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Pressure tightening on midsized RIAs

The pressure on midsized advisory firms to scale up and improve efficiency or be left behind is intensifying, according to Fidelity’s Scott Slater.

Even if RIAs with less than $500 million in AUM aren’t ready to buy or sell, they should be assessing their M&A prospects, said Slater, vice president of practice management and consulting for Fidelity Clearing and Custody Solutions.

Advisors who fail to evaluate the strengths and weaknesses of their firm are putting their hard-won independence "at risk," Slater told firm owners attending an M&A session at Fidelity’s Inside Track conference in New York City.

“If you do nothing, you’re putting yourself in a precarious position,” he said.

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The forces challenging independence today, he says, include scalable platforms, greater industry concentration and a plethora of capital providers with formidable war chests, led by private equity firms.

Midsized RIAs are already losing market share, Slater noted.

While large firms with more than $500 million in client assets under management represent only 6% of the roughly 13,000 SEC-registered advisors, they control fully 70% of the industry’s assets, according to a recent study from Cerulli Associates.

Slater also cited Michael Kitces' recent article “The future looks bleak for midsize RIAs.”

The current sellers’ market has resulted in high valuations and favorable deal terms.

The good news, Slater said, is that advisors have never had more options to choose from – or a better time to consider them.

He cited the many different acquirer models RIAs can seek out, including passive investor (Fiduciary Network), financial acquirer (Wealth Partners Capital Group), strategic aggregator (Focus Financial), branded acquirer (United Capital, HighTower, Captrust, Mariner) and wealth management RIA acquirer (Savant Capital, EP Wealth Advisors).

The current sellers’ market has resulted in high valuations and favorable deal terms, he pointed out.

Multiples of EBITDA or earnings before owner compensation are now determining valuations, Slater said, not multiples of revenue.

Firms with under $250 million in AUM can expect valuations of around five to seven times earnings, while RIAs with $250 million to $500 million can expect a slightly higher valuation, all things being equal.

Firms with between $500 million and $2 billion should command a stepped-up valuation of six to eight times earnings, Slater said, while RIAs with over $2 billion in AUM may get an outsized 12 or 13 times earnings.

What’s more, sellers are now taking at least half of their cash up front, and earn-out periods have shrunk to around three years from approximately five to six years, Slater said.

If a firm wants to buy or sell, they need to asky why.

But he cautioned that buyers are smart and are taking a close look at sellers’ size, growth rate, client demographics, technology and next-generation talent.

Both buyers and sellers need to prepare for a potential deal, Slater said. If they decide to take action, they need to ask why.

“It’s the most important question in the whole process,” he said. “Do you want to improve your firm’s offering? Achieve scale? Reduce cost? Attract and upgrade talent? Better serve your clients?”

If due diligence isn’t thorough, Slater cautioned, the laborious dealmaking process can lead to undesirable results.

Too often, he explained, the “energy” involved in doing a deal can “drive decisions that aren’t the best outcome" for either party.

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