Demystifying RIA Mergers and Acquisitions in the Context of Succession

The term “M&A” is thrown around rather loosely. We read about Mergers & Acquisitions activity daily in financial publications like the Wall Street Journal, but usually what’s being reported on relates to one corporate giant acquiring another. Even when we read about one asset manager buying another, this usually refers to large-scale organizations combining due to market conditions.

For RIA firms, the vast majority of which are private entities with fewer than ten employees, what does an acquisition or sale truly mean? Typically, an aging advisor who has built her retail advisory business over the past 20-30 years is nearing retirement and seeks to pass the reigns onto another advisor. If she sells her business to another firm, this is often called a “private party” sale. If she passes the torch to an internal successor, this is referred to as an “internal sale.” Each sale type has implications for her firm’s sale price, deal structure, and tax treatment associated with it. The vast majority of these transactions don’t make the news.

So, from a seller’s perspective, though, what are they selling? The firm’s hard assets, as reported on a balance sheet, are generally minimal. What is truly being sold is the income the advisor’s client base produces. How the sale is handled can either ensure a smooth transition for those clients or give them an excuse to “jump ship”. A well thought out client transition plan will maximize the assets that transfer to the buyer.

Even if this advisor is selling to a more sophisticated buyer, the acquirer is still “buying” client-produced income in order to achieve scale. Transactions are structured in various ways to suit the needs of both buyer and seller. From a tax perspective, both parties need to work closely with their tax advisors to determine if the transaction should be handled as an asset or stock sale. But no matter what the deal structure, or how the transaction is treated for tax purposes, generally a seller is simply transitioning her clients to a buyer.

Also, because most RIA firms are closely held and run in a familial style, staff will be severely affected by a transaction. If handled correctly, however, buyer and seller should recognize that a union will provide new career paths and firm ownership opportunities for top legacy staff.

Common Misconceptions

Even if one recognizes what “RIA M&A” is all about, a couple common misconceptions pervade. The first is that an accurate measure of an RIA‘s value is based on applying a multiple to gross revenue. It’s very outdated and is misleading to buyer and seller – two RIAs with the same top line may have very different cost structures and growth rates. Revenue is not a proxy for value. You just can’t be accurate using this approach.

The second misconception has to do with a seller believing that he or she can make the same income after the business has been sold for a market-based valuation. Of course, it is a preferred scenario for the seller to stay on for a while to ensure a successful transfer. But that misconception is the one we call having your cake and eating it, too. You can’t sell your cash flow and continue to take that cash flow as your income. An exception to this would be for very large firms, say, with $20 million in revenue or more. These firms have achieved scale and high enough margins to continue compensating their selling principals at high levels. Another exception would be in a merger where the selling principal(s) plan to stay on with the buyer for many years. Since mergers are primarily done in stock, the buying organization should be able to keep the selling principal(s)’ compensation at pre-deal levels, or at least at market competitive rates.

About David Selig, CEO & Founder, Advice Dynamics Partners:

David has over twenty years experience in M&A, management consulting and financial services.  Mr. Selig has authored two whitepapers on the subject of mergers & acquisitions, is regularly quoted in the press, and is a featured speaker at conferences and industry events around the country.

Prior to founding Advice Dynamics Partners, David worked for Pershing Advisor Solutions. Before this, Mr. Selig worked for Deloitte Consulting and for high profile technology companies.  David holds an MBA in Strategy and Management of Organizations from the Graduate School of Business at Columbia University and a BA from University of California at Santa Barbara.

Important Disclosure: This content is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. Some information may have been obtained from third-party sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. Only private legal counsel may recommend the application of this general information to any particular situation or prepare an instrument chosen to implement the design discussed herein. An investor should consult with their financial professional before making any investment decisions.

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