Desire for scale now 'primary' M&A driver
Imagine the future of the RIA industry as a barbell. A few large firms sit at one end counterbalanced by many solo and smaller practices at the other end, while a declining number of mid-sized firms thinly occupy the middle.
That's how some industry executives see things shaking out.
Reviewing the record number of 176 M&A deals for advisory firms last year, consultant David DeVoe is watching the big-firm side of the barbell take shape.
“Five years from now I can see a dozen or so mega-firms dominating the industry,” says DeVoe, managing director of his eponymously named firm in San Francisco. “For the first 12 to 14 years that I tracked M&A, the key driver for sellers was exiting the business. Now the desire to achieve scale is the primary driver.”
That drive has pushed the average deal size past $1.3 billion, according to Echelon Partners' latest RIA M&A Deal Report. The most active buyers were consolidators and large RIAs, who snapped up a combined 81% of all firms, according to DeVoe's most recent RIA Deal Book, his own report analyzing the space.
DeVoe’s vision is shared by Brent Brodeski, a strategic buyer and CEO of Savant Capital Management, a firm with around $6 billion in client assets under management in Rockford, Illinois.
“I think you’ll see 10 to 15 large firms that will be dominant regionally and a few who may have a truly national presence,” Brodeski says. “It’s just the way the industry is developing.”
“I think sellers are still guided by 2018 and believe they can get top dollar,” says Mercer Advisors M&A head Dave Barton.
But while mid-sized firms with between $200 million and $1 billion in AUM may have a harder time keeping up with the industry leaders, solo practices can do just fine, DeVoe says.
“I don’t see them being decimated like small travel agencies were," he says. "You can earn a very good living as a solo practitioners. That cohort is not going away."
Indeed, Financial Planning contributor and Pinnacle Advisory Group Partner Michael Kitces argues that solo advisors who are CFPs shouldn’t worry and the imperative for smaller firms to grow and scale may be overstated. Kitces is putting his money where his mouth is with the XY Planning Network, a network of small independent planners, that he co-owns.
The challenge remains in the middle of the barbell. Many RIAs, most with older owners, have expanded beyond a one or two-person shop, but have failed to grow any farther. They face rising expenses but haven’t put their firms up for sale yet, DeVoe points out.
“There are over 5,000 RIAs with over $100 million in AUM,” DeVoe says. “There could easily be two to three times more of those firms coming to market than we’re currently seeing. If that happens in a given year, supply could outstrip demand, and valuations could drop drastically.”
A trigger event for such a surge of sellers hitting the market could be a major drop in the stock market or a confluence of aging baby boomers deciding to sell at the same time, DeVoe says. He thinks there’s approximately a 30% chance of that happening over the next seven years.
The market has of course already been jolted recently by serious volatility, prompting some strategic RIA acquirers (not without a hopeful dose of self-interest) to proclaim that the seller’s market of the past several years has begun to shift in their favor.
“There’s no denying the impact of a market correction on sellers and buyers,” says Dave Barton, vice chair at Mercer Advisors who heads the private equity-backed firm’s M&A activity. “I think sellers are still guided by 2018 and believe they can get top dollar. They’re going to have to clean up their profit and loss lines and understand that buyers are buying risk, and the risk is increasing.”