Key Takeaways
Issues involving client concentration, succession, growth, and earnings quality can affect both the price and structure of an RIA transaction.
A weakness disclosed and explained early is easier to address than one the buyer discovers after signing a letter of intent.
Preparing for diligence gives owners time to fix what can be fixed, document what cannot, and go to market with a price they can defend.
Halloween is a good time for surprises. Selling your RIA generally isn’t.
By the time a buyer signs a letter of intent, it has usually seen an attractive version of the business: recurring revenue, loyal clients, healthy margins, and opportunities for growth. Due diligence is where it gets to look behind those numbers, and where the price and terms in the letter of intent get tested.
Every firm has weaknesses. Most are manageable, and many are familiar to anyone who has owned an advisory business. The problem comes when something the seller considers routine changes the buyer’s view of the earnings or relationships it expects to acquire.
With that in mind, here are five skeletons worth taking out of the closet before opening the data room.
1. A Few Clients Are Carrying More Weight Than You Think
A firm with hundreds of accounts may still depend heavily on a handful of relationships. One family can have a dozen accounts across trusts, retirement plans, and related entities. An account-level report can make that concentration look smaller than it actually is.
Buyers will want to understand concentration by household and revenue, along with who manages those relationships. A large client paying a discounted fee has a different earnings contribution than its share of AUM might suggest.
Concentration becomes more concerning when the largest relationships belong exclusively to a founder who plans to retire shortly after closing. Prepare a household-level revenue analysis and explain how those clients are served. Introducing additional advisors before a sale gives a buyer more reason to believe the relationships will survive the transition.
2. The Client Base Is Retiring Alongside the Founder
Longstanding clients are usually a selling point. But a client base that has aged with its advisor can create questions about future withdrawals, estate transitions, and the durability of the revenue stream.
An older client base does not automatically make an RIA less attractive. Retired clients may have substantial assets, complex planning needs, and strong loyalty. The relevant questions are whether distributions are outpacing new assets and whether the firm has relationships with spouses and the next generation.
A buyer will have a harder time underwriting retention if the firm has never met the people who will eventually inherit the assets. Review revenue by client age, historical withdrawals, and the status of family relationships. A documented history of retaining assets through estate transitions is more persuasive than an assurance that the children will probably stay.
3. Growth Looks Better Until You Separate Out the Market
As we discussed in Organic Growth Is Becoming the RIA Valuation Differentiator, increases in AUM can come from several sources with different implications for value.
Consider a hypothetical firm that starts the year with $1 billion, benefits from $100 million of investment appreciation, and finishes with $1.05 billion. The reported growth looks respectable. Assuming no acquisitions or other adjustments, however, the firm experienced $50 million of net outflows.
That deserves an explanation. Was it an unusual estate distribution, a departing advisor, or a persistent shortfall in new business?
Reconcile changes in AUM across market performance, client additions, contributions, withdrawals, departures, and acquisitions. Then connect those changes to revenue. AUM growth can overstate economic progress if new assets carry lower fees than the assets leaving.
4. The Founder Still Does Everything
Many successful RIAs were built by an owner who serves as chief executive, lead advisor, primary rainmaker, and occasional IT department. That arrangement may have worked for years. It becomes harder to value when the owner wants to leave.
An organizational chart with several senior employees does not establish that those employees can retain clients, win business, or manage the firm independently. Buyers will want to understand who actually makes decisions and maintains the relationships.
The economics matter, too. If replacing the founder requires additional compensation or hiring, that cost belongs in the assessment of ongoing earnings. Plans to remain involved should be specific about responsibilities and timing.
Owners planning a sale can start delegating now. Give other advisors meaningful client responsibility, develop management capacity, and demonstrate that business development continues when the founder takes a vacation.
5. Adjusted EBITDA Requires Too Much Imagination
Most RIA transactions involve some discussion of normalized earnings. Personal expenses, unusual professional fees, and owner compensation may warrant adjustments. Each adjustment still needs support. The multiple in a letter of intent is applied to this number, so every adjustment the buyer rejects comes straight off the price.
A recruiting expense described as nonrecurring becomes harder to add back when the firm recruits every year. The same applies to technology spending that will continue under the buyer. Vacant positions can also inflate reported profitability if someone will eventually need to do the work.
Not every adjustment invites skepticism. Run rate adjustments that restate revenue on current AUM and fees are generally accepted by buyers, and in a rising market or after a strong organic growth period they are often the largest positive adjustment of all. Buyer specific adjustments, such as savings that only a particular acquirer can realize, are a different matter. It is generally helpful to consider them separately from universal adjustments, and they tend to shape the process: if value depends on a certain kind of buyer, outreach should focus there.
As we have previously discussed, quality of earnings work is a standard part of buyer diligence. Sellers who work through the same questions before going to market find these issues before the buyer’s provider does. Prepare a documented reconciliation from reported results to proposed ongoing earnings, including expenses that need to increase.
Open the Closet Before the Buyer Does
Finding one of these issues does not mean a sale is doomed. Most are priced, not fatal. A buyer may be comfortable with the risk at an appropriate price or address it through transition arrangements and contingent consideration.
Discovering it late is more disruptive. It can reopen negotiations and cause the buyer to question other information it has received.
Before going to market, review the business as a buyer would. Some weaknesses take years to improve; others simply need better documentation and a candid explanation. Either way, sellers are better positioned when they can explain what is in the data room before the buyer starts finding surprises. That review is work we do with owners before a process starts: the buyer’s view of the earnings and the client base, before there is a buyer. It is easier to set a price with that in hand than to defend one without it.
About Mercer Capital
We are a valuation firm organized according to industry specialization. Our Investment Management Team advises owners of RIAs, asset managers, and independent trust companies on the sale of their firms, from the kind of pre-market review described above through a competitive process and closing. The same team provides valuation, litigation, and consulting services to those firms and to broker-dealers, private equity firms, alternative managers, and related investment consultancies.