Smaller 401(k) plan advisers losing fight to stay afloat
Facing regulatory and cost pressures, many consider selling out to larger firms
Look for large players in the retirement plan market to become even bigger.
Registered investment advisory firms, roll-up groups and retirement plan specialist broker-dealers are stepping up efforts to acquire smaller plan advisers or to buy up blocks of 401(k) business from them. The acquisition movement is being driven by tougher regulations from the Labor Department, higher demands for service from plan sponsors and the lure of profitable rollover business.
“In the past, there was a lot of noise about firms’ wanting to consolidate or acquire advisers,” said Rick Shoff, managing director at Captrust Financial Advisors, which has aggregated advisory firms that specialize in the 401(k) business. “This time, there’s less hype, but the firms having consolidation conversations are serious.”
Still, prospective buyers warn that the acquisition of a 401(k) block of business won’t necessarily produce a windfall for the seller.
Purchasers are very picky about the retirement plans that potential acquisitions serve, placing a high value on business that is easy to transfer and free of compliance worries. And because the retirement plan business has lower margins than wealth management practices, sellers can expect a multiple in the range of one to two times revenue.
“HIGHER RISK’
“It wouldn’t surprise me if the purchase price for a retirement plan business were maybe half as much as a true wealth management practice,” said Mark Tibergien, chief executive of Pershing Advisor Solutions LLC. “It’s a little more labor-intensive and regulatory in nature, so there’s a higher risk.”
Larger RIA firms think that they will be the beneficiaries of what could be a buyer’s market for acquisitions. They see themselves as being best-prepared to face an onslaught of new rules from the Labor Department that will require retirement plan providers to spell out fees and services to the plans that they serve.
They also think that an upcoming rule proposal from the Labor Department that would expand the definition of “fiduciary” will lead nonfiduciary providers of services to shed their retirement plan businesses. Acquisition by a larger RIA firm also could be attractive to smaller firms or those that haven’t achieved economies of scale in the 401(k) business, which are likely to find themselves struggling with higher compliance costs and demand for deeper retirement plan services.
“Broker-dealers aren’t allowing many reps to service plans in a fiduciary capacity, so there’s this opportunity to buy up some of those blocks of business,” said Stanley D. Milovancev, executive vice president of Sequoia Financial Group LLC. “It’s a real opportunity for broker-dealers to divest some of those businesses.”
At the same time, plan sponsors are becoming savvier about the services that advisers provide them and are demanding more.
“Clients know the difference between renting someone else’s research versus providing original research,” Mr. Shoff said.
“In many requests for proposals, sponsors want to know the number of people on staff doing research and whether the adviser has its own customer relationship management system,” he said. “If you don’t say yes, you’re going to get screened out.”
Advisers who are weighing whether to join a retirement plan specialist or sell their business should be aware that buyers will be looking at them with a cold business eye.
“Buyers seem to understand the return potential, and sellers have an inflated perception of value,” said Mr. Tibergien, who noted that 401(k) practices, despite their predictable cash flow, are typically low-margin, high-volume businesses.
THREE BIG FACTORS
The three biggest factors in determining the value of such businesses are free cash flow after all expenses involved in servicing the retirement plans, continuity risk (whether the plan sponsors will renew) and growth potential, according to Mr. Tibergien.
Buyers also will want to know how a seller won its retirement plan clients, especially if below-market pricing was a factor, and if acquiring the plans will necessitate a move to new custodians and record keepers, which can be time-consuming.
“We want to know if the business is transferable and whether it has major compliance issues,” Mr. Milovancev said. “With small books of business, you want to look at this on a plan-by-plan basis.”
Location and similarity to an existing block of business also can be factors in determining whether a firm wants to make an acquisition, advisers said.
Terms of deals involving retirement plan business are just as important as the price, Mr. Shoff noted. Sellers may get a better price in deals structured to be paid out over a period of years, since these may be tied to plan sponsors’ sticking around through the transition.
Likewise, sellers looking to get out quickly typically will receive a steep discount for their business.
“Someone might get two times revenue but receive less upfront and earn the remainder over five years,” Mr. Shoff said. “But there is no guarantee you will get the full two times revenue.”
TRANSACTIONS TAKE TIME
Since smooth transitions are the goal, a transaction may take several years to complete.
“If the seller is retiring, we want them to say, “I’m stepping away in a few years, so let me transition some of my business to your servicing planners,’” Mr. Milovancev said. “We want a long-term relationship, not just a transactional business.”
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