Spacs Are Extremely Unlikely to Supersede Traditional Private Equity As a Popular Capital Structure for Wealth Management Firms
Echelon Partners, Managing Director
SPACs have become the new way for companies to go public. But do they work for the wealth management industry?
In some cases, they might. Yet, it’s hard to imagine they’ll ever replace private equity as the leading purchaser of RIA firms. Here are a few reasons why:
- The clients are too important. As with many owners of service businesses, RIA founders invariably have a deep desire to ensure that the level of client service stays the same or perhaps even gets better once they sell their firms. This increases the chances that most will continue to seek deals with other RIA owners or private equity firms who have a strong track record of success.
While some SPACs may be able to entice sellers with the promise of infrastructure improvements, that still won’t ensure a great client experience. In fact, it could do the opposite, as these “improvements” could result in technology replacing human interaction.
- There’s a difference between making a deal and making the right deal. RIA transactions take about a year to complete. That creates a narrow acquisition window for SPACs, which must spend at least 80% of their capital within 18-24 months, per SEC rules. Is that enough time to get a deal done? If everything goes well, yes. But it may not be enough time to produce a deal that works well for everyone.
The issue is – curveballs happen. While no one likes to walk away from a negotiation after expending months of effort, sometimes that’s the best option. But SPACs often can’t afford to stop and start again with another seller. These time pressures can yield a poor result for clients and employees.
- Mania, investor delusion and potentially increased regulation. The SEC recently issued an alert warning the public not to get involved in a SPAC “just because someone famous sponsors or invests in it…” This is notable because it demonstrates, along with Chairman Gary Gensler’s recent comments, that the SEC is likely to take a hard look at SPACs in the future.
When it does, it will likely take a dim view of how the average investor gets treated. SPAC sponsors, directors and executives get paid no matter what if they can close a transaction. But because some investors will exercise their right to redeem their shares before a deal is completed, the other, less watchful investors – who may not be as aware of voting deadlines – will see the value of their shares diluted.
To make matters worse, even those early redeemers will pay a price because they’ve endured the opportunity cost of having their money tied up for up to two years. If the SEC changes regulations as result of these issues, SPACs may no longer be such an easy way to go public.
- Public vs. Private.The benefits associated with staying private are significant. Not only can there be tax advantages, but private companies don’t have to reveal their strategic plans and financials.
Public companies normally feel outsized pressured to beat Wall Street expectations each quarter. While growth is good, often demonstrating the health of a company, growing too quickly can be detrimental, no matter how many superstars are on the team – and that can make for a difficult environment for sellers, employees and clients alike.
These are a few reasons SPACs won’t be the dominant player in wealth management acquisitions in the near term. Going forward, however, as private equity firms seek an exit for their portfolio companies, they’re likely to sell to a SPAC instead of the traditional IPO path – which could change the dynamic around this debate.
Carolyn Armitage is a managing director with ECHELON Partners (www.echelon-partners.com), a leading Los Angeles-based investment bank focused on the wealth management industry. In the past three years alone, the firm has advised on 35 transactions that collectively encompass more than $63 billion in assets under management.
Ajax Investment Partners, CEO
Tae Bo, the Macarena and Special Purpose Acquisition Companies (SPACs) each originated in the 1990s. But thank God, only SPACs remain relevant today, generating a surge of interest and attention among owners of closely-held wealth management businesses seeking growth capital for acquisitions.
Whatever the skeptics might say, SPACs offer privately-owned wealth management firms the ability to access public capital markets more efficiently than traditional IPOs, while offering owners more flexibility than they would likely get in a standard private equity deal.
Indeed, it’s quite possible that SPACs could become at least as popular as traditional private equity investment for owners of wealth management businesses exploring capital structures options.
“GROW OR DIE”
Closely-held wealth management firms increasingly face a stark choice: Grow or die.
Increased scale via acquisitions is crucial to successfully operating in a fee-compressed environment that requires constant reinvestment in new technologies, as well as an aging, more financially savvy client base and the changing business economics of client service.
Until now, the best ways to access significant capital for future M&A deals have been private equity or the public markets – Each with their share of shortcomings.
Traditional IPOs have the potential to turn on the cash spigot, but the process can be dauntingly complex, slow and expensive – Not to mention subject to big picture disruptions outside of anybody’s control. Imagine, for instance, having the bad luck to list during the same week as the recent GameStop-driven market volatility.
Standard private equity deals can provide more immediate access to capital, but with potentially increased future ownership uncertainty and higher debt.
EASIER THAN AN IPO, BETTER THAN GETTING ‘PRIVATE EQUITIED’
In addition to a less cumbersome listing process compared to traditional IPOs, SPACs deliver the following advantages:
- Owners retain significant or controlling stake. Most wealth management firm owners have developed close personal relationships with their advisors. By maintaining a controlling or significant stake, owners can secure growth capital while making sure they’re doing right by their advisors and keeping skin in the game for future upside opportunities.
- Better prices for owners’ equity. After a traditional IPO, share prices are subject to market fluctuations and other tough-to-control factors. In a sale to an already public SPAC, owners negotiate with a single counterparty, which creates more valuation control.
- Avoidance of expensive debt. Using leverage to magnify returns is a hallmark of any successful private equity deal. Debt isn’t necessarily a bad thing, but it is understandable why owners of wealth management firms would be cautious about higher debt obligations as a potential drag on future growth. By contrast, SPACs, even if private equity firms run them, rely more on the proceeds of their IPOs to fund acquisitions, and less on debt that is expensive to service.
- Sidestep fears of micromanagement and other agendas from outside forces. Many private equity groups offer exceptional expertise as well as access to capital, but wealth management firm owners nevertheless will always be sensitive about the risks of being micromanaged by outsiders with their own value creation agenda. And going IPO via the traditional route similarly opens up the risks of shareholder activism, change of control proxy contests and the like.
SPACS WILL KEEP GROWING
Could SPACs someday become nothing more than a final value creation tool for private equity owners of wealth management firms seeking a public market exit? Yes.
But above and beyond such a purpose, SPACs have the potential to drive many other strategic goals for leaders of closely-held wealth management firms across the industry.
You’d be better off betting that the Macarena will become massively popular once more than betting against the rising popularity of SPACs for wealth management firms.
Adam Malamed is CEO of Ajax Investment Partners (www.ajax-partners.com), a Miami-based fintech incubator and strategic consultancy for the wealth management industry. He previously served as Chief Operating Officer of NYSE-listed Ladenburg Thalmann. In this role, he grew Ladenburg from $35 million to $1.5 billion in annual revenues, before helping to spearhead its sale to Advisor Group in February 2020.
Winner: Adam Malamed