BAYFRONT CAPITAL PARTNERS | RIA RESEARCH REPORT
This research report from BayFront Capital Partners discusses the impact of an economic slowdown on merger and acquisition activity in the Registered Investment Advisory industry, while consolidation is underway due to other industry trends.
INTRODUCTION
The Registered Investment Advisory (RIA) industry is currently experiencing significant changes due to consolidation, merger and acquisition activity, and private equity trends. At the same time, valuations are under pressure from the Federal Reserve Board-induced credit compression cycle of 2022-23 that is currently driving an economic slowdown.
This report provides an overview of the current M&A market, the demographic factors contributing to consolidation in the RIA market, and the impact of baby boomer-aged advisors retiring on the pace of M&A activity. Additionally, it discusses economic forecasts for the US economy and provides an outlook for the industry while identifying key economic drivers.
IMPACT OF BABY BOOMER-AGED RIAs RETIRING
The transfer of wealth from the baby boomer generation is a major factor driving consolidation, mergers, acquisitions, and trends in the private equity space within the RIA industry. Cerulli Associates reports that boomers hold over $59 trillion in wealth and will be transferring approximately $30 trillion of that wealth to their heirs within the next 20 years. This substantial transfer of wealth has led to an increased demand for wealth management services, which has in turn creates significant opportunities for advisors to increase their AUM. As a result, the RIA industry has seen increased activity around mergers and acquisitions and has become more attractive to private equity firms.
Meanwhile, mergers and acquisitions in the industry have been increasing for several years, and this trend is predicted to continue well into the 2020’s as the pace of retirement for baby boomer advisors increases. The retirement of baby boomer-aged RIA's is expected to have a significant impact on the pace of M&A in the next decade. KPMG’s report states that the retirement of these RIA's will likely lead to a rise in M&A activity, as younger advisors are more likely to acquire existing firms.”
The retirement of boomer-aged advisors is causing a decline in the number of smaller RIA’s, too. According to a report by Ernst & Young, “The retirement of baby boomer-aged RIA's is likely to result in a decrease the number of smaller advisors as older advisors are more likely to operate independent firms.” As of 2022, about 50% of all RIA’s are baby boomers aged 60 or older, which highlights the significance of succession planning to ensure the continuity or transfer of RIA businesses.
In 2019, a report by the Pew Research Center revealed that around 3.4 million baby boomers were retiring each day. However, we believe that a substantial portion of independent RIA owners have kept their firms well past 65 and are operating them deep into their 70’s. Meanwhile, the pace of M&A deals arising from retirement, health concerns, or death is slightly increasing.
“We predict that M&A deal flow will increase once again this year after plateauing in 2022 due to the seven Federal Reserve rate increases” David Lissek, BayFront Capital Partners
CURRENT STATE OF THE RIA M&A MARKET
The M&A market in the US has been in a period of consolidation since the financial crisis of 2008. Over the past two decades, the number of RIAs has decreased while the size of the average advisory firm has increased. This trend has been influenced by various factors such as the rising cost of compliance and technology, the surging demand for specialized services, and the necessity for scale to maintain competitiveness. According to Deloitte, since the financial crisis, there has been a reduction of almost 25% in the number of RIAs, whereas the average RIA size has increased by more than 50%.”
This demand for wealth management services is causing wealth managers to expand their capabilities. InvestmentNews reports that RIAs are broadening their services to include financial planning, tax planning, and estate planning, on top of investment management. This trend is driven by the desire to provide more holistic capabilities for clients to capture additional financial assets.
On the other hand, the current economic downturn is significantly impacting the consolidation of the RIA M&A market in the US. According to the Capital Group’s DeVoe & Co., there were 63 M&A transactions totaling over $100 billion in 1Q23, which is slightly down year-over-year from 68 in 1Q22.
