Why private equity capital will keep flowing to RIAs

Registered investment advisory firms offer "a perfect storm of market opportunity, fragmentation and revenue" for private equity investors, according to a new report.

The investors often credited with driving 10 years in a row of record volumes of M&A deals in wealth management still have an opportunity amounting to $3.7 trillion in client assets managed by RIAs that need a succession plan, a path to greater growth or the means to break away from employee brokerages, research firm Cerulli Associates said in a study earlier this month. The conclusion belies some predictions that M&A will slow down due to macroeconomic conditions.

Conventional wisdom held that investors such as private equity firms and other RIA acquirers were "going to get real nervous and shut this whole thing down," but they're instead focusing on "the long game," Brandon Kawal, a principal with M&A advisory firm Advisor Growth Strategies, said at a panel of dealmakers held this week in New York.

"These are high-margin businesses. These are high cash flow, high-margin businesses. We hear this all the time, like, 'Wow, these businesses are so profitable,'" Kawal said. "If you're  running a good business and you're being thoughtful around how you're running your [profits and losses], and you're managing clients' money, which is your core job within these businesses, I think, largely, you can absorb some shock."

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What's driving big deals
Private equity firms and RIAs with backers from that sector are capitalizing on that attraction, as demonstrated by major recent deal announcements. 

In the first quarter, Focus Financial Partners struck a deal to go private under Clayton, Dubilier & Rice at a valuation of more than $7 billion, while fellow RIA acquirers Mercer Advisors and Pathstone received new private equity investments as well. 

This week, Geller & Company, which uses the private equity-backed RIA platform of Dynasty Financial Partners, opened a new Jupiter, Florida-based office of the advisory practice with $5 billion in client assets. And Carson Group — with minority backing from Bain Capital — acquired another RIA managing $5 billion in its largest deal ever. 

The private equity investors see ample reasons to continue their investments in the channel.

RIAs get an average of 82% of their revenue from recurring account fees tied to the value of assets from "sticky client relationships," according to the Cerulli study. On top of that business, they add an average of $6.8 million in assets from six new client accounts coming into the RIA each year. 

The number of assets managed by RIAs soared by a compound annual growth rate of more than 13% to $8.2 trillion in the past decade — amounting to 27% of the total across the entire wealth management industry. RIAs had just a 20% share in 2011, according to Cerulli.

"As the number of private equity firms participating in the RIA market grows, Cerulli anticipates that the roll-up model will continue to proliferate," the report by analysts Stephen Caruso, Donnie Ethier and David Fletcher said. "In tandem, the increased number of investors will coincide with a rise in aspiring RIA acquirers, creating an inflection point where investment capital moves downmarket and smaller RIAs turn into buyers, when in some markets, they'd be considered sellers."

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Dealmaker tips
For financial advisors entering into RIA M&A discussions in these conditions, dealmakers say it's paramount to have a clear understanding of the firm's goals with any transaction and the need to find a partner that is aligned with the same objectives. 

Similar views on "client experience, on your growth strategy, on how much you believe in technology" and other areas like investment philosophy are a "good green flag," Raj Bhattacharyya, the CEO of San Francisco-based RIA Robertson Stephens, said on the panel.

"It's very important to both sides to ask, 'Who is your ideal client, and what is your ideal client experience?' And if those two things do not align at least 75%-80%, it's probably a red flag for both parties," Bhattacharyya said. "Every buyer and every seller out there has a certain client experience and what it means to be a client of their firm. That doesn't change overnight. And, just because you've bought someone, sold yourself to someone, merged with someone, if that is not going to be the same going forward, likely the clients will leave and then, likely, that should have been a red flag." 

The team led by Marc Cabezas, executive director of mergers and acquisitions at Chicago-based RIA acquirer Hightower, speaks with hundreds of advisory firms every year, he said at the panel. The RIAs that stand out "are incredibly self-aware of where their business is in its business cycle and evolution," he said.

"They have a firm understanding of where they want to take the business, what's the future vision for the firm," Cabezas said. "As an investor, it's then easy for us in the relationship-building process to focus all of our time on how can we align our resources and capabilities with that vision to help them accelerate their ability to get to that future state faster, cheaper, and really in a more sustainable way than going at it alone."