Behind Record Deal Volume, a Tax Proposal Pushing Wealth Managers To Sell

Proposed legislation that would raise the capital gains tax created a deadline for RIAs hoping to sell before it is enacted.

(Illustration by RIA Intel; Bigstock photo)

(Illustration by RIA Intel; Bigstock photo)

Owners of wealth management firms are trying to sell their stakes before possible changes to the tax code, leading to a record number of mergers and acquisitions in the third quarter and setting the stage for a record number of deals this year, according to one investment bank.

There was a record 78 deals (including 26 in September) in the third quarter of 2021, beating the previous record of 76 set the first quarter this year, according to Echelon Partners, a boutique investment bank focused on wealth management firms and TAMPs. The dealmaker publishes the most inclusive report on mergers and acquisitions in the industry, although many deals aren’t publicized or reported.

Echelon estimates there will be a record 287 deals in 2021, a total much higher than the 205 that happened last year. If the rate of M&A continues as predicted, this will be the 9th straight year of record-breaking M&A activity in the wealth management industry.

Improving access to capital to fund deals, as well as continuing consolidation, competition, and an aging advisor workforce seeking succession plans, are bringing more sellers to the market. But potential changes to capital gains tax have added fuel to the fire, as wealth managers seek to complete transactions before the end of the year, bankers say.

Earlier this year, President Biden’s plan proposed to increase the capital gains tax to 40 percent for top earners. Then, in September, Democrats in the House of Representatives proposed raising the top tax rate on capital gains and qualified dividends to 28.8 percent. The current tax rate sits at 20 percent with an existing 3.8 percent surcharge on net investment income. The new law could be adopted as early as November and potentially enacted starting January 1, 2022.

“That’s basically put pressure on these founders and owners of the businesses to get deals done in 2021 rather than waiting until 2022, just given their respective tax rate on the new transaction will be potentially lower versus next [year],” Barnaby Audsley, vice president at Echelon Partners, told RIA Intel.

[Like this article? Subscribe to RIA Intel’s’ thrice-weekly newsletter.]

Potential changes to tax legislation are having a big impact on the timing of deals this year, said Peter Nesvold, managing director at Republic Capital, a firm focused on advising wealth managers on deals. Some sellers on track to do a deal have adjusted their timelines to ensure, as best they can, that a transaction happens in the second half of 2021, Nesvold said.

Assuming year-over-year fourth quarter deal volume growth continues, Echelon estimates there will be 82 deal in the final months of the year.

Large strategic acquirers and consolidators, many of which have acquired at least two firms in the past year, accounted for 56 of the 78, or 72 percent, of deals in the third quarter. Those companies are also buying larger companies, in terms of assets. Firms selling to strategic acquirers and consolidators had an average of $1.9 billion in assets under management, nearly three times the average assets when typical RIAs are the buyers, according to Echelon’s third quarter deal report.

Strategic acquirers and consolidators “typically have a business model centered around scale and rely heavily on M&A activity to drive growth and expansion. They are often backed by Private Equity capital,” according to the report. Compared to five years ago more RIAs now have an active M&A strategy, Audsley said.

It is becoming a challenge for smaller RIA firms to compete with the diversity and level of services, like tax and legal, offered by larger firms, according to John Langston, the founder of Republic Capital. Langston said he routinely hears from firms that they need to have $5 billion or $10 billion in assets to match the level of complexity of service offered by competitors.

“From an acquisition point of view, because there’s more receptivity from those firms, it’s making it more possible for the larger RIA to make acquisitions,” Langston said.

For owners considering selling, they might have already missed the mark if the proposed tax legislation becomes law.

Due to the timeline of any deal, it would be too late to get one done before 2021 — unless they wanted to cut corners, Audsley said. Most sell-side investment banking processes take six to eight months of careful planning, he said.

Nesvold said for any firm considering a change of control (firms selling more than 30 percent) the doors are closing quickly as it takes 45 to 60 days to complete the required client consent form. However, in minority transactions, or deals in which 25 percent or less is being sold, a client consent form is not required.

“For minority investments, there still is an opportunity, although it’s going to come down to the wire relatively soon,” Nesvold said. “If you’re starting now, it’s going to be pretty difficult.”

Holly Deaton (@HollyLDeaton) is a staff writer at RIA Intel and based in New York City.

Subscribe to RIA Intel’s thrice-weekly newsletter and follow the publication on Twitter and LinkedIn.

Related Articles