Advisors Warned Against “Over-Reaching” in M&A Deals
On the heels of surging activity in RIA mergers and acquisitions, 2017 is shaping up as another record-setting year. At the same time, market analysts are debating whether stretched valuations and a maturing stock market present red flags heading into the second half of a white-hot year for M&A.
“This looks a little like 2007 all over again – when buyers were acting totally irrationally,” says Matt Brinker, head of national partner development at United Capital in Newport Beach, Calif., which manages more than $17 billion.
In a report set to be published Tuesday and sponsored by asset manager Nuveen, San Francisco-based investment banker David DeVoe finds first-quarter M&A deal-making among independent RIAs hit new heights. The fresh stats show a total of 44 new deals between RIAs – a 29% uptick compared to the opening three months of 2016.
“The first quarter of 2017 was the most active quarter ever for mergers and acquisitions in the RIA industry,” DeVoe tells FA-IQ. “Both of the major areas we track – established RIAs and breakaway advisors – are growing through M&A.”
At this stage, though, he’s skeptical a bubble might be forming. Longer-term demographic trends, DeVoe says, give recent RIA buying and selling trends a strong backdrop. Those include a confluence of rising demand by baby boomers as well as an aging advisor workforce and succession planning needs of firm owners.
“We see a lot of this record M&A activity over the past four years being fueled not only by a desire to broaden service platforms and client bases,” DeVoe says, “but also the attraction in a highly competitive environment of taking advantage of greater economies of scale by merging operations.”
Still, others warn that storm clouds might be hovering. Brinker, the United Capital market tracker, agrees long-term demographics remain favorable for wealth managers. At the same time, he says history suggests it’s important for firm managers to be vigilant in guarding against potential short-term market disruptions.
Brinker recalls that in the heady days of the late-2000s, growing demand for advisory services helped to bid up prices to valuations that approached “nosebleed” levels. Several big M&A players and “rollups,” he adds, became so “over-leveraged” that once markets cratered “so did they.”
“Based on what we saw in 2016, M&A valuations are butting up against record highs,” Brinker says. “It raises real concern that too many big rollups and RIAs are overreaching at this point to cut new deals.”
In such an environment, he recommends firm owners push to get more cash – as close to 100% as possible – in negotiating terms with potential acquirers. If equity is required, Brinker advises, sellers need to press for the most “transparent” and “favorable” options available.
“You’ve got to fully understand the rights of the share class you’ll be getting in case of a liquidity event such as an IPO or a firm-wide recapitalization of assets,” he says.
Todd Thomson, chairman of Dynasty Financial Partners, also sees a need for firm owners in today’s M&A market to “take a more thoughtful approach” in negotiating new deals.
After all, he says, a “natural” next step in the evolution of RIA dealmaking is to see greater market consolidation. “It’s inevitable that we’re going to continue to see smaller players being absorbed by larger firms at a fairly healthy pace,” Thomson adds.
That could lead to wider variations in how businesses are valued, he says. In coming years, Thomson is predicting operational efficiencies, diversity of clients and practice size – already major factors considered by acquirers – will be even more critical in shaping deal structures and prices.
“As we keep seeing a narrowing and recalibration of valuation metrics, acquirers are going to increasingly put a premium on RIAs with an ability to easily scale their operations and generate strong cash flow,” he says. “These are the types of practice managers who are going to be able to keep commanding top dollar for their businesses.”