We predict that M&A deal flow will increase once again this year after plateauing in 2022 due to the seven Federal Reserve rate increases. The anticipated increase in activity is driven by the desire for scale and the need to capture more assets under management while the boomers born between 1946 and 1964 exit the workforce.
CONSOLIDATOR ACTIVITY
Though their share of acquisitions has recently declined, “Consolidators” continue to be the dominant buyers of RIAs. Capital Group defines consolidators as companies whose business models are predicated on making RIA acquisitions. In 1Q23, consolidator driven M&A transactions decreased slightly to 48%, down from 50% in 2022 after a peak of 54% in 2021. For the first quarter, the most prominent acquirers were Wealth Enhancement Group, Cerity Partners, and Beacon Pointe, each completing four transactions. Prime Capital was just behind those leaders with three transactions in the quarter.
Consolidator models are impacted by interest rate increases, which have indirectly contributed to a slowdown. They are often backed by private equity and leveraged with debt, and therefore affected by rate increases in several ways. Firstly, the cost of financing current transactions increases, and perhaps more importantly, the debt service on loans from previous transactions may balloon.
BENEFITS OF M&A
M&A can be strategically deployed to achieve growth, augment market share, and enhance profitability. However, implementing an M&A strategy has both advantages & disadvantages for firms in the RIA industry, particularly during an economic slowdown or recession.
Increased Market Share: A significant advantage of M&A is that it can expand a firm's market share. Through the acquisition of other companies, an advisor can gain access to a broad client base and reach more locations, resulting in improved revenue and profitability.
Diversification: M&A activities can also help firms diversify their offerings. By merging or acquiring firms with different specialties or areas of expertise, RIA’s can broaden their service offerings and increase potential revenue streams. This can be particularly beneficial during an economic slowdown or recession when certain investment strategies may become less popular, profitable, or available.
Improved Ops: By merging two advisors, there’s an opportunity to remove redundancies and streamline operations, leading to cost savings and improved efficiency.
Talent: Another benefit of engaging in M&A is access to talent. Advisors can access a larger pool of professionals through M&A, which can be particularly advantageous during an economic slowdown when talent becomes more available.
Valuation: By acquiring other firms and expanding its operations, the overall value of a firm generally will rise. This can be beneficial for firms looking to sell or go public in the future. EY reports that M&A can aid firms in achieving higher valuations, which can be beneficial for shareholders.
POTENTIAL DRAWBACKS
Integration: A significant area of risk for M&A transactions is integration. Combining two firms can be a complex and time-consuming process, and there’s a risk of disruption to the business during integration. According to a study by McKinsey, "M&A can be a distraction for management and take time to realize the benefits of transactions."
Culture Clash: Mergers and acquisitions can result in a clash of cultures. The dominant firm may have a different culture than the firm being acquired or merged, which can lead to a lack of cohesion and issues with employee morale.
Financial Risks: M&A activities can pose financial risks for the acquiring firm, particularly if taking on debt to finance the acquisition.
Oversight: RIA M&A transactions require regulatory scrutiny, where the acquiring firm needs to obtain approval for the transaction. This can be time-consuming and costly.
Key Employees: Employees may be hesitant to stay with a firm after acquisition, particularly if there’s uncertainty about their new role. So special care should be taken to insure employee confidence and continuity.
“Mergers and acquisitions in the RIA industry remains extremely high on a relative basis, despite the recent market slowdown due to the 2022 Fed tightening cycle"
M&A AND THE ECONOMIC DOWNTURN
Analysts predict the current economic downturn will have a long-term impact on the economy. According to McKinsey, “The key economic drivers in the US are likely to be the availability of financing, investor confidence, and the cost of compliance and technology.”
The RIA industry is experiencing significant changes due to consolidation, demographics, M&A trends, and private equity. In parallel, boomer-driven generational wealth transfer is creating opportunities for RIAs to grow while advisors retiring. We expect the pace of RIA M&A transactions to grow as market factors drive advisors to capture assets and deliver more extensive services to their clients.