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Navigating Growth Through M&A
The past decade has seen record M&A activity1 in the wealth management space, reflecting intensifying competition among firms to attain rapid growth, scale, and a strategic edge. Industry dynamics evolved dramatically during this period of consolidation. Acquisitive firms have pursued scale amid increasing operating and regulatory costs, a “war for talent”, volatile macroeconomic conditions, and a mounting necessity for technological innovation.
The argument for M&A is simple: there is a current financial arbitrage opportunity where larger firms trading at a high multiple can boost their valuations by acquiring smaller firms with lower multiples.
Those lower-priced assets from smaller firms become even more valuable when included in larger firms’ multiples, driving consolidation activities. Larger firms can also bolster resources and capabilities in front and back offices to gain synergies with the acquired firms. At the same time, smaller firm owners with succession planning issues can monetize their life’s work by selling to fund their retirements, while mid-career owners can access a more scalable and resource-rich partner to accelerate their growth.
Over the past decade buyers have become more diversified, with private equity playing a significant role2 in driving industry consolidation, according to Fidelity’s Q4 2023 M&A report. PE-backed firms drove 78% of last year’s M&A activity in the RIA space, up from 75% in 2022 and 52% in 2018. The report notes that the wealth management industry’s “stable and consistent revenue stream” and potential for further consolidation appeals to PE investors.
Since 2022, higher interest rates have also impacted M&A. Financing acquisitions has become more costly while deal structuring and negotiations have become more complex. While deal making remains robust, higher rates contributed to a slowdown in M&A activity in 2023 for the first time in nine years, according to DeVoe & Co RIA Deal Book3 for Q4 2023. However, deal making appears to have just taken a breather in 2023, as results from the first quarter of 2024 show a strong rebound with record results once again4 .
M&A Challenges
M&A in the wealth management sector is frequently a time-consuming and complex process. Acquisitions need to be implemented at the right multiples to ensure that deals are accretive and meet the financial objectives of the buyer. Challenges can arise in assessing certain intangible assets like client relationships and brand values. Thus, achieving the right multiple requires a lengthy due diligence process, covering financial, operational, and compliance aspects to accurately assess the value and potential synergies of the target. As a result, M&A is not for the faint of heart. Current complexities and a growing pool of well-capitalized competitive buyers require that you have well-resourced and experienced teams who are skilled in understanding and executing upon the many components that go into making a successful deal.
Due to volatile financial markets, regulatory changes, and economic cycles, forecasting growth in M&A can be particularly challenging. Accurately predicting the future performance of a target firm and potential synergies can require increasingly sophisticated modeling. Pitfalls stemming from M&A can also arise when integrating different systems, corporate cultures, and processes, which can be disruptive and lead to employee turnover and client retention risks. To maximize their investment and retain as much AUM as possible, firms should focus on providing newly acquired advisors with a clear career path and compensation targets in the newly combined entity, along with robust growth tools to not only keep them in their seats, but to also help them add value to the firm.
According to Fidelity Investments’ 2023 M&A Valuation and Deal Structure survey, buyers walked away from about 52% of evaluated deals. Among the key factors, 87% cited a misalignment of valuation expectations, 73% highlighted cultural mismatch, and 50% noted conflicts with the target firm’s long-term vision. Additionally, 1 in 3 buyers in the survey said that recent market volatility had affected deal-completion timing.
Organic Growth Edge in M&A
Sustained organic growth is often reflective of strong management teams and thriving business models. Acquiring top advisor talent was the leading driver (90%) among buyers in Fidelity Investments’ M&A survey. This signals that a solid track record of growth, driven by management expertise, can promise continuity post-acquisition and mitigate risk.
Yet the path to durable organic growth extends beyond the scope of talented financial planners; it calls for continuous and dedicated effort over time. Building enduring client relationships, forging brand awareness, and expanding service offerings requires a persistent dedication to strategic objectives.
Organic growth often requires innovation and adaptability to changing market conditions and evolving client needs. This means allocating financial and organizational resources towards marketing and sales initiatives in which results may not be immediate. In addition, a strong organic growth strategy can make a firm a more attractive M&A target. Firms both large and small that demonstrate strong organic growth are potentially viewed as less risky investments and may be more appealing to acquirers who are not only looking for an immediate growth boost, but also long-term strategic value.
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[1] Source: DeVoe & Co RIA Deal Book, 4Q 2022
[2] Source: Fidelity Quarterly M&A Review Report Q4 2023
[3] Source: DeVoe & Co RIA Deal Book Q4 2023
[4] https://citywire.com/ria/news/ria-dealmakers-had-the-best-q1-on-record-marshberry/a2441565
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