The term “M&A” is thrown around rather loosely. We read about mergers-and-acquisitions activity in financial publications daily, but usually what is being reported relates to one corporate giant acquiring another — for example, Verizon Communications Inc. acquiring its remaining stake from Vodafone Group PLC for $130 billion. Even when we read about one asset manager buying another, this usually refers to large-scale organizations combining due to market conditions — for example, last week's announcement that Fiera Capital Corp. is acquiring Bel Air Investment Advisors LLC for $125 million.
For registered investment advisers, the vast majority of which are private entities with fewer than 10 employees, what does an acquisition or sale truly mean? Typically, an aging financial adviser who has built a retail advisory business over the past 20 to 30 years is nearing retirement and seeks to pass the reins to another adviser.
If the adviser sells the business to another firm, this is often called a private-party sale. If the adviser passes the torch to an internal successor, it is an internal sale. Each sale type has implications for the firm's sale price, deal structure and tax treatment. The vast majority of these transactions don't make the news.
From a seller's perspective, though, what are they selling? The firm's hard assets, as reported on a balance sheet, generally are minimal.
SELLING INCOME
What is truly being sold is the income that the adviser's client base produces. How the sale is handled can ensure either a smooth transition for those clients or give them an excuse to jump ship. A well-thought-out client transition plan will maximize the assets transferred to the buyer.
Even if an adviser is selling to a more sophisticated buyer, the acquirer is still “buying” client-produced income in order to achieve scale.
From a tax perspective, both parties need to work closely with their tax advisers to determine if the transaction should be handled as an asset or stock sale. But no matter what the deal structure is or how the transaction is treated for tax purposes, generally, a seller is simply transitioning the clients to a buyer.
Also, because most RIA firms are closely held and run in a familial style, staff members will be affected severely by a transaction. If it is handled correctly, however, buyer and seller recognize that a combination will provide new career paths and ownership opportunities for top staff members.COMMON MISCONCEPTIONS
Even if one recognizes what RIA M&A is all about, a couple of common misconceptions pervade.
The first is that an accurate measure of an RIA's value is based on applying a multiple to gross revenue. It is very outdated and is misleading, as two RIAs with the same top line may have very different cost structures and growth rates.
Revenue is not a proxy for value. There is no accuracy using this approach.
The second misconception has to do with a seller's believing that he or she can make the same income after the business has been sold for a market-based valuation. Of course, it is a preferred scenario for the seller to stay on for a while to ensure a successful transfer.
But that misconception is one we call having your cake and eating it, too. An adviser can't sell the firm's cash flow and continue to take that cash flow as income.
An exception to this would be for very large firms, say, with $20 million in revenue or more. These firms have achieved scale and high-enough margins to continue compensating their selling principals at high levels.
Another exception would be in a merger where the selling principal(s) plan to stay on with the buyer for many years. Because mergers are done primarily in stock, the buying organization should be able to keep the selling principal(s') compensation at pre-deal levels, or at least at market-competitive rates.
David Selig is chief executive of Advice Dynamics Partners, a consulting firm focused on M&A and succession planning for the wealth advisory industry.
