The Un-Unsustainability Of RIA Multiples: A Contrarian Perspective

Current Multiples Are Justified Because Of Fragmentation, Private Equity, And The Advantages Of Acquiring Talent And Clients Rather Than Recruiting Them

The financial advisory industry has witnessed a surge in mergers and acquisitions, accompanied by considerable handwringing and a sense of doom around the “unsustainable” multiples being paid for RIAs. While some market participants express apprehension about the current valuation levels – sentiments that are understandable and not completely invalid – we at Gladstone Group hold a contrarian view.

We believe that the multiples being paid for RIAs are not only sustainable but also justified by three key factors: the unique characteristics of the industry, the transformative impact of private equity involvement and the strategic value of talent acquisition.

The Business Of Financial Advice Is A Cottage Industry (And Don’t Believe Everything You Read And Hear!)

The financial advice industry is a cottage industry characterized by a lack of dominant market share players. While businesses with huge capital requirements – such as automobile manufacturing and energy production – are dominated by a handful of players, the dispensing of financial advice remains fragmented. This absence of market concentration provides ample room for growth and acquisition opportunities without the risk of a single player controlling the market.

The fragmented nature of the industry ensures a level playing field for RIAs of various sizes, fostering a dynamic and competitive environment that supports the sustainability of multiples. Based on our ongoing financial reviews of hundreds of RIA P&L’s and valuation and M&A transactions scores, we believe rumors around multiples are sensationalized and overblown.

Rumors around multiples are sensationalized and overblown.

The fact is that successful RIA owners with good CAGR, quality client demographics and defensible EBITDA will receive tremendous, life-changing money for the businesses they have built and nurtured over the years, but the 20x multiples that are bandied about are reserved for the biggest roll-ups, not the RIA next door.

Private Equity Has Changed The Game Forever

Let’s keep it real: PE firms, renowned for their astute investment strategies and access to substantial capital, are nothing more than companies that employ a group of smart cookies with sharp elbows who have piles of cash and want to deploy it to increase their piles of cash.

While some PE firms have better talent, operational control of their invested businesses, or better “court sense” than others – and different funds within PE firms have varying objectives, market specialties and durations – most PE firms love businesses with the following characteristics: predictable revenue streams, good margins that they can improve, roll-up potential, no market dominant players, and perceived inefficiencies that they can rectify with scale.

RIAs check all of these boxes, making them attractive investment targets for PE firms. The entry of PE firms into the RIA space has revolutionized the industry landscape, driving up multiples and providing RIAs with the resources necessary to accelerate growth, enhance operational efficiency and expand their service offerings.

The best integrators and growers will win, not the low bidders.

This PE-driven transformation has created a virtuous cycle, as the improved performance and growth prospects of RIAs justify the higher multiples. There will be winners and losers among the PE-backed aggregators inclusive of “intra-aggregator” mergers and sales, but the best integrators and growers will win, not the low bidders.

The Talent Arbitrage

When you buy an RIA, you’re not just acquiring assets, revenue and profits – you’re making a strategic investment in human capital – a self-contained team of talented professionals with deep industry expertise, valuable client relationships and a proven track record of success. This “talent arbitrage” is a key driver of the sustainability of RIA multiples.

Here’s what you get when you acquire an RIA:

  • The founder/partner(s) of the business – They have the vision, know-how and drive to create a sustainable and profitable business. If they have gas in the tank and want to be part of your growth vision, you want to keep them around, especially if they hold the client relationships.
  • The staff members that find, manage and service clients – These are the key soldiers you must have in your platoon.
  • The investment professionals who conceive, execute and manage the investment platform – Depending on where you are as a buyer, these folks will maintain consistency, help with retention and bolster your investment department.
  • The back-office professionals who handle finance, operations, administration, marketing, technology and compliance – While there may be some redundancy, there are gems you will want on your team.

The employees of the RIA you buy like being in a small, “boutique-like” environment where they can build their career path on merit more than politics and be rewarded and fulfilled for their contributions. Trying to recruit these types of people – especially client advisors – and hoping they bring their clients over is an expensive and tedious process with no guarantee of success. There’s far more certainty and less risk in onboarding a self-contained team that is ready to go, provided they are excited by the long-term value proposition you lay out.

It’s a win-win-win when you assure clients that this is a positive change, not an upheaval.

While the employees you acquire may be concerned about you as the new employer, most buyers provide better benefits, more resources (i.e., the ability to spend money on growth and withstand market downturns) and an accelerated career path – all by-products of being part of a bigger (but not too big) company. For Next Gen staff, there is more certainty. For minority equity holders, there is a monetization event that they can now participate in without getting a second mortgage to buy out the majority owner(s). It’s a win-win, and really a win-win-win when you assure clients that this is a positive change, not an upheaval.

Buying Clients

When you buy an RIA, you’re also buying clients. We have engineered dozens of deals, and buyers almost always ask for “clawbacks” or retention payments – a holdback on the initial payment, typically with a one to three-year term tied to the proportion of client defections.

Virtually all sellers we advise receive the full amount of the clawback because both sides message the new scenario in positive terms. Also, buying a business rather than poaching an advisor means there is virtually zero chance of a lawsuit from the angry former firm whose profits are threatened, minimizing litigation risk.

Dan Kreuter is the Founder and CEO of Gladstone Group, which specializes in M&A advisory, strategic growth consulting, valuation and executive search.

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