Why some RIAs aren't riding the private equity wave

Jamie Mackay and his firm are staking out an increasingly lonely position in the wealth management world.

At a time when private equity firms are buying up small advisory practices left and right, Mackay and SFA Partners offer advisory, broker-dealer and insurance services without accepting an ownership stake from an outside partner. Rather than secure financing from private equity investors, SFA pays for growth by reinvesting profits and taking out loans when needed.

Mackay, the president and chief operating officer of the Atlanta-based firm with nearly $7 billion under management, knows he and his colleagues are probably forgoing some of the skyrocketing gains offered by private equity. But that growth is often bought at the price of frequent changes of ownership.

"We just celebrated 21 years in the business," Mackay said. "So in 21 years, you can obviously tell that firms that started around the same time that we did, a lot of them are gone. A lot of them are gone because they've been packaged up by private equity and eventually sold."

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Proponents of private equity credit it for providing financing needed to revive the fortunes of often flagging companies and industries. Private equity, many say, enjoys the independence needed to impose the sort of discipline that might have been lacking under previous owners. 

And if all goes to plan, investors — often pensions, endowments, family offices and high net worth investors — get to walk away in the end not only with the knowledge that their money was put to good use, but also with a healthy profit.

The shifting ownership puzzle

But it's exactly that emphasis on returns that leads to criticism of private equity. Private owners' standard plan is to invest in a business for five to seven years with a goal of eventually selling it to other private equity investors or taking it public.

At a minimum, such frequent changes in ownership can be an annoyance to clients, said Peter Nesvold, the managing partner of investment bank and M&A consultant Nesvold Capital Partners. Investors can become puzzled about why they receive notices every few years that their wealth management firm has switched hands, even as they maintain their existing relationships with advisors.

"Every time there is a change of control, another round of notices has to go out to clients," Nesvold said. "And it can be irritating." 

But for Mackay and others of a similar mind, something more fundamental is at stake.

"When an advisor joins an independent firm like ours, they know who the management is and they know that they're shaking hands with the person who is going to be delivering long-term benefits to them, versus being part of what I would say as a being part of the digestive process of something that's being built to sell along the way," he said.

The drive toward consolidation

But firms like SFA are increasingly becoming outliers in an industry in which consolidation, much of it driven by private equity, is the prevailing trend. Following a slight slowdown in deals early in 2024, acquirers have stepped on the gas in recent months.

Consolidation has been particularly prevalent among registered investment advisors. Recent years have seen a large number of so-called aggregator firms tap private equity to pursue their ambitions to build nationally recognized brands.

The research firm DeVoe & Company reported in December that the number of RIA merger and acquisition deals hit an all-time high in 2024, with 269 for firms with $100 million or more under management recorded at the time. Of those, 71% were financed by private equity.

DeVoe predicted in 2023 that lowered borrowing costs brought on by falling interest rates would lead to a resurgence in M&A deals. 

"But an equally important factor is the increased confidence among private equity-backed buyers to deploy capital," said David DeVoe, the founder and CEO of DeVoe & Company.

Large aggregators are sitting on an ever-greater proportion of the industry's total assets under management. In a report from November, the consulting and research firm Cerulli found that more RIA aggregators, most backed by private equity, are taking an ever-larger share of the wealth management pie. Industry consolidators could boast of having $1.5 trillion in assets under management in 2023. That, according to Cerulli, came to 18% of the industry's total asset share, a figure up 10 percentage points since 2018. 

Nesvold said the appeal for many of the firms being bought up is the deep pockets of private equity.

"If price is the No. 1 objective, these firms are going to be hard to beat," Nesvold said. "But that's not going to be the case for all."

Yes, private equity offers a lot, but …

Steve Resnik, a founder and the managing director of Burling Wealth Partners in Chicago, said he thinks private equity does bring some benefits to RIAs. Large buyout firms can be particularly helpful to older advisors who are looking to feather their retirement nests by selling their books of business.

"For the 60-year-old or 65-year-old that is trying to create a succession within their business, it's a great solution," said Resnik, who himself worked for five years at the $4 billion private equity firm The Edgewater Funds. 

"You know, people have founded firms that were lifestyle businesses that have become 15 to 20 times enterprise value businesses," he added. "And so for them to liquidate their assets, it's a great thing."

But that's not what Resnik and his partners envision for Burling Wealth, which was founded earlier this year and has about $750 million under management. Resnik said his goal is instead to have a firm where young advisors who are just starting in the industry feel comfortable joining to build a book of business.

Resnik said he thinks private equity firms — which by their very nature place a priority on securing returns for their investors — don't necessarily have the patience to wait for novice advisors to turn into top producers. That's in part why he and his partners have pledged to do without private equity investments for the foreseeable future.

"Where I think our firm has a competitive advantage is we have a clean balance sheet, and we have clean cash flow," Resnik said. "We're not using any of our cash flow to pay down debt. We can invest in our people in a way that you just can't when you've got interest payments coming every quarter."

The bigger they are, the bigger they get

Yet, despite such holdouts from consolidation trends, the industry is increasingly becoming dominated by a few large players. In a recent "industry snapshot," the Investment Adviser Association and regulatory consultant COMPLY found more than 88% of all RIAs had less than $5 billion under management. But they also accounted for less than 8% of the industry's total AUM, according to the annual report. Firms with more than $5 billion in AUM comprised less than 12% of all RIAs, yet managed more than 92% of the industry's assets. In other words, the 207 largest firms manage two-thirds of RIA assets.

The same consolidation can be seen in industry headcounts. Large private equity-backed aggregators — firms like Creative Planning, Focus Financial Partners and Dynasty Financial Partners — had 14% of all RIA advisors in 2023. That was up by 8 percentage points since 2018.

