[From Issue 1 2020]
Until recently, 401(k) firms were buying and selling in an M&A mashup unlike any previously seen.
[Related: RIA M&A Decade in Review (and 2020-2029 Preview)]
“Any industry that can consolidate will,” says Dick Darian, CEO of The Wise Rhino Group, an M&A advisory firm on both the buy and sell-side. “And certainly, the retirement advisory market was ripe for consolidation.”
M&A among financial firms overall hit a record in 2018, one that was again shattered in 2019, according to “Mergers & Acquisitions Activity: 2019 Year-End Update” from FA Insight and TD Ameritrade Institutional (which, in a bit of a meta moment, is itself the subject of a high-profile acquisition by Charles Schwab).
Many factors contributed to the announcements, and were pretty much what one would expect: “a strong stock market, abundant capital, high firm valuations, increasing demand for scale, aging firm founders hungry for an exit strategy and multiple options for transacting partners,” according to the report.
A similar report from Echelon Partners followed suit, finding that 2019 was the seventh straight record-setting year in terms of the number of deals completed, which represented a 12.2% increase over 2018 and a 15.4% annual growth rate over the past five years.
In the 401(k) space specifically, industry veteran Darian points to recent Hub International rollups as emblematic of what’s happening.
Hub acquired several high-profile retirement advisory firms in a frenzy of activity last fall, including notable names like StoneStreet Pearl River (Barbara Delaney), Washington Financial Group (Joe DeNoyior), Inter-Mountain Retirement Partners (Chad Larsen) and, earlier in the year, Sheridan Road Financial (Jim O’Shaughnessy), among others.
Yet, as with concerns about an overheated economy as a whole, anxiety is on the rise over the current acquisitions’ staying power, and whether the clock is ticking in the runup to the November election.
Early Innings
Darian isn’t buying it, and looks to similar industries for guidance.
“The insurance brokerage side is very similar to retirement and wealth; an established marketplace and a good number of businesses. There are more firms on that side, but they’ve been going through a high amount of acquisitions for over 10 years. They’re in the seventh or eighth inning. On the RIA side, it’s the fourth or fifth inning, and you’re seeing the building of these mega-firms, which is not that different from the wirehouses forming 30 and 40 years ago. And now retirement firms (with a little bit of wealth) are in the first inning.”
What does it mean, he rhetorically asks?
By his count, there are another 500 to 750 high-quality, independent RIA retirement and wealth businesses that could be acquired, and the industry is still a long way from their completion.
Diving deeper into driving factors, he then mentions (of course) buy-side firms’ desire—or need—to be in the retirement and wealth business “in a bigger way.”
“There are enough strong retirement and wealth advisory firms that, whether it’s demographically and they’re aging out, they’re simply ready for something else or they see the opportunity in joining a bigger, firm, the environment was ripe for this.”
Because it’s a sellers’ market, he adds, it sets up a dynamic where the prices will be above market. Firms have undoubtedly gotten great prices for their businesses, and at the beginning of this kind of a market, the early opportunities are often the best.
“Over time, however, as each of these firms absorb and begin to build out their operations, the multiples will normalize. The question is, how long will that take? But it’s inevitable.”
And it’s not only about the multiples. In many cases, practitioners have been building their firms for 20 or 30 years; they don’t want to leave until they’re ready for the next step, “or that career move to build something bigger, different and special.”
Emotions in Motion
Darian makes an important point, and many sellers note that although they thought they were ready for the emotional impact of a merger or acquisition, reality differed when the deal was done. Indeed, it particularly resonated when raised by Sheridan’s O’Shaughnessy during a panel discussion about the current M&A environment at industry aggregator GRPAA’s Finnovation Conference in San Diego last fall.
Redundancy often means a certain amount of staff are let go, and no longer working with dedicated employees was difficult for O’Shaughnessy and the firm’s other executives, especially co-founder Daniel Bryant, who was now on a side of a transaction that he was not used to.
“I was an investment maker beforehand, so I’ve seen hundreds of M&A transactions,” says Bryant, president of National Sales, Retirement and Private Wealth at Sheridan Road Financial (now a division of Hub International).
“You don’t have an emotional attachment to it. I always knew I’d be emotionally attached to a brand I created, but candidly, I didn’t realize just how difficult it would ultimately be to relinquish control over certain aspects like hiring, culture and teamwork. The things that made us a family— open-door policies were everyone can just come in—that’s changed a little bit just given the nature [of being acquired]. I guess I expected it, but I didn’t expect how it would make me feel and react. It’s nothing negative, this is just me personally.”
So, what, if anything, would he do differently, and what would he like other sellers to know?
“The most important thing is emotionally and mentally getting your head around relinquishing control over your business and your practice,” Bryant reiterates, “because things will change, and they will do it differently than the way you would do it. They will want to hire people you wouldn’t normally hire. They may want you to go in a different direction than you normally would. It’s nothing earth-shattering, but be prepared for knowing that, ultimately, there’s somebody else in charge. It’s largely the case that they will let you do your thing, but for those of us like Joe DeNoyior, Barb Delaney and Chad Larsen, who have had total control over all aspects of our daily business, that goes away a little bit.”
Like Darian, he notes that it’s a sellers’ market with a massive amount of money up for grabs, and private equity firms have finally realized the opportunity that comes with the client relationship.
“Once you have the client relationship, there is financial technology, other insurance, and a lot of other things that you can sell through the distribution channel. Having that channel is unbelievably attractive for buyers, and they’re willing to pay a premium for that cross-sell.”
And like Darian, he believes it’s still early innings.
“I’m looking at the TV now. The Dow, S&P and Nasdaq are all at record highs. And maybe tech companies like Tesla’s valuations are high. But in our world, at the end of the day, these companies that are buying us are still trading for pretty normal values—they’re not trading for 25 times cash flow, they’re still trading for 10 or 12 times cash flow, which is high, but not crazy.”
Keep it Real
Sellers’ market or not, it’s critically important to stay grounded and realistic about the potential for a career-making deal, or it can all easily fall apart.
A Fidelity study from January found that while firms being acquired are worth more now than they were five years ago and EBITDA multiples have increased, sellers appear to have inflated expectations of their firms’ values compared to the reality of the market.
“Sellers expect an EBITDA multiple ranging from 8x to 10x, according to the buyers surveyed,” Fidelity noted. “As a result, buyers surveyed estimate that, on average, nearly 40% of their deal conversations fell through in the last five years due to unrealistic valuation expectations by the sellers.”
“Firm valuation is as much of an art as it is a science, and we believe the most successful firms will be those who take the time to understand all of the dynamics involved and align their own motivations with the value their businesses bring to the table,” Scott Slater, vice president of practice management and consulting for Fidelity Clearing & Custody Solutions, said in a statement. “We continue to see a rapid pace of M&A, but our study showed that there could be even more deals happening if valuation expectations were better aligned.”
The majority of participating firms in the study agreed that unrealistic comparison multiples in large sales (91%) and a lack of understanding of valuation drivers (83%) are the top factors driving sellers to overvalue their businesses.
Other drivers include a misalignment between seller cash needs and firm value (61%), being too close to the business to recognize weaknesses (57%) and failure to recognize the synergies sought by buyers (26%).
The research also revealed that when it comes to making a deal, sellers and buyers are coming to the table with differing motivations and expectations.
“Rather than being opportunistic in their approach to M&A, sellers can better understand what buyers are looking for, and build those interests into their succession strategy and timeline to help improve their pricing and increase appeal,” Slater added.