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The registered investment advisor industry may be the perfect playground for private equity investors. It has good growth, high profit margins, consistent cash flow and low capital needs. With roughly 13,000 firms in the industry, it is also highly fragmented, ripe for roll-up, and begging for consolidation.
“The industry has a lot of the traditional ingredients that private equity investors like,” said Brad Armstrong, a partner at Lovell Minnick Partners in Philadelphia. Lovell Minnick Partners is one of the more active private equity investors in the wealth management industry.
The firm sold its stake in Mercer Advisors in September and last week announced its latest investment in Pathstone, an RIA focused on ultra-high-net-worth clients, managing $16 billion in assets. “We felt under-invested in an industry we have a lot of conviction in,” said Armstrong.
A lot more private equity investors are showing conviction in the value of independent RIAs. The pace of consolidation in the industry has picked up dramatically in the last several years. Mergers-and-acquisitions activity is poised to set its sixth consecutive record this year and valuations on acquired firms continue to climb.
“This space has blossomed,” said Liz Nesvold, head of asset and wealth management investment banking at Raymond James Silver Lane in New York. “Cash flows are up, the markets are good, debt is cheap and the trend to [advisor] independence remains strong.
“All these things moving in the right direction have created a frenzy in the industry.”
When Nesvold started in the business in 1991, there were six transactions in the wealth management industry that year. This year she expects roughly 200 — one good reason she sold her firm to Raymond James earlier this year. “RIA firms need capital solutions,” she said. “Some require growth capital, others leadership capital and succession planning solutions.
“Private equity is fostering a lot of those solutions.”
For the most part, private equity investors are interested in the upper end of the market. They want to write big checks, taking majority stakes in large firms with the goal of spurring further growth with needed capital.
The recent Pathstone transaction was a good example. So was the blockbuster deal done by Hellman & Friedman last year. The private equity firm payed more than $3 billion in cash to buy 401(k) plan robo-advisor Financial Engines, then merged it with Edelman Financial to form the biggest RIA in the country.
Private equity, however, has also fueled deals in the mid-size and smaller end of the market through its investments in acquisitive RIAs and consolidator firms such as United Capital — formerly backed by Sageview Capital, Bessemer Venture Partners and Grail Partners, and acquired by Goldman Sachs for $750 million in May — and Focus Financial, in which KKR and Stone Point Capital took a stake in 2017 then brought to the public markets last year.
Consolidator firms have accounted for one-third of all RIA acquisitions in the first nine months of this year, according to David DeVoe, managing director and founder of investment bank DeVoe & Co. More than half the deals done this year have been for firms managing less than $500 million in assets.
“The more acquirers in the marketplace, the better,” said DeVoe, who said he is now fielding calls from private equity investors every week or so. “From blue-chip mega-firms down to little boutiques, the market has been strong.”
Private equity investors are projecting a kinder, gentler profile these days — a good idea in the fiercely independent RIA industry. Long seen as short-term investors looking to juice growth and cash out of their investments, more PE firms are now willing to take minority stakes in companies and serve as collaborative partners for advisors.
“We have to do more than just provide capital,” said LMP’s Armstrong, whose firm is currently invested in seven RIAs. “All our resources and research are focused on this industry.
“We vet new products, new business relationships and evaluate M&A ideas for our partners,” he added, “We have some shared services but we don’t force them on our companies. We honor their independence.”
Addressing the succession conundrum
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One of the key problems PE firms now help RIAs address is succession planning. With the industry still grappling with the impending retirement of thousands of baby boomer advisor/owners, it can use the help.
“Succession planning has played a role in every transaction we’ve undertaken,” said Armstrong. In the case of Pathstone, the deal included adding 16 additional existing employees as shareholders in the company.
The influx of private equity and other capital to the industry is also helping smaller firms more at risk from a succession perspective. “More mid-size firms are buying smaller firms now,” said Armstrong. “The capital coming into the space is pushing a succession planning solution downmarket.”
For RIAs considering a private equity investment to cash out senior leadership or finance growth, finding the right firm is crucial, said Nesvold. “It’s not a permanent marriage, but RIAs need to find the right cultural fit,” she said. “Some firms take a more consultative board member role while others are more change agents.
“That may not work for a firm that feels they have things right,” she added.
Robert Bradley, a founding partner of Bradley Foster Sargent, seems to have it right. The Hartford, Connecticut-based firm, ranked No. 31 on the CNBC FA 100 list of the nation’s top financial advisors, has grown assets under management to more than $4 billion, from $90 million when it launched in 1994, without any acquisitions of other firms.
“I think we’re an attractive target for private equity firms, and we do get solicitations, but we’ve chosen not to sell,” said Bradley. “Once you sell a majority of your firm, you’re no longer master of your fate.”
One of the big downsides of that is lower compensation for everyone going forward. “They take a big chunk of cash flow every year and that means lower compensation,” said Bradley, who at age 75 plans to work for another five to 10 years.
For the three founding partners who own most of the firm, it might be an acceptable tradeoff, but much less so for the other 12 employee shareholders at BFS. “Circumstances could change,” he said. “We never say never, but we’re not headed in that direction.
“We’re doing our succession internally.”
Bradley does understand other firms, particularly those started in the 1980s and 90s, opting for a buyout. “The reason usually involves generational transfer of the business,” he said. “The older generation founders want to get full value for their companies and that’s more than the next generation [of employee/shareholders] can come up with.”
He also thinks the added capital from private equity investors is a big positive for the industry. “It’s helped create a robust market of buyers and sellers in the industry,” he said.
And that’s good for everyone.