M&A and succession planning in a time of high inflation, rising rates

Advisors looking to sell their practices can still get fair value for their life’s work, but they should avoid overly complicated deals and do their homework to find the right buyer.

With inflation still running hot, the Federal Reserve has signaled that it will continue raising interest rates at coming meetings even in the face of recent events. While the 40-year high in inflation and the unprecedented increase in rates have had consequences for your clients, impacting everything from their portfolios to grocery bills, they have also hit closer to home for many advisors, throwing the wealth management mergers and acquisitions and succession market into a state of confusion.

After a decade of easy access to capital and high-flying equities, consolidation in the independent wealth management space boomed. Independent broker-dealers, private capital and RIA aggregators went on a shopping spree, buying up small, medium and large practices with abandon. Advisors were being offered high multiples and great terms, and many cashed out.

But the environment has changed for both buyers and sellers, and all involved will need to temper their expectations. Acquiring firms will need to adjust their asset growth projections and sellers will need to be more realistic about what their businesses are worth.

DEMOGRAPHICS STILL DRIVING CONSOLIDATION

When real estate hits a rough patch, homeowners who don’t need to sell can take their homes off the market and wait for better conditions. In a similar way, financial advisors who don’t have to sell their practices in the current environment can continue serving their clients until the time is right to sell. But what about older advisors who are ready to retire today? Many of them may not have the luxury to wait things out.

We’ve all seen the studies. Like the clients they serve, advisors are aging, and many are looking to retire. According to a 2019 J.D. Power study, the average financial advisor is about 55 years old, with nearly one-fifth of them 65 or older. Over the next 10 years, Cerulli Associates estimates that more than 111,500 advisors will retire. That’s about one-third of the workforce.

For some of these older advisors, the rapidly changing landscape over the past 18 months may be causing them to change their plans and rethink some assumptions. If they can delay retirement, they might decide that’s their best option. They can bide their time and hope markets rebound, assets under management rise and interest rates come back down. They are making the calculation that buyers may be willing to offer better multiples if the cost of capital falls and forward-looking revenue projections improve.

BE PREPARED TO ACCEPT LESS

Advisors who can’t or don’t want to wait can still find buyers, although they will not get the high valuations and multiples their businesses were commanding even a year ago. Deals may also be more complex, with lower up-front and higher contingency money. Some acquiring firms may only offer to take a minority stake in an advisor’s practice. This trend is not as clean as a full buyout, but it at least allows the advisor to monetize a part of the business, while putting off full retirement for a few years.

Firms with broker-dealer cash sweeps programs are in a stronger position to step into the acquiring role RIA aggregators had occupied in recent years. The same higher interest rates that are making the cost of capital to finance deals more prohibitive are making these cash sweep programs more profitable, increasing revenue for the broker-dealer and freeing up assets for them to make strategic acquisitions.

While deals are still getting done, volumes may have peaked. According to the quarterly DeVoe & Company RIA Deal Book, deal volume set a ninth consecutive record in 2022, rising 10%. However, transactions for the fourth quarter dropped 20% from the same quarter in 2021, the first year-over-year quarterly drop in four years.

Advisors looking to sell their practices can still get fair value for their life’s work and take care of their clients. They should avoid overly complicated deals and do their homework to find the right buyer.

Michael Nessim is CEO, president and managing partner of Kingswood U.S., a wealth management firm with more than $3 billion in assets under management.