Value Judgment

The retirement plan advisory space will consolidate at an increasingly accelerated rate, predicts Rick Shoff, managing director, advisor group at CAPTRUST in Doylestown, Pennsylvania. Even faster than it has in the past two or three years? “Big-time,” he responds.

“We’re seeing bigger advisory firms now consider being acquired. The story for the next two years will be that there may be fewer advisory firms acquired, but the ones that do ‘tuck in’ are going to be a ‘drop-the-mic’ moment,” Shoff says. “I do think the retirement space will be fully consolidated over the next three to five years.”

This year’s third quarter saw 55 registered investment adviser (RIA) merger and acquisition (M&A) deals, up from the temporary lull of 35 deals in the second quarter, according to the “Q3 2020 RIA M&A Deal Report” from Echelon Partners, an M&A advisory firm in Los Angeles that focuses on investment managers and wealth advisers; its data encompasses both wealth management and plan advisory RIA practices.

“We saw pretty normal activity in January and most of February, picking up where 2019 left off—and 2019 was a record year for RIA M&A,” Echelon Managing Director Mark Bruno says. “Second-quarter 2020 numbers were low, because many deals were put on hold due to the pandemic and market volatility. If you think about advisory firms, when there’s a major market issue, they’re ‘all hands on deck’ with their [current] clients. But in May, that bottleneck started to clear, and deals picked up.”

It is hard to pinpoint the deal outlook for the next year or two with certainty, Bruno says, because of the pandemic’s unknown course and ramifications. “But if you take unknown events out of the mix, we see a strong pipeline of deals. Deals don’t happen overnight: It’s a six-to-18-month process, so you do have a pretty good visibility into the future,” he says. “And there’s a ton of interest in buying $1 billion-plus [in asset-under-management (AUM)] RIA firms.”

The entrance of new, large acquirers has played a big part in the acquisition upswing. Hub International Ltd., headquartered in Chicago, has made numerous high-profile deals for advisory practices in little more than one year. Its recent acquisitions include Baystate Fiduciary Advisors Inc. in November. And a year ago September, all in one day, it acquired Inter-Mountain Retirement Partners Inc. (MRP), StoneStreet Pearl River LLC, Washington Financial Group and WhartonHill Advisors.

And Hub is not done yet. “We intend to do more acquisition in the next year than we did in the past two years,” says Adam Sokolic, chief operating officer (COO) of retirement services. “We intend to ‘keep the pedal to the metal.’”

The acquisitions fit into Hub’s growth strategy of having an integrated products and services offering for employers. “We’ve frequently heard from our clients that they want to have one benefits provider,” Sokolic says. Hub already has a large client base in its insurance and employee benefits businesses. “We look at [retirement and wealth management advisory services] as the last leg of the stool, so we can provide the entire range of benefits and risk services to employers,” he says.

Adds Hub Director, Business Development Jim Owen, “Clients want specialists in the different benefits areas, but now they want the specialists to be under one broad roof.”

Employee benefits consultant OneDigital made an effective entry into the retirement and wealth management space in February when it acquired Resources Investment Advisors LLC. That group’s high-profile advisory practices include 401k Advisors Intermountain, Bukaty Companies Financial Services, Cafaro Greenleaf, Chepenik Financial and Strategic Retirement Group (SRP).

The retirement and wealth management advisory space is “the single most natural extension of our business,” says Mike Sullivan, OneDigital co-founder and chief growth officer. He says employers increasingly want to look at their benefits holistically, rather than as separate silos. “Previously, employers picked a benefits consultant and a retirement plan adviser, and never the two shall meet,” he says. “It turns out, that’s not the best way for them to do it. It’s much better to take a holistic view of their overall benefits spend and to craft a customized benefits solution that is best for that employer and its employees.”

OneDigital foresees making more advisory practice acquisitions imminently. “And if you flash forward three, four or five years, I think you’ll find that the stand-alone retirement plan advisory firms will have much less market share,” Sullivan predicts. “The silos are quickly breaking down, and a more integrated approach is going to win in the marketplace.”

Private equity firms also have started making deals in the advisory space.

In June, CAPTRUST announced that GTCR LLC in Chicago had taken a 25% minority stake in the firm. Shoff says the advisory firm did the deal in part to reward longtime CAPTRUST employees who have accumulated, via a merit system, a substantial number of shares and who could liquidate part of them in this deal. Some have become millionaires as a result, he says.

“The second reason is that we’ve always used our own capital to grow,” Shoff says. “But we believe that the opportunity in front of us now to grow through acquisitions is so huge that we needed more growth capital.”

The larger acquiring advisory firms that Advice Dynamics Partners LLC works with tend to be private-equity-backed, and they have a mandate to do acquisitions as part of their growth strategy, says David Selig, CEO and founder of the company, an M&A and valuation adviser to wealth managers and asset managers, in Mill Valley, California. The private equity firms’ interest in the RIA business stems largely from the fee-based RIA model, he says. “These advisers have recurring revenue streams, and investors like to see predictable revenue streams,” he notes.

“It’s become really competitive among the private-equity-backed firms to do acquisitions, and, as a result, the valuations have risen,” Selig continues. “A private-equity-backed advisory firm can afford to pay a relatively high multiple to acquire a smaller advisory firm, because the acquiring firm received an even larger multiple investment from the private equity firm.”

To Centralize or Not to Centralize

There is more than one flavor of advisory practice acquisition. Some acquirers take a less centralized approach, and the acquired advisory practice keeps its brand name and much of its operational autonomy. “If you’ve already achieved a semblance of scale as an advisory practice, which usually means you have at least $1 billion to $2 billion in assets under management, this could be a good option,” Selig says.

