M&A deal structures have changed dramatically amid the bear market

Despite the bear market and the decline in firm revenues, the pace of mergers and acquisitions in the adviser sector has continued to accelerate. How are all these deals still getting done?

If you’d asked advisers at the beginning of the year what they thought will happen to the pace of consolidation if a bear market struck, most would’ve told you the number of deals would drastically slow. But not only hasn’t that happened, the number of completed deals will likely set another record this year.

Consistent with the last few years, dozens of deals are still being completed every month. What has changed is how these deals are being structured.

Coming into 2022, deal structures were based upon a few key factors, one being a firm’s valuation. With markets and assets under management both high through the fourth quarter, advisers were able to use their year-end 2021 revenue run rate and project those earnings into the future.

Deals were structured with a “contingent payment” that was typically payable within a year. That is, in an alignment of interests, the firm had to commit to ensuring that their clients and their AUM transitioned to the acquiring firm to receive the contingent payment.

Given that markets were at all-time highs, many advisers wanted guarantees that they’d receive their full contingent payment regardless of what happened in the markets. The argument was that they shouldn’t be penalized for a short-term bear. So most deals were structured in a manner that ensured the selling firm its payments regardless of what happened with the values of equities and bonds.

Well, once the markets dropped, taking the AUM managed by advisers along with them, selling advisers began asking for something different. Their argument was (and is) that market declines are temporary, and the business should be valued based upon the results that would be achieved in a “normal” market cycle.

This has resulted in a fundamental shift in the way deals are being structured.

Today, unsurprisingly, selling advisers are much less concerned about protecting against further market declines, and instead want deals structured that will compensate them when, and if, the markets recover.

Clearly, it’s tough for an acquiring firm to write a check to pay a selling firm based on Jan. 1, 2022, valuations, so many deals are constructed in a manner that provides a selling adviser a fair compensation based upon the current business valuation, along with an “earn out” that enables them to achieve full value for their firm if the markets bounce back over time.

An example of a deal from last January might’ve been something in the realm of 50% cash, 25% in rollover equity and 25% payable in 12 months, contingent on the successful transfer of clients and AUM. Today, that deal may be structured more along the lines of 35% cash upfront, 30% rollover equity and 35% contingent in 18 months.

The contingency, rather than being based solely upon client retention and integration, may now be slanted toward a firm’s revenue. Based on the performance of the financial markets, the more revenue “recovery” the firm experiences, the greater payout the sellers will receive for their firm.

Today’s deal structures stipulate that if the markets recover in the next 18 months, principals will be able to realize a January 2022 value for their firm, even after selling during a bear market.

Scott Hanson is co-founder of Allworth Financial, formerly Hanson McClain Advisors, a fee-based RIA with $15 billion in AUM.