Despite resurgent deal volume and a market as competitive as ever, few wealth managers are convincing buyers to pay a coveted double-digit multiple. But the sellers that can demand that premium have some things in common that other wealth managers can emulate.
Bankers, consultants, and industry executives predicted the Covid-19 pandemic would cause a lull in wealth management M&A activity in the second quarter, but pick up again in the third quarter. That prophecy came true.
There were 35 deals in the second quarter, down 20% quarter-over-quarter and 34% lower compared to the second quarter of 2019, according to Echelon Partners, a boutique investment bank that publishes the industry’s most inclusive report on mergers and acquisitions. But activity rebounded and was strong in May, June, and July and “competitiveness has never really been higher,” Dan Seivert, the founder and CEO of Echelon Partners, told RIA Intel in early August.
Still, although a growing number of well-capitalized buyers have been pushing up company valuations (in 2019, RIAs were trading 40% higher than they were five years ago), few sellers can realistically demand the double-digit multiples some hope to get, according to a new report on the wealth management industry by investment bank Piper Sandler.
Business strengths that some wealth managers perceive as differentiating are actually attributes expected of well-run companies in the industry.
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Strong client retention is table stakes; the industry’s annual retention rates are above 90% and increase with wealthier clients. Clients with more than $1 million in investable assets are retained over 95% of the time, according to Piper Sandler.
Success attracting referrals and modestly growing doesn’t guarantee a wealth manager will stick out in the crowd either. Most companies do this by choosing to focus on local areas, in a certain city or region. Expanding outside that would mean installing new management, a risk to any business.
“Expansion beyond an RIA’s local market can require significant costs and senior management resources, ultimately with an unpredictable outcome. As a result, many RIAs choose the more predictable path of further penetrating their local market,” according to the investment bank.
A diverse client base is part of the most stable wealth managers. For example, an RIA with assets under management dispersed amongst multiple households — rather than highly concentrated with, say, one or two — is more attractive. A buyer doesn’t want to pay for a firm only to find out a golden-goose client isn’t coming with a seller (and taking a significant chunk of assets with them). Advisory businesses avoid this even unintentionally as advisors serve more and more households.
Buyers are paying a premium for wealth management firms that have three things: strong leadership, growth, and scale.
“Strong management and a depth of talent is often a baseline requirement among buyers and can be a significant driver of premium valuation, particularly with acquirers that are making a first-time acquisition in the space and thus need the leadership that experienced wealth managers can bring,” according to Piper Sandler’s report. This is especially true of sellers with leadership that has a long road ahead of them before retirement.
Buyers also don’t just want to see growth in any form, they want to buy wealth managers with expanding top and bottom lines and stable or improved profitability as they scale, showing efficient leadership. Companies that achieve that, in turn, are able to invest in themselves, in the form of technology, personnel, or merger and acquisitions of their own.
“These firms in particular become the primary targets for buyers with deep pockets that are looking to gain access to the attractive wealth management space. While these components will impact the valuation a firm will receive, the increase in acquisitive buyers, as seen in recent years, has created a scenario where nearly all firms are saleable.”
A seller that checks everything on that buyer wish list — a fast-growing, mid- or large-scale firm — can expect a multiple of at least 12 times Ebitda (earnings before interest, taxes, depreciation, and amortization). Piper Sandler defines mid- and large-scale wealth managers as those managing over $1 billion and $5 billion, respectively.
Large-scale wealth managers that aren’t growing like weeds could still demand a multiple of 10 to 12 times, assuming other wants and needs are met. But even with high organic growth rates, sub-scale wealth managers with less than $1 billion won’t likely convince a buyer to pay a multiple more than nine times Ebitda, the bank says.
That means a double-digit multiple is unattainable for most RIAs, at least at this moment. Piper Sandler estimates there are over 6,600 RIAs registered with the Securities and Exchange Commission focused on managing private assets. More than 3,600 of those manage less than $250 million and fewer than 2,200 manage between $250 million and $1 billion.
“While notable, keeping these transactions in perspective is important and acknowledging that few firms offer the size, growth and scalability to command a valuation at those premium levels. As mentioned, larger firms are most likely to receive double digit multiples as there is a scarcity value associated with those firms. Even the fastest growing firms are likely to face headwinds in achieving a premium valuation if they have not achieved significant scale, as forward looking buyers evaluate not just historical growth, but ability to grow in the future.”
Michael Thrasher (@Mike_Thrasher) is a reporter at RIA Intel based in New York City.