A trade-off exists between how closely an advisory business integrates with the acquirer and how much scale it gains: An acquired RIA that integrates more gains more scale, but it gives up more control. “When we talk with an adviser who is interested in selling his or her business, we start by asking questions about, ‘What’s important to you? Is it important to you to retain control over your operations? Is keeping your brand important?’” says David DeVoe, founder and CEO of DeVoe & Co., an RIA M&A consultant in San Francisco.

Other acquirers, such as OneDigital, take a more centralized approach to acquisitions. The acquired advisory practices will transition to the company’s name and integrate much of their operations with OneDigital’s advisory business. “We’re 100% focused on building the brand in the small- and midsize employer market, so everyone will take our brand and get on our platform,” Sullivan says. “It’s so important to build brand awareness at the employer level and also to manage the data in a way that creates new and interesting insights for employers.” OneDigital has embarked on a project with Microsoft to capture a wide breadth of data on participant behavior in its clients’ plans and then to deploy artificial intelligence and machine learning to produce those insights, he says.

CAPTRUST has taken a centralized approach to acquisitions all along. “Our model is to have fully integrated services in one unified practice. By having one brand name and many centralized operations, we gain efficiencies,” Shoff says. “It allows us to truly build scale. Some of our competitors that are acquiring retirement firms are really just a mash-up of $1 million to $3 million [in revenue] practices. The idea that you can buy a couple of firms and bolt them together with marketing and not integrate the operations and infrastructure—we think that’s going to be a failed strategy.”

An advisory firm team that is considering selling should think in depth about how much control it wants to keep once the deal closes, DeVoe suggests. “The degree of control they kept used to be extremely important to advisers making a deal. Most wanted to keep making all of the decisions. But in today’s environment [with intense competition and compressed fees], many have decided they’re willing to give up some control in return for getting scale,” he says.

Valuation Drivers

A quick, starting approach to an advisory practice valuation is to use a multiple of five times the practice’s annual EBITDA—i.e., earnings before interest, taxes, depreciation and amortization—or two times the practice’s revenue. So a practice with EBITDA of $2 million could be worth in the ballpark of $10 million in a sale. Bruno says an in-depth valuation typically takes one week to one month, and the actual multiple ultimately used for the acquisition of a practice varies based on factors such as its size and growth pattern.

DeVoe sees three main drivers of current valuations: the RIA’s growth, its profitability and its risk level. Risks can be multifaceted: DeVoe & Co. has 48 risk factors that it looks at when it does a valuation. Risks that could reduce a valuation include a business heavily dependent on one adviser, an RIA lacking noncompete agreements with key staff in case they depart the firm, and an RIA very concentrated in a particular client segment.

Acquirers considering a deal also take a close look at a potential acquisition’s financial performance, and the key factors CAPTRUST considers include total revenues and revenues per client, Shoff says. “We’re generally interested only in acquiring retirement-focused practices that have at least $1 million of [total] revenue per year, but, ideally, we want firms north of $3 million in annual revenue.” CAPTRUST also considers an advisory practice’s revenue per employee. “If you look at healthy, retirement-focused RIAs, their annual revenue per employee should be over $300,000,” he observes.

In addition, how a practice spends money affects its valuation. “Acquirers are looking to buy profitable businesses, but they’re also looking to buy businesses that are investing in their growth,” says Bruno. “That means investing in the people and technology needed for growth, and paying their people well and providing them with good incentives. Firms that are growing because of the strategic investments they’ve made in the business are very attractive to acquirers.”

With the goal of maximizing their EBITDA-based multiple, some advisers take cost-cutting too far. “Many times, you have an adviser who knows he wants to sell the practice soon and tries to pretty up the EBITDA by cutting expenses,” Sokolic says. But potential acquirers such as Hub look very closely at a practice’s expenses, he says, and will realize when a firm has artificially low staffing costs and will need to hire more people soon.

An advisory practice’s growth patterns also play a major role in its valuation. “A big part of what buyers look for is synergy,” Bruno says. “If a firm being acquired specializes in retirement plan advice, that can mean also demonstrating the ability—and the potential for an acquirer—to leverage those relationships with plan sponsors and participants to connect to new wealth management clients.” An advisory practice with a track record of being able to do that would get a premium on the valuation, and wealth management advisory services also typically have higher profit margins, he says.

While a potential acquirer will look closely at how much new growth opportunity an advisory practice could offer, Hub’s Owen says an adviser considering being acquired should do the same. “One thing I’d look at with a potential acquirer is, geographically, does it have a large base of existing clients in my target geographic area that it could refer to me?” he says. “For an adviser, it’s also important to ask yourself, what is the size of the typical client that the acquiring firm has? Some acquirers may have many clients, but these clients mostly have very small retirement plans that are not a good target for the adviser.”

The Affiliation Option

Choosing to affiliate with an aggregator instead of being acquired still can make sense for an advisory practice, sources say.

“If you lean toward affiliating, it’s because you want to stay independent. And I believe there’s still much room for the affiliation model, particularly for firms with under $200 million in assets under management [AUM],” Advice Dynamics Partners’ David Selig says. “They can get branding, technology and [back-office] support from the aggregator.

“You get to almost ‘rent’ services,” Selig says of the affiliation model. “There are thousands of small practices for whom affiliating might make sense: They can hitch their wagon to the aggregator’s star and take advantage of the scale the aggregator has built.”

“It can be a way to get ‘synthetic scale,’ and that can be an intelligent decision,” says David DeVoe of DeVoe & Co. “You determine the things you’re really good at—your core competencies—and then it can make sense to pay a fee to [an aggregator] with different, operational core competencies.” —JW

Art by Gizem Vural