Fallout from the coronavirus might cause the U.S. economy to shrink as much as 14% in the second quarter, a chief economist at JPMorgan said Wednesday, and IHS Markit expects the country will enter a recession. But even that scenario won’t halt RIA deal activity or devastate seller’s valuations. It will have an impact though.
To be sure, it seems most observers expect the number of deals involving RIAs to fall.
“I think this is likely to play out similar to 2008,” Karl Heckenberg, CEO of Emigrant Partners, a minority investor and service provider to wealth and asset managers, told RIA Intel. Heckenberg is also the chief executive of Fiduciary Network, an Emigrant-owned aggregator of RIAs.
The number of big, often headline-grabbing, deals involving RIAs fell about 70% during the global financial crisis and activity didn’t recover until 2011, Heckenberg said. Although, smaller deals, including many that go unaccounted for, will keep happening and net deal volume will not fall that drastically in 2020.
Dan Seivert, CEO and founder of Echelon Partners, an investment bank and consulting firm focused on wealth and investment managers, estimates that each quarter the pandemic impacts the world like it currently is — keeping borders and businesses closed, and people working exclusively from home — the total number of deals this year will fall between 5% and 7%.
The number of sellers will be lower but buyer demand “should remain strong,” according to Seivert.
“Bankers, sellers, and buyers do not turn deals on and off like a faucet. Deals take 9-12 months to complete and often times the last five months of a deal the terms have already been agreed to and the buyer and seller are just finishing due diligence, legal and client consents. What might slow down or pause is the number of new firms entering the pipeline,” Seivert said in a note to RIA Intel.
Deal volume leading up to this was robust. There were a record 132 mergers or acquisitions involving RIAs in 2019 and industry observers expected the 2020 total to be even higher. Whether deals were getting bigger or smaller depends on who you ask and their methodology. Deal structures have been slowly changing but valuations have remained relatively stable.
Echelon has not seen a slowdown in would-be buyers or sellers happen yet. The company is currently representing several clients on the sell-side (including one it added last week) and one on the buy-side. “We haven’t seen the pullback yet. That doesn’t mean it’s not coming,” Carolyn Armitage, managing director of Echelon Partners, said.
Armitage had the most positive outlook on deal volume. Even in the months or year after the coronavirus outbreak turns a positive corner globally (the number of cases and deaths continues to rise) activity could be strong. The pandemic might be the inflection point that prods advisors to sell or retire. The workforce is aging at an alarming rate; the average age of advisors is currently 51 but 44% are 55 or older. Looking back on the pandemic, and the chaos it caused in markets, many advisors will make a change before the next downturn, she said.
Seivert also said valuations “should soften a little” but pro forma Ebitda (earnings before interest, taxes, depreciation, and amortization) “should hold up for well-diversified firms.” Most wealth managers have invested an average of one-third of client assets in fixed income or other non-correlated investments, which means their revenue is tied to the equity market but does not move in equal tandem, according to Seivert. As a result, a wealth manager’s revenue typically falls two thirds of the broader market’s decline, Seivert said. For example, an 18% market decline would result in a 12% hit to revenue.
What the fastest-ever bear market will change about RIA deals are the terms.
Before the market’s downturn, buyers were already paying less cash at closing and holding more money in escrow, paid to the seller with contingencies, according to Scott Wetzel, managing partner and CEO of SkyView Partners, a Minneapolis-based company that matches broker-dealers and RIAs with a network of banks willing to give them traditional loans for succession plans, mergers, and acquisitions. At the end of January, SkyView had helped generate 83 loans and a total of over $189 million in debt.
But if a seller expects a sale price aligned with its trailing 12-months revenue, and not just what it’s going to generate in the first two quarters of 2020, it’s likely going to have to make some concessions, Wetzel said.
Buyers might lock up more money owed to sellers in an escrow account until terms of a deal are met. They might also extend the escrow period, which is typically one to three years, or adjust other hurdles advisors must meet to get all of their money.
It’s not so much an evolution of RIA mergers and acquisitions as it is a move in favor of buyers because of the market environment, Armitage said.
“The seller is going to have to take more risk. I haven't seen the multiples expand [in the years leading up to 2020]. What I’ve seen is the risk really get shifted to the buyer and I think, in this market environment, that’s the thing that is going to really change,” Heckenberg said.
“It goes back to that old quote: Tell me the price and I’ll tell you the terms.”