In its 2024 RIA Deal Room report tracking M&A activity, the consultant Advisor Growth Strategies found that the pace of acquisitions has redefined what it means to be a large firm. Sixteen large firms ended 2022 with more than $30 billion in assets, and the top 50 firms all had more than $10 billion.

And a handful of firms, benefiting from outside capital, are pushing toward $500 billion in AUM. Advisor Growth Strategies wrote that the market RIA deals a few years ago most closely resembled a "gold rush." Firms were moving as quickly as they could to hoover up as many assets as possible.

RIA aggregators are now looking to become "institutional" players with staying power equal to their better-known wirehouse and independent broker-dealer rivals.

"2023 was an inflection point that saw the shift from a gold rush mentality to an institutional arms race," according to Advisor Growth Strategies.

The case for private equity

One of the most active acquirers is Focus Financial Partners. In a recent headline-grabbing deal, the private equity-backed Focus merged Buckingham Strategic Wealth, a St. Louis firm with $70 billion under management, into its existing Colony Group RIA. Focus is now in the midst of a massive internal reorganization that will see roughly 90 RIA practices consolidated into five "hubs."

The firm's deals are being financed largely by the private equity firms Clayton, Dubilier & Rice and Stone Point Capital, which bought Focus Financial in 2023 in a deal valuing it at $7 billion. Michael Nathanson, the CEO of Focus, said in a recent interview that wealth managers who decide to go it alone without private equity aren't just giving up capital. They're also leaving expertise on the table.

"I would say, from a consulting perspective and a strategic planning and envisioning perspective, I think that firms that try to do it without private equity are missing the opportunity to partner with people who just might know more than they do about running a successful business and still flash for entrepreneurs," Nathanson said.

Focus Financial has figured among the top dealmakers in 2023. In a quarterly M&A review issued in the third quarter, Fidelity Investments counted 10 acquisitions to Focus's credit last year, through both its Colony Group and Kovitz Investment Group hubs. That put it on par with its aggregator rival Wealth Enhancement Group, which then also had 10 deals to its name, and just ahead of MAI Capital Management, which had seven deals. Wealth Enhancement's backing comes from the private equity firms TA Associates and Onex Corporation, and MAI Capital is owned by the private firm Galway Holdings. 

Rob Sechan, the co-managing partner of NewEdge Capital Group, sees many of the same benefits as Nathanson does to private equity ownership. NewEdge Capital, the parent of NewEdge Wealth and NewEdge Advisors, is owned by EdgeCo Holdings, a fintech company drawing financial support from the private equity firm Parthenon Wealth Partners.

Sechan said private equity enables him and his partners to "invest in the business in a way that we could not as founders or executives. 

"That allows us to embrace long-term strategies beyond the next quarter or year," he said. 

"In general, PE partners can provide a stable source of capital and inform critical business decisions, particularly if the PE partner is experienced in your industry and understands critical value drivers."

Sky-high valuations?

Advisor Growth Strategies found in its "RIA Deal Room" report that purchasers were willing on average to purchase practices for roughly 9.6 times their earnings before interest, taxes, depreciation and amortization, or EBITDA. RIAs managing between $200 million and $500 million have become particularly desirable, likely because they are perceived as easier to integrate than larger outfits.

Nathanson said he's heard some in the industry express anxiety that the zeal to buy is pushing the price of mergers and acquisitions beyond the actual value of the underlying assets. Nathanson said he thinks some buyers are probably overpaying. But he also believes there are enough disciplined purchasers to prevent any sort of bubble from forming.

"The winning acquiring firms are the ones that are able to differentiate, the ones that are able to say, 'You know what? That firm offers more capabilities, offers intriguing geographies, offers true organic growth capabilities and has a good next generation. If you look at a firm like that, then those firms do deserve higher multiples."

The industry's profitability also helps justify the prices. The consulting giant McKinsey reported in January that the average profit margin for wealth managers of all stripes last year was 26%. RIAs had it slightly better, boasting an average margin of 27%.

Meanwhile, the supply of acquisition targets continues to grow. The number of RIAs registered at the federal level went from 13,494 in 2019 to 15,396 in 2023, according to the Investment Adviser Association and COMPLY's industry snapshot. That helps ensure aggregators that are still hungry for deals won't lack opportunities in coming years.

The abundant supply should also help to hold prices in check, Nesvold said.

"The likelihood of further multiple expansion seems small," he said. "And unless there is a big blow up, which I don't see happening, I also don't see valuations coming down anytime."

Clients looking for 'one-stop shops'

McKinsey predicted consolidation will also be driven by clients seeking "one-stop shops" for all their financial service needs. "RIAs in particular," according to McKinsey, "have been acquiring tax practices, setting up trust administration, and building out concierge service."

Nathanson said he thinks one distinct advantage firms with private equity backing enjoy is the ability to pay for the latest technology. It's not just cybersecurity systems and online portals for investment management that he has in mind. 

Nathanson said Focus has also invested heavily in artificial intelligence and machine learning types of technology that can ingest reams of market data to make sure advisors and clients stay abreast of the latest market trends.

"All RIAs and aggregators and platforms need to have the ability to press a button and understand in seconds any important data point or other point of information about their company, to understand its health, its direction, what's going right, what's not going right, where there are vulnerabilities," Nathanson said. "I don't believe that most firms in our industry are at that place yet."

Yet, Mackay remains comfortable with the place SFA Partners has carved out for itself without private equity.

"Would that ever change in the future?" he said. "I guess anything is possible. Sometimes there are multiples that come in for people that are looking to invest that would be hard to ignore. But from our standpoint, we just haven't had the interest in it. We've been able to fuel our growth based upon doing the right thing for the advisor."