Gladstone, DeVoe And NewEdge Discuss Market And Interest Rate Challenges To M&A, Countervailing Forces, Resilience Of RIAs And Robust Due Diligence
RIA M&A set new records in 2022, and many experts expect it to flourish long-term, though views differ on how market and interest rate conditions will affect the near-term RIA M&A space. For some, choppy markets and high interest rates constitute a headwind against the steady increase of M&A in wealth management, while others see a variety of factors propelling M&A forward.
Add to this uncertainty recent scandals and lawsuits originating outside the RIA space, such as JP Morgan’s suit against Frank founder Charlie Javice and the FTX debacle, and some buyers and sellers may feel uneasiness about signing onto a deal.
After all, no one wants to be locked into a bad deal, whether because of market conditions directly affecting the transaction or weakening the deal partner, or because due diligence failed to uncover exaggerated metrics or – in the case of JP Morgan – worse, if the allegations are true.
These concerns focus us on challenging market conditions, countervailing forces, resilience of RIA sellers and effective due diligence.
Challenging Conditions Versus Driving Forces
Addressing the extent that current interest rates and market uncertainty challenge M&A activity, Derek Bruton, Senior Managing Director at Gladstone Group, says that his firm “does not believe that these will lead to a measurable slowdown in activity. These challenges have largely been mitigated by the rising level of competition from new buyers entering the marketplace.”
David DeVoe, Founder & CEO of DeVoe & Company, states, “M&A activity may continue at a slower sustained pace due to the already high interest rates and the anticipation that they will continue to climb in 2023.”
However, DeVoe believes that the forces underpinning M&A remain: “Aging owners increasingly seek an external sale to solve for succession, while a growing percentage are merging into larger firms to gain the benefits of scale and optimize growth.”
He concludes, “Given these competing drivers and a wide variety of other unpredictable factors, the M&A volume for 2023 is challenging to forecast.”
Bruton points to the same contributing forces of aging owners and the need for scale, stating, “The smart money loves predictable, recurring revenue, high client ‘stickiness,’ and the American investor’s increasing demand for independent, fiduciary advice in all market conditions.”
Neil Turner, Co-Founder and Co-CEO of NewEdge Advisors, says that while M&A may continue, the buyer profile could change. “Many RIA-only firms, especially those backed by institutional capital, may be forced to take a back seat because of the rising cost or even the availability of debt and EBITDA that went backwards due to the market pullback. Now, corporate debt is more expensive if it can be obtained at all.”
At the same time, Turner points out that “wealth management firms with IBD platforms that have well-run cash sweep programs are in a position where the passive income can be used to fill the void of M&A transactions.”
Resilience And Weakness
Current challenges and countervailing factors affect more than the M&A landscape, they affect the strength of the underlying purchase – the businesses of the RIAs themselves.
DeVoe points out that an RIA’s revenues are linked to assets under management, which may be impacted during difficult times, but, “As the stock market generally increases over time, this correlation is typically positive and is an attractive element of the business model.”
“Market declines will compress an RIA’s economics, but these companies are resilient,” he concludes.
DeVoe explains how market challenges can catalyze growth for well-run RIAs: “Their low client/advisor ratio and fiduciary duty drive a higher level of care than other broker/advisor models, and consequently, their clients feel supported through crises. Happy clients refer their friends – who are often unhappy with their current provider.”
“Wealth management firms have weathered market and regulatory challenges pretty well,” says Bruton.
However, not all RIAs are equally strong in the face of challenges, according to Bruton, noting that average annual growth of independent advisors is in the low single digits for all but the largest RIAs.
Wirehouse advisors, on the other hand, “grow their books of business as fast, and perhaps even faster, than independent advisors. Brand, scale and marketing prowess – hallmark traits of the wirehouses – can only be matched by the largest RIAs.”
Bruton states that, “There always has been and will always be more value in RIAs with proven growth and good client demographics and less for the inverse.”
Turner looks to larger organizations and IBDs to lead the way in M&A. “I believe that RIA M&A this year will be driven by wealth management firms with established IBDs and aggregation of RIA aggregators.”
Another possibility remains – that market challenges reveal exaggerated seller metrics that increased deal valuation beyond prudent limits.
Bruton does not believe we’re likely to see that type of scenario in RIA M&A. “It’s not the exaggeration of metrics by sellers that leads to bad deals. Good, educated buyers understand the components of actual and forward-looking earnings.”
DeVoe agrees, saying, “Today’s buyers are sophisticated and implement comprehensive due diligence reviews.” He adds that his firm “guides buyers and sellers to conduct detailed assessments of historical economics, and thoughtfully consider synergies in projections.”
Bruton warns that the origin of bad deals lies elsewhere. “Sometimes a buyer’s eyes get too wide when they fall in love with an RIA seller, and while competition may lead to a premium bid, clawback and earn-out terms will temper ultimate results.”
Bruton says that his firm leads potential buyers and sellers in a successful direction via “a disciplined focus on striking a balance between the buyer’s and seller’s needs to produce a partnership that each constituent can toast to not only at deal close – but also a year later!”
Janeesa Hollingshead, Executive Editor at Wealth Solutions Report, can be reached at firstname.lastname@example.org