August 2020
Since the close of Q1 2020, we have seen consistent unrest, including market turbulence that has put many advisors, their relationship with clients, and their investment strategies, to the test. Fortunately, it is times like now that highlight the work advisors do for their clients, much of which is unnoticed when markets are steadily improv-ing. The relationship between the advisor and their clients is the bedrock of value in an RIA, regardless of the amount of AUM, revenue, or profitability. And, while 2020 won’t be the best year for advisors, the inherent value of RIAs seems to be one of the few things unaffected by COVID-19. But, like throwing a pebble into a pond, we will see the ripple effects of 2020 on the M&A market for years to come.
Short Term Impact
Advisor M& A activity was on a record-setting pace in 2019, with 2020 expected to be more of the same. Then COVID-19 happened.
Deals that reached the letter of intent stage largely persevered despite COVID-19 and markets suddenly declining. However, the pace of sales slowed as buyers reevaluated offers to account for the newfound uncertainty and potentially declining revenue. Even buyers with a longer-term outlook and stomach for short-term risk were forced to reevaluate as their lender became understandably more conservative. As April ended and nerves had calmed, advisors began picking up where they left off with their deals. Despite a short-term decline in revenue through June, valuations remained consistent with year-end 2019 expectations, climbing 3.3% on average through the first half of 2020 from an average multiple of revenue of 2.72x in 2019, to 2.81x YTD 2020.
However, there has been a lasting effect on deal structures, with most deals now containing a clawback feature, and an average down payment of 60% (down from an average of 83% in 2019). Based on Succession Resource Group’s data, 85% of RIA purchases in 2019 used an industry lender, and with the low interest rate environment, SRG expects this number to reach 90% of all deals by the end of 2021. With more lenders every year, increased deal volume, and each lender having unique loan programs, resources such as LendingWell, will play an increasingly important role ensuring advisors find the right financing solution.
Beyond 2020
The COVID-19 impact on advisor revenues rebounded much quicker than initially anticipated, which is expected to act as a catalyst for those advisors who were considering a sale at any point in the next 1-3 years. Kristen Grau, CPA, CVA, SRG’s Listing Director, anticipates increased deal volume as early as this summer based 1) COVID-19 and recent market conditions creating unrest with advisors; 2) Increased compliance challenges (Reg BI and the DOLs proposed new standards for example; 3) The graying of the industry and aging cliens; and 4) A lack of succession planning.
Looking into 2021 and beyond, SRG expects multiples of revenue or earnings to continue to increase, but at a much slower pace as the market sees a significant increase in smaller practices coming to market. Offsetting this appreciation is the expectation that capital gains tax rates and interest rates will rise, driving up the cost of capital and making the near term the most viable time to exit the business for any advisors looking to maximize value and eliminate uncertainty.
Disclaimer
This article was first published by David Grau Jr., MBA. The original article can be found here. All rights to the original content are held by wealthmanagement.com.