Judging by the first quarter, 2018 looks like it will be a banner year for RIA mergers and acquisitions.
The number of deals rebounded from a mild slump in the second half of 2017 to near record highs, according to two of the industry's leading M&A consultants, DeVoe & Co. and Echelon Partners.
DeVoe recorded 47 M&A deals and Echelon reported 46 deals. Both firms believe that the robust activity will continue through the year — and beyond.
"RIA M&A should increase and even accelerate over the next five to seven years," says David DeVoe, principal of the eponymous San Francisco-based firm. "The underpinnings of the trend remain unchanged. For sellers, RIA valuations are high, the number of potential buyers is high and there are clear benefits of scale. For buyers, RIAs are selling in record numbers and are genuinely curious about joining firms who can help them run better businesses."
Echelon CEO Dan Seivert, based in Manhattan Beach, California, also expects a high level of deal volume to be sustained.
"More entrepreneurs are telling us they've blown through their internal targets for an after-tax liquidity event as a result of the continuing bull market," Seivert says. "This is a new phenomenon and we expect it to continue. We're seeing more owners exploring their strategic options than since the peak levels of 2008."
Both executives agree that while a sharp market downturn is likely to curtail M&A activity, a continuation of the kind of volatility the stock market experienced in the first quarter may well spur more RIA transactions.
"Periods of extended volatility can sow the seeds of increased RIA sales," DeVoe notes. "Owners who are nearing retirement may become fatigued by the ups and downs of a volatile market, while others may fear that volatility at the end of a long bull market will lead to a correction, which may compromise their valuation, prompting them to sell instead of waiting things out."
The consultants disagreed, however, about the volume of breakaway brokers and impact of the Broker Protocol on M&A activity.
Breakaway activity remained strong in the first quarter, according to Echelon's RIA M&A Deal Report, with a 6% increase in breakaway brokers during the first quarter compared to the fourth quarter of 2017.
In light of defections from the Broker Protocol last year, the further dissolution of the pact "would signal increased legal liability for advisors attempting to leave wirehouses," the Echelon Report notes. As a result, brokers considering going independent face "increased pressure to make a decision now or face greater potential consequences in the future."
Quote"More entrepreneurs are telling us they've blown through their internal targets for an after-tax liquidity event," says Echelon Partners CEO Dan Seivert.
But DeVoe's quarterly RIA Deal Book report concluded that activity for breakaway brokers joining RIAs was just "lukewarm." The 17 breakaway teams that did merge with independent firms in the first quarter "was right in line with the three year average," according the report.
"Every week that wirehouses don't exit the protocol, brokers lose a degree of urgency to leave," DeVoe says. "We may see a pop in the second quarter, but if not, it may just continue to be business as usual."
The size of the average deal in the first quarter exceeded $1 billion for the third straight year, Echelon reported. However, that figure may be skewed by a few exceptionally large deals, such as Lightyear Capital's acquisition of HPM Partners, which had over $7 billion in AUM.
DeVoe recorded a decline in the average AUM of established RIA sellers to $858 million from $905 million last year. DeVoe points to the high volume of smaller firms joining larger ones in sub-acquisitions, which accounted for nearly a quarter of all first quarter transactions, according to the Deal Book.
Sub-acquisitions of firms with less than $250 million in AUM continues to be a favorite strategy of Focus Financial affiliates Buckingham Strategic Wealth and The Colony Group, which together transacted five such deals through March.
Private equity also continues to be a force in M&A activity.
PE firms such as Thomas H. Lee Partners and KKR, investing in and backing consolidators like Focus and HighTower Advisors are "increasingly seeking and finding established businesses that fit their investment criteria," the Echelon Deal Report states. And Seivert estimates that as many as 60 private equity firms are investing in the RIA market.
DeVoe, however, notes that private equity firms usually have a criterion for the amount of capital they deploy, such as Thomas H. Lee's $100 million stake in HighTower, and tend to concentrate on large deals. "M&A deals have to be the right fit for them," he says.