How advisers can add value to their firms

You can’t pick up (or click on) an issue of InvestmentNews without seeing a headline announcing another advisory firm merger or sale. The pandemic has put things into perspective for our industry. Advisers have become acutely aware of the need to manage risks associated with their firms. 2020 saw a record number of M&A transactions, several hundred in fact, and 2021 will be even higher.

What’s behind the frenzy?

For one, there’s a lot of competition to buy, which is driving up the multiples being paid, so it’s simply an excellent time to sell. Investors have come to appreciate the value of owning advisory businesses, particularly those with compelling value propositions, strong recurring revenue streams, healthy organic growth rates and a successful track record of growing through acquisition. The influx of private equity capital has resulted in more suitors for firms interested in selling or finding partnerships.

Other factors include the opportunity for advisers to eliminate the financial risk of owning a firm and realize the benefit of a record-high stock market driving up valuations, as well as the fact that many advisers are quickly approaching retirement age and need a succession plan.  

Another key factor that has driven prices upward, is that there are now roughly 15 to 20 firms that are aggregators of advisory businesses. Many of these enable principals to roll some of their equity over into the acquiring firm. This “rollover equity,” while typically less than the cash proceeds at the time of the transaction, could be the most important factor in the sale. That’s because the adviser stands to potentially make more money on this equity than the total value of their business at the time of their sale.

Lastly, we’ve recently seen an uptick in advisers looking to sell before 2022’s capital gains tax increase kicks in.      

As the CFO of one of the fastest-growing firms in the country, I’ve been the numbers person behind more than a dozen acquisitions in the last three years. While everyone seems to understand that prices have risen (multiples of six-to-eight times EBITDA are increasingly common), what’s less clear in the minds of some are the other considerations that determine selling price.

What — besides managing a lot of assets, having a clean U4, and owning a well-run firm — can an adviser who is considering selling do to increase value?

Sometimes it’s what you don’t do. For example, some firms mistakenly trim expenses too aggressively to lower their costs and maximize their earnings to attract buyers. It may seem counterintuitive, but the opposite approach can make a firm more desirable. That’s because infrastructure investment, talent in the firm and organic growth (adding new clients) all increase value. Investment expenditure in areas such as marketing aren’t prohibitive because when sophisticated buyers evaluate, they either value those benefits, or they’ll know to strip them out if the investment has been unsuccessful.

As mentioned above, another facet that firms, such as ours, look for is fee-based, recurring client revenue streams, rather than firms with nonrecurring revenues or trail commissions. All other things being equal, fee-based advisory firms typically command more than commission-dependent firms.  

In addition, a key value driver is client concentration risk. For example, a firm with 200 $1 million clients is likely to be more attractive than a comparably sized firm where a small number of clients own most of the AUM (this also applies to adviser concentration risk).

No one can predict the future, and a sobering market correction is certainly out there somewhere. But we at Allworth are more excited than ever about the future of the industry, and don’t foresee an M&A slowdown any time soon.

Chris Oddy is chief financial officer at Allworth Financial, formerly Hanson McClain Advisors, a fee-based RIA with $8 billion in AUM.