How financial advisor compensation is crucial to succession and M&A

With fresh signs of momentum for wealth management dealmaking amid the ongoing need for succession planning, financial advisors' pay is becoming critical to M&A strategy.

In 2024, registered investment advisory firms booked notable growth and record volumes of deals. Succession planning for looming advisor retirements and the need for capital and scale were key drivers for sellers choosing among an increasing array of prospective acquirers. The compensation of possible internal succession partners is playing a bigger role in how that process plays out and morphing into a different model, according to a webinar by M&A consulting firm Succession Resource Group on its annual study of RIA deals with David Grau, the firm's founder and CEO and Parker Finot, its director of transaction advisory services.

M&A dealmakers have seen "a huge shift in the last couple of years away from a production focus" on a payout of a percentage of revenue or gross dealer concessions to team compensation that Succession Resource refers to as "base-bonus profits," Grau said. He described the approach as "a salary and bonus structure where we start to have more specialization," rewarding professionals as either "farmers" or "hunters" for the RIA.

In terms of succession planning, the "I don't know if you say, 'antiquated,' but traditional method of compensation" creates challenges "when you're looking at structuring internal equity and transition plans and separating the profits that are produced, versus the equity ownership and the trade-offs that someone who's a non-owner sees when they're prompted to purchase into the business, and what the what the plan itself entails over time," Finot said. "Even with business valuations, it can have an impact."

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Retention and succession problems

Succession Resource's findings followed that of research and consulting firm Cerulli Associates, which found in its own report earlier this month that more than a quarter of advisors who expect to retire in the next decade have no succession plan. At the other end of the career spectrum, rookie advisors struggle to stay in the industry with a failure rate above 70% in their first five years. It's one of the factors driving further M&A consolidation and efforts by wealth management firms to boost long-term retention of advisors by promoting paths into the industry through teams, said Kevin Lyons, a senior analyst with Cerulli's wealth management practice.

"Broker-dealers certainly recognize this, and they've started and begun to put more structure in place to ideally provide them a little bit more of a soft landing and set them up for success," Lyons said.

To compile the data in its report, Succession Resource used figures from deals the company facilitated and numbers from other M&A advisory or financing firms such as Oak Street Funding, PPC Loan and Skyview Partners. In 2024, the study covered 176 RIA M&A deals involving firms managing a combined $13.3 billion. In addition, Succession Resource conducted a survey of more than 300 participants about their succession readiness.

Here are some of the most interesting takeaways:

• The mean ratio of a firm's purchase price compared to its earnings before interest, taxes, depreciation, and amortization in 2024 held "steady" from the prior year at 9.2x, the report said. The average multiple compared to recurring revenue ticked up to 3.08x from 3.02x. Last year, the average number of potential buyers for each seller was 66.
  

• Buyers from outside of a seller's state paid a 16% premium over the price collected from an in-state acquirer. Out-of-state buyers completed a third of the deals reflected in the study. In addition, a seller that retained a professional advocate rather than representing themselves in a transaction received a recurring revenue multiple 0.21x higher.
  

• Just over a quarter of the deals were entirely in cash, and 51% of them paid the entire purchase price within a year of closing. Average cash down payments as a percentage of the purchase price rose slightly to 65% in 2024 from 63% a year earlier. Lender-financed deals brought down payments of 74% on average, compared to 49% without a loan. However, only 43% of the deals tapped any third-party financing.
  

• At least 53% of deals required sellers to agree to retention clauses tied to possible clawbacks, contingent payments or the pullback of part of a bank loan. The mean target rate was 88% of yearly gross revenue 12 months after close. 
  

• In the succession survey, 43% of participants said they anticipate retiring in fewer than 10 years and 17% expect to exit the profession within three years. Only 1% of the participants said they had a succession plan that has been written and shared with the relevant parties, and 55% gave themselves a score of five on a 10-point scale when asked to rate their readiness to hand off their clients and business someday. 
  

• At least 28% of the survey participants said succession planning is a primary focus for their firm this year, and 48% out of the group described internal staff members as their "ideal" buyer. Just 5% said a private equity firm or a wealth management firm aggregator was their ideal acquirer.

  
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Getting buy-in from the team

Given advisors' preferences toward internal succession, compensation for the less-tenured professionals on their team is taking on importance "in a much bigger way" after the topic "just hasn't been on folks' radar" historically, according to Grau. The team-based career paths and pay packages require a mindset shift among the prospective succession partners, too, he said.

"It's tough to get folks on your team to want to become an owner and get paid last, because that's what owners do," Grau said. "You might get paid the most, but you always get paid last. To get those folks who have been getting paid a percentage right off the top to then take risk and commit funds to get a percentage at the bottom line. I'll just take it right off the top — getting paid better than the owners are — conceptually, at least."