WealthManagement.com: Should I Stay or Should I Go?

The M&A market for Registered Investment Advisors (RIAs) was poised to be a record year in 2020 based on yearend 2019 data, with volume, valuations, and deal terms reaching all-time highs. Fast forward three months and COVID-19 has eroded most of the 2019 gains in most mar-kets, and the M&A market for advisory practices was no exception leaving many advisors reeling and re-evaluating their options and timeline. As an advisor thinking of phasing out at any point in the near future, many have found themselves balancing their original timeline with recent changes to their revenue and profitability, long-term market outlook, and their willingness to adapt to new compliance requirements such as Reg BI.

Given current market conditions, the question is, what will produce the best outcome for an exiting advisor and their clients – do they sit on the sidelines and try to time the market to maximize value, or pursue a sale today? There are a variety of reasons to delay selling:

• Too much going on with the business
• A passion to continue serving clients
• The owner is in good health and not ready to give up control
• Unsure about post-retirement plans
• Concerns regarding retention of staff
• Concern clients won’t transition to a new advisor
• Concern a buyer may not deliver on the same caliber of service to clients
• Too much debt on the books or a forgivable loan outstanding
• Don’t want to have to change broker-dealers, custodians, etc.
• No compatible or capable buyers in the local market
• Value of the practice may not be high enough to retire

Whether an advisor considers delaying a sale for one or a combination of these reasons, selling the business now remains the safest option as all of the aforementioned elements are normal considerations navigated as the deal is put together. Selling now may not only be the best solution for clients and your role as a fidu-ciary, but it may also protect the seller from waiting and being exposed to changes in tax rates or an increase in the cost of capital for buyers. According to William McCance, chairman and president of TAG Group, “Most advisers without a succession plan recognize the potential perils of not having one, but without motivation to retire, advisers may feel they have plenty of time to plan, even when they are beyond the typical retirement age. It’s time for the aging army of financial advisers to follow their own advice when it comes to their businesses . for their clients’ sake, as well as their own [1].” The most compelling reasons advisors are considering a sale today instead of putting the sale off:

• Current demand and valuations remain strong despite short-term market movement
• Buyers remain well-capitalized and interest rates remain at all-time lows
• Long-term capital gains rates are at all-time lows and expected to increase
• The age of a seller’s clients will only get worse the longer they wait
• Reg BI will lead to many new sellers flooding the market in 2020 and 2021, changing the buyer-to-seller ratios Based on current data from Succession Resource Group,

and substantiated by other third-party sources, the market for advisor practices remains a robust seller’s market, even in spite of COVID-19 and recent market fluctuation. The value of an RIA has not been materially reduced due to the recent and sudden (and hopefully short term) decline in the market. Steve Levitt, Managing Director of Park Sutton Advisors, shared a timely quote in a recent article, stating, “The inherent value of RIAs is the same as one month ago” [2]?

Based on SRG’s annually published data, the average value of practices continues to be at an all-time high [3]. For those considering selling, it is also important to understand how value is assessed. The value of an RIA is not based on one month or quarter, or a simple multiple on revenue based on the rolling 12 months. Qualified valuation analysts review historical revenue and expenses, looking at both short and long-term trends with both topline revenue and net income, and use this information to estimate the future earning potential.

While values have not changed in the short term, the financing terms of the deal have changed given the new risks in the market. Given current market conditions, the upfront cash component is now typically 50%-80% of the total deal depending on the size of the book, size of the buyer, and expenses of the combined companies. This is down slightly from the average 80-100% before March 2020. The result is a portion of the purchase price is paid out of cash flow after closing. The upside to deferring payments into later years is the ability to mitigate taxes and potentially keep the payments at a lower tax rate, in addition to earning interest on the money.

According to Cerulli Associates, the average age of a financial advisor is 55 years old, and only 30% have formal succession plans – despite 2/3 of RIAs who would like to transition within five years. Based on SRG’s recent deal data, there has been a consistent trend year-over-year of buyers retaining the seller for an elongated transition period, allowing for a smoother transition and higher retention rates. This trend has been driven by advisors becoming more proactive with their exit plan and has been exacerbated by the current market conditions. There has been a consistent trend towards creating greater continuity for the clients, with buyers now typically retaining the seller for two or more years, the seller’s staff, and assuming the current office location. Both buyer and seller want to eliminate risk in the deal, and when market conditions are tur-bulent, that becomes critical to long-term success.

Advisors are very good about helping clients understand the perils of trying to time the market.

The same concepts apply to the eventual sale of an advisory business – timing the market typically does not produce the desired outcome. It is important to consider the more important factors, such as the owner’s interest and ability to continue providing the same level of support and service to their clients as they have over the last few decades. If the owner(s) is planning to reduce their workload or wants to retire soon, a sale or merger today is likely the best decision for everyone involved. Given the current values paid for RIAs, availability of financing, low-interest rates, and expected increases in tax rates, there may not be a better time to be a seller. 

[1] Financial Advisor 10. “Older FAs Who Refuse to Retire May Harm Clients, Violate Fiduciary Duty”. Alex Padalka. May 1, 2020.

[2] Financial Planning. IS the wild ride for the RIA MA market over?”. Charles Pailkert. March 18, 2020.

[3] succession Resource Group. 2019 M&A Data.