Independent financial advisory firms are hugely attractive to private equity funds, with 2020 a record deal-making year for the biggest advisors

RIA deals smash another record, but things are still only starting, DeVoe says

January 5, 2022 5:00 AM

It’s beginning to sound like a broken record. Registered investment advisory firms, or RIAs, spent last year on an acquisition tear. Despite, or because of, the pandemic, 2021 was the eighth successive chart-busting year of deals, with the industry exceeding 230 transactions for the first time in history, according to the Annual RIA M&A Outlook from DeVoe & Co. released on Jan. 5. The all-time high was for the first nine months of last year, so the final total will be even higher.

The big picture is that the wealth management industry’s most profitable and fastest-growing niche, according to McKinsey, is undergoing a massive consolidation, with “serial” acquirers backed by private equity funds snapping up ever more competitors and prices spiraling higher. Cue the FOMO (fear of missing out): “Deals beget deals,” the DeVoe report quoted Mike LaMena, the CEO of Wealthspire Advisors, as saying. “When RIA leaders see others selling, it causes many to reflect on their situation.”

The latest findings from DeVoe, a consulting and valuation firm for wealth managers, are a stark contrast to what advisors expected when the COVID pandemic emerged in 2020. In an earlier study covering that year, three in four managers surveyed by DeVoe expected a decline in mergers and acquisitions (M&A). That didn’t happen. “In retrospect,” DeVoe’s most recent report concluded, “COVID likely drove M&A activity, as advisors reflected on their goals, mortality and lack of succession plans. And in many cases, the outcome was the decision to sell” to an outside buyer.

Here are seven big takeaways from the latest report, which surveyed 131 advisors and executives at advisory firms ranging from $100 million in assets to more than $5 billion over last September and October. There are several surprises.

Big firms are rapidly increasing their domination of a very fragmented market

Over the first nine months of 2020, nearly two in three, or 64%, of transactions were by sellers with assets under management (AUM) of at least $500 million. RIAs with at least $1 billion in assets represented nearly half, or 44%, of all sellers — a 10% rise on their historical share.

“The larger the firm, the greater the appetite to acquire another firm,” DeVoe said. What it called a “shockingly high” 90% of all firms with more than $3 billion in clients assets plan to make acquisitions during the next two years. Many firms between $3 billion and $10 billion “are feeling pressure to ramp up their businesses to better compete with META-RIAs” — DeVoe’s term for the 25 largest advisory firms.

Things are only beginning

Eight consecutive record years of M&A activity notwithstanding, advisors think that things are only getting started. Nearly two thirds of RIAs think that M&A will increase during the next year. “The recent 30%+ year-over-year increases in M&A volume are seemingly driving expectations of a ‘new normal’ trajectory, as opposed to anticipating fatigue and a slowdown,” Devoe said.

Advisors expect increased M&A volume for a variety of reasons. High valuations, an aging founder demographic and the proliferation of serial acquirers are some of the key contributors to accelerating momentum. Some 60% of RIAs plan to acquire another RIA within two years.

Firms are buying other firms primarily to acquire talent

Top-performing advisors and executives have or oversee the most lucrative clients, which are the real quarry. Three in four advisors named “talent” as the “top motivator” for doing a deal, just barely ahead of “growing clients and assets” (74%). With attracting and retaining top employees becoming increasingly challenging in the financial services industry, RIAs need to up their game. “Perhaps this is a good time to contemplate your overarching HR strategy and work environment,” DeVoe said.

If you have never done a deal, things will get tougher

Some 85% of deals were done by RIAs that have already made at least one acquisition. Many “consolidator” firms have done dozens of deals. “The list of serial acquirers has gone from a few to a dozen or more,” the report said, adding that “these are firms that have become very efficient both in executing transactions and onboarding/integrating
the acquired firms.”

If you’re in the 15% who have yet to make a deal, “then prepare yourself,” DeVoe said. “It won’t be easy. And the odds of you elbowing your way to your first closing dinner are becoming increasingly difficult.”

Why? Only a few years ago, first-time-buyers represented 25% of all transactions. Now, 80% of Devoe clients who are selling or trying to sell require a potential buyer on their candidate list to have already acquired at least one RIA. Many require a minimum of four previous acquisitions. “These sellers understand the vast complexities of negotiating, structuring and closing a transaction, and then the challenges associated with integrating companies, cultures and processes,” the report said. Most buyers “don’t want to be a guinea pig” for firms seeking to make a deal for the first time.

Why do advisors sell their businesses?

No. 1: To rake in cash to grow the firm or take “some chips off the table." Nearly one in two sellers, or 49%, cite liquidity as their top reason, followed by growth (47%); scale, i.e. doing more with less (44%); and succession planning for the business (40%).

Things don’t look easy for the younger generation of advisors inside RIAs who hope to acquire the firm one day. Three in 10 firms surveyed by DeVoe said that so-called “G2 can NOT afford their firm.” The reason: “These firms have grown to a size that their valuation is beyond the grasp of the second generation to purchase. As retiring owners reduce their stake, they will most likely need to look for an external purchaser. In some cases, a partial sale will work. In others, it may be a full sale of the business.”

Another 32% of advisors said they were unsure whether they could sell their firm to internal buyers. In any case, more than six in 10 advisors, or 61%, said that younger partners were not ready for a transition into an ownership role. Larger firms are more likely to see a lack of succession planning as a big problem for the industry in the future.

“The convergence of an aging founder demographic with an industry-wide lack of succession planning will further accelerate M&A activity,” the report said. “RIAs are becoming increasingly aware that the next generation of future leaders simply can’t afford to buy them out.”

First-time sellers see dollar signs, but…

“There continues to be a fundamental divide between what small firms think they're worth and what we would be willing to pay,” DeVoe quoted one RIA acquirer as saying. As such, the price that a seasoned buyer will pony up will generally be higher than the price that a first-time or occasional buyer will pay. DeVoe cautioned prospective buyers to “beware.” It typically takes 12-18 months to consummate a deal, but using an investment bank can cut the time to six months. “If you plan to spend half of your time on M&A, you will be lucky to get a deal done once every two years,” the report said.

Private equity is fueling higher prices

As private equity funds take stakes in large RIAs and fuel their acquisitions, it’s driving up prices to record high valuations. While the DeVoe report didn’t detail pricing trends, it quoted one advisor as saying that “the attraction of the RIA model has caught the attention of private equity, and with the additional tailwind of low interest rates, valuations are being driven higher.”

Nearly four in 10 advisors surveyed, or 29%, expect prices paid to go even higher in 2022, while 53% expect valuations to remain steady. Only 8% expect them to decrease this year.

The report said that RIA M&A activity will continue to increase for the next five to seven years. “The business case for ‘private-equity-backed consolidator models,’” it added, “has been validated by ‘proof of concept’ successes such as Focus Financial Partners and United Capital.”