Addicted to RIAs, Private Equity Keeps Binge-Buying

“Power has shifted from investment managers to wealth managers” and private equity is clamoring for the high margins and recurring revenue that RIAs offer.

(Illustration by RIAIntel)

(Illustration by RIAIntel)

When a potential acquirer contacts Summit Wealth & Retirement Partners, partner Robert Cucchiaro usually knows who’s calling - private equity.

With private equity firms aggressively acquiring registered investment advisors, attracted by high-margin, recurring revenue, Summit Wealth’s appeal is easy to see.

Based in Danville, Calif., about 30 miles east of San Francisco, Summit Wealth has two partners, seven employees, and $550 million of assets under management. About 20% of its clients are ultra-high-net-worth individuals. The firm also has many young, high-income clients, including doctors, lawyers, and retirees.

“We can offer you capital to grow your business” is the usual pitch. Though Cucchiaro is in his prime at 39 years old, and not looking to cash out, his partner, Hal Porter, 64, is closer to considering his next options.

Private equity firms find Summit Wealth enticing because it offers “recurring revenue based on higher client retention rates, a scalable business, and a modest number of employers including two partners, analysts in the middle and administrative staff,” Cucchiaro says.

But there’s one big reason why Cucchiaro keeps rebuffing overtures: private equity firms always demand a majority interest, enabling them to call the shots.

If Cucchiaro and his partner sell, the private equity acquirer would have “hiring and firing decisions, control of the purse strings, and control of who we keep and how we market ourselves,” he says.

Cucchiaro has a good friend whose RIA was acquired by a private equity firm. She told him in the new environment, “It’s growth at all costs.” The new firm has lowered its standards and started marketing to clients based two hours away while relinquishing some of its personal touch and frequent client meetings.

But Cucchiaro is quick to acknowledge that being run by a private equity firm with deep pockets could yield monetary rewards. “Our growth rate goes from 15% to 25%. If 80% of your net worth is in the business, isn’t it good to diversify?” he asks himself.

Cucchiaro conjures a future ruled by private equity firms. In it, there’d be growth but massive dark clouds. He imagines hearing, “We’re going to feed you new leads and you have to take on all newcomers, and your criteria for clients will diminish. Eventually you could be taking on more clients than you could serve.”

“Bottom-line,” Cucchiaro, says, “the private equity firm is not a long-term owner. They want to pump it full of growth and sell it. So, you’re going to cash out and move on.”

Summit Wealth has also received offers from family-owned wealth management firms, and merchant bankers, to buy a minority interest in the firm. In this kind of a deal, Cucchiaro and his partner could still call the shots while gaining an infusion of capital. However, thus far, they’ve resisted this option, too.

Summit Wealth may have been wise to go it alone given that private equity firms continue to aggressively pursue RIAs. Joseph Gerakos, a professor of business administration at the Tuck School of Business at Dartmouth College, notes that “private equity firms are buying more of everything. Are they buying more investment advisors than exterminators?”

Gerakos has a major concern about private equity firms scooping up investment advisors. “Are they buying RIAs to somehow end up distributing investments in their own private equity funds or distribute investments in their portfolio companies?” These are questions that he hopes the SEC is exploring.

For most private equity firms, RIAs also hold appeal, Gerakos says, because private equity firms can “lower their fixed costs since they already have trading agreements with brokerage houses and have great negotiating power.”

RIAs have several options other than selling to private equity. They could sell to a “junior partner, liquidate, bequeath it to their children, or sell out to someone younger,” asserts Gerakos. If they sell out to a private equity firm, “the question is do they lose their personal touch.”

Despite the reservations that some have about cashing out to private equity, David DeVoe, managing partner at San Francisco-based DeVoe & Company, a consulting firm that specializes in M&A and wealth management companies, notes that RIA valuations are at an all-time high. “Deal structures have gotten much more attractive for RIAs,” he noted.

RIAs, therefore, can often negotiate unique deal terms such as shelter from stock market declines or larger down-payments. “Or they can tie future payments to the growth of the company and live or die by the sword,” DeVoe says.

Lee Beck, managing partner of New York-based Kudu Investment Management, which oversees $17.5 billion in assets under management, sees the private equity buying spree of RIAs continuing because “organic growth rates are high and volatility of revenue is low.”

Private equity firms have similar profiles to RIAs, and Beck says the “power has shifted from investment managers to wealth managers.” Wealth managers can opt for the lower cost options, which clients prefer.

Most private equity acquirers are looking to double, if not triple, their investment, says Beck. However, after private equity firms purchase RIAs, it’s often business as usual, he notes. “If they didn’t think of the client first, this business model will cease to exist and decline. The client has too many options to choose from to move their capital.”

M&A consultant DeVoe adds that no private equity firm “wants to kill the golden goose that lays the egg. Growth is good, but they are long-term investors who want to create a machine that will increase and optimize clients.” Anything that tarnishes a RIA’s reputation would limit its future selling price, DeVoe says.

The major impact occurs later, when the private equity acquirer sells. Beck notes that the exit can be “disruptive for clients and for RIA managers. And that’s why private equity isn’t always the sought-after capital partner of first choice.”

And should the stock market or economy sputter, private equity owners, happy talk be damned, could shrug their shoulders, apologize, and speed to an early exit.

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