Looking for capital? 5 key sources for RIAs
If you look at industry headlines, one thing is clear; a lot of capital is chasing RIAs.
Aggregators, traditional private equity firms, minority-interest private equity firms, family offices and various lenders are all in on the act. There are huge differences between them, however, and navigating the options is like running across a minefield. The wrong deal may blow you team to smithereens. The right partner, on the other hand, can help you address succession and liquidity needs and grow your business to the next level.
I first became interested in this area 2 1/2 years ago when Savant needed to recapitalize. My co-founder was ready to retire, but he would only sell if he got all cash with “no strings attached.” My team and I were willing to commit many millions in new money, but even then, we came up short.
I needed to raise outside capital or sell the company. We wanted to stay independent, continue to grow organically and complement it with highly select, accretive acquisitions. I started talking to anyone who could provide capital. The process killed many brain cells, but I got an honorary Ph.D. in capital raising. I interviewed more than 70 capital sources, got proposals from 20-plus investors, speed-dated 10, then whittled it down to three, and finally went to the altar with new investors (it has been a great marriage so far).
These deals aren't just about the money. Cash is table stakes. Terms related to the cash can be even more important.
To spare you similar headaches, I will share a few insights I gained regarding RIA capital sources.
Aggregators: This category includes companies where the primary business is to use some form of financial engineering to acquire RIAs and place them under a common holding company. Examples include Focus Financial, Fiduciary Network, United Capital and AMG.
The positives: 1) they are real pros at doing deals, and 2) they offer turnkey templates and consistent deal structures. Their offers were reasonable but not great. The negatives: they typically will buy control but not 100% of your business. This may be OK if you only want partial liquidity, and if you and your team are OK forgoing the ability to later sell the rest of your firm.
The biggest issue is that their deal structures shift most of the risk to you. The minority ownership that you retain supports a preferred return for the aggregator, meaning that the employee owners may give up part or all of their remaining profits to the aggregator in a market downturn since the aggregator generally gets the higher of: 1) 100% of the equity return, or 2) a guaranteed (preferred) return. Heads they win, tails you lose!
Traditional private equity: Private equity firms of all sizes have been active in acquiring RIAs. Examples include Parthenon, Hellman & Friedman, Lightyear Capital, Stone Point Capital, KKR and Lovell Minnick.
These buyers tend to pursue larger firms that are willing to sell control through a mix of cash and debt. As part of their endgame, they seek firms that are capable of becoming a platform for future acquisitions. The upside: sometimes they pay the most and you might get another bite of the apple when they re-sell your firm (they will want you to roll a piece of your equity to keep you around). The negatives: their time frame is short, they use lots of leverage, they will put you on a treadmill, pump you full of steroids and auction you off to the highest bidder in three to six years (their funds have time limits, so they sell even their best investments). A final warning: you also might find yourself unemployed. PE firms typically change the CEO.
Minority-interest private equity: These players are similar than traditional PE firms (examples include Rosemont Investment Partners and Estancia Capital). They make smaller investments and leave you still in control. However, the devil is in the details. Minority PE firms typically assure their liquidity within five years by requiring you to guarantee their exit. If you do not sell the company, you have to buy back their investment at a much higher price. You have to pay them: 1) 100% or more of your equity return or 2) a full return of their investment plus an 8% to 12% preferred annual return. Therefore, you get all the downside risk if things go awry. They also typically charge babysitting (monitoring) fees, get paid board seats and demand minority protections and consent rights.
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Family offices and UHNW investors: Well into our process I discovered a growing contingent of billionaire types who make direct “patient capital” investments in RIAs. Some families are household names while others are lesser known. They like RIAs because they distribute high current cash flow and can be great long-term investments. The biggest plusses: these investors have long time horizons (20 or more years) and can buy common equity with reasonable minority protections. In addition, the last thing they want to do is operate your business. That said, the right ones can make great board members and advisors. The downside is that deals with multiple investors can be complex and are inevitably less turnkey. The price they offer may also be lower than traditional PE, but they do not want to heap on extreme debt and quickly flip your business. Therefore, you have more time for compounding.
Traditional and nonbank lenders: We interviewed four lender types: 1) large banks, 2) community banks, 3) SBA banks (i.e. Live Oak Bank) and 4) nontraditional lenders (i.e. Oak Street Funding). Traditional bank plusses: bank capital is the least expensive and you do not have to sell equity or lose control, unless you default. The downside: too much debt can sink your ship if the market gods get mad!
Large banks work with large RIAs. Community banks can work with large or small RIAs and are a great solution — with less red tape — if you know them. Rates vary depending on personal guarantees, loan terms and loan size. SBA loans work for small RIAs but always require personal guarantees and are laden with fees. Nonbank lenders include mezzanine and business development companies. The plus: they will lend you a lot with good terms (e.g. interest-only loans). The negative: rates are high and you often have to give up warrant coverage.
Where did Savant land? We took capital from four family offices and strategic high-net-worth investors and borrowed from our local community bank (without personal guarantees). We retained control and now have “patient capital” partners (they can never make us sell nor buy them out). We got more than just cash — our investors offer lots of expertise and connections and pledged additional follow-on capital to support M&A. Maybe the most important aspect of the transaction, though, was the fact that we increased the number of employee owners, times three (we now have nearly 50 employee owners). I was not interested in Savant ending with the founders, so having a capital provider whose timeframe aligned with Savant’s trajectory allowed us to make ownership steps that fostered succession and long-term viability.
What should you do? That depends. The advice I offer is to get clear regarding your goals. Do you want to sell 100% soon or stay in business for 100 more years? Is control important? Do you have a one-time or ongoing need for capital? Do you want advice or just hard cash? Are you OK offering personal guarantees? Do you care how the transaction affects employees and clients? Once you are clear, it will become evident what capital provider is best aligned with your plan, preferences and unique needs.
Finally, remember, it is not just about the money. Cash is table stakes. Terms related to the cash are just as important, or maybe even more so.