Rising interest rates not a killer for RIA M&A

Meanwhile, though, some RIA buyers are 'dancing' to get necessary capital to do deals, says Dan Seivert of Echelon Partners.

While the Federal Reserve has been increasing short-term interest rates since the beginning of 2022 hoping to curb inflation, the current federal funds rate of more than 4% isn’t likely to dampen the frenetic deal-making for registered investment advisors seen over the past few years, according to one long-term RIA industry banker.

The fed funds rate was just 8 basis points, or effectively zero, at the end of 2021, prior to the Fed’s multiple increases in the past 12 months. But that spike shouldn’t completely dampen RIA deal-making, according to Dan Seivert, CEO and managing partner of Echelon Partners, an investment bank focused on RIAs, because of borrowing constraints put into place by the federal government during the mortgage crisis of 2008.

“From a deal-making perspective, there’s a lot of talk about the impact of rates, rising interest rates, in the past nine to 15 months,” said Seivert, speaking Tuesday morning at the Financial Services Institute’s OneVoice conference in Palm Desert, California.

“What I always remind our clients of when doing an M&A transaction is that banks will only lend up to four times of EBITDA,” or earnings before interest, taxes, depreciation and amortization, said Seivert, who was speaking on a panel titled “The Golden Age of M&A and What It Means for Boutique Firms.”

RIA deal-making and mergers have been rampant for the past several years, with 200 to 300 or more deals occurring per year. And the appetite is only going to increase as Wall Street and private equity buyers assess the potential to make more money from RIAs, which routinely kick off annual returns of 25% to 30%. Seivert noted that 15 years ago, there were some 20 private equity buyers kicking the tires of RIAs; now there are about 200.

The cash flow metric EBITDA is a common valuation multiple used in RIA transactions. RIA firms have routinely been valued at multiple of eight to 10 times EBITDA, but in the recent sellers’ market, multiples of 12, 15 or even 20 times a firm’s EBITDA have been cited.

While surging interest rates mean that borrowing to finance mergers and acquisitions is more expensive, the borrowing cap of four times EBITDA means the impact of rising rates is limited to an extent many RIA owners don’t fully appreciate, Seivert said.

[More: How high can RIA valuations go?]

“If you buy a firm for 12 times EBITDA, you can only borrow four times, or one-third the amount,” he said. “If it were a situation where you could borrow 12 times, that would mean the higher price of the debt would be a bigger deal to the borrower and buyer.”

“From a deal-making perspective, there’s been a lot of talk about the impact of rising interest rates in the past nine to 15 months,” Seivert said. “What I always remind our clients of when doing an M&A transaction is that banks will only lend up to four times EBITDA.”

“So, if a deal is at 10, 12 or 20 times EBITDA, the amount you can borrow is a very small percent of the total capital outlay,” he said. “It’s easy to overexaggerate the impact of interest rates on deal-making. I think buyers have used that as an excuse to change a valuation in a deal structure.”

“There are some realities where we see some buyers who have moved at such a fast pace that they lack enough capital to continue at that pace,” Seivert added. “And when those buyers went back to the markets, it was much more expensive [to borrow], so they’ve had to do some dancing to get the capital necessary.”