted in the first quarter of 2023, M&A activity was 7% lower than the 68 transactions that marked the opening quarter of 2022 — the first time since 2014 that the year has started with a weaker first quarter than in the previous year.
The current slowdown came on the heels of the fourth quarter's 20% decline and marks the industry's first six-month downturn since 2018.
Several factors are driving the slowdown, DeVoe reported. The confluence of slightly compressed valuations and increased transaction expenses — brought on by a declining stock market and rising interest rates — and distracted sellers contributed to the deceleration. Even consolidators reduced their standard level of activity, with some traditional buyers not completing transactions in the first quarter.
According to DeVoe, despite the dampening effect of these factors, "M&A activity in the industry remains extremely high on a relative basis in comparison to even recent years."
DeVoe focuses on transactions of $100 million or more in assets under management. The firm limits its tracking to $100 million-plus RIAs to optimize the statistical accuracy of its reporting and screens out the SEC-registered hedge funds, independent broker-dealers, mutual fund companies and other companies that do not operate as traditional RIA firms.
Consolidators Remain Top Buyers
Consolidators are still the dominant buyers of RIAs, notwithstanding the recent fall in their share of acquisitions. In DeVoe's definition, these are companies whose business models are predicated on making RIA acquisitions or are active acquirers with inorganic growth as a core plank in their business strategy.
Consolidators' share of transactions deflated to 48% in the first quarter from 50% for all of 2022 and 54% for 2021. They announced 30 transactions in the first quarter, down from 38 a year ago.
Interest rate increases indirectly contributed to consolidators' slowdown, the report noted. These acquirers, commonly backed by private equity and leveraged with debt, are affected by rate increases in several ways. Higher rates increase the cost of financing current transactions.
Perhaps more important, debt service on the loans from their historical transactions balloon. These costs not only erode future profits but can also limit access to additional capital or even threaten debt covenants.
Buyers are also reworking deal structures to the benefit of sellers. Many firms are adding more consideration to earnouts. The new structures will enable today's sellers to benefit from tomorrow's expected stock market increases, which can ameliorate resistance to selling while the stock market is compressed, according to DeVoe.
