Key Takeaways
Buyers generally value an RIA based on the earnings it will produce after closing under the buyer’s operating model.
The same RIA can produce different margins for different buyers because each has its own platform, compensation structure, and approach to integration.
Sellers should understand those differences. A buyer that can generate more cash flow from the business may have greater capacity to pay.
Ask an RIA owner what the firm earns, and the answer will usually come from the current income statement. A buyer asks a slightly different question: What will this business earn inside our organization after closing?
In underwriting a deal, the buyer builds a new cost structure based on the continuing employee base, post-transaction compensation for selling shareholders, the functions that will move onto the buyer’s platform or go away, and any new costs that may arise. The resulting margin may look quite different from the seller’s historical margin. It may also differ from the margin another buyer would expect from the same firm.
Starting With the Post-Closing P&L
A buyer does not carry the seller’s current expense structure straight into its model. Owner distributions may be replaced with salaries or incentive compensation. Investment management, trading, compliance, reporting, billing, and other functions may remain with the RIA or move onto the buyer’s platform. Existing technology and vendor costs may disappear, while platform charges or corporate allocations take their place.
For some buyers, relatively little changes and the acquired firm continues to use much of its existing infrastructure. Other buyers integrate the business more fully into systems they have already built. Most transactions use some combination of the two approaches.
The post-closing expense base is a mix of the target’s existing costs and the buyer’s operating model. Historical results remain the starting point. The seller’s adjusted EBITDA establishes the baseline earnings stream presented to the market, while the buyer’s model estimates what it expects to own after closing.
The Same Firm Can Have More Than One Margin
Suppose an RIA generates $10 million of revenue and $3 million of EBITDA. One buyer plans to preserve much of the existing operating structure, including the firm’s technology, investment process, and local infrastructure. After adjusting owner compensation and removing expenses that will not continue, that buyer expects the business to produce about $3.2 million after closing.
Another buyer already has centralized investment management, compliance, finance, and technology. It expects to move the acquired firm onto those systems, eliminate overlapping vendor costs, and replace some of the target’s current expenses with its own platform charges. That buyer may underwrite something closer to $4 million of EBITDA contribution from the same revenue base.
The buyers have different plans for the business, so they see different margins. The second buyer has more capacity to pay, although it will not necessarily offer more unless the process requires it. When several buyers can produce attractive post-closing economics, competition gives the seller a better chance of capturing some of that value through a higher price or better terms.
The Multiple May Be the Output
RIA offers are usually discussed in terms of EBITDA multiples because multiples make the bids easier to compare. But the buyer will also have tested the purchase price against the cash flow it expects after closing and the return it expects to earn. The quoted multiple may be an output of the underwriting rather than its starting point.
A buyer that expects to maintain most of the current expense structure may need a lower price to reach its return. A buyer that can move the business onto an existing platform may be able to pay more and still underwrite an attractive transaction.
The revenue assumptions can differ as well. One buyer may expect referrals, additional services, or better business-development support to increase revenue after closing. Another may expect some disruption from changes to the brand, fee schedule, investment offering, or client experience. Those assumptions also feed into the buyer’s view of post-closing earnings, which is why two buyers can place different values on the same historical EBITDA.
Adjusted EBITDA Still Sets the Baseline
Adjusted EBITDA is the earnings stream the seller presents to the market, and it usually anchors the valuation discussion. Excess owner compensation, personal expenses, transaction costs, and other items that will not continue should be identified and supported.
Buyers will question each adjustment. They will want to understand the expense, why it will not continue, and how the amount was calculated. The better supported an adjustment is, the more likely a buyer is to accept it and pay a multiple on it.
Run-rate adjustments require the same discipline. The historical period may not contain a full year of fees from a client relationship that is already onboarded, a fee change already in effect, or savings from a vendor contract that has already been replaced. Annualizing the realized effect of those changes can provide a better measure of current earning power. The seller should be ready to support the timing and amount with billing records, executed agreements, invoices, or other relevant documentation.
Expected new business, planned cost reductions, and savings available only to a particular buyer or subset of buyers are worth highlighting; but keeping those items separate from the core adjusted EBITDA figure makes the seller’s baseline easier to defend.
Even a well supported adjusted EBITDA schedule only describes the firm on a stand-alone basis. Additional value may come from the buyer’s operating model. Sellers should understand which parts of the current cost structure each buyer expects to preserve, which functions will move onto the buyer’s platform, what existing costs will be replaced, and how the selling shareholders will be compensated after closing.
Buyers may not share their full acquisition models, but their questions, integration plans, and proposed terms usually reveal a fair amount. A buyer that preserves the target’s existing systems is underwriting one margin. A buyer that can use an established platform is underwriting another, and those two buyers should not necessarily arrive at the same price.
The Margin That Matters
The seller’s adjusted EBITDA establishes what the firm earns on a stand-alone basis. The buyer’s underwritten margin reflects how the business is expected to operate after closing. Both are relevant, but they answer different questions.
For sellers, value comes partly from current profitability and partly from how efficiently the firm’s revenue can fit onto a larger platform. Different buyers will see that opportunity differently. A well run process gives the buyer with the strongest post-closing economics a reason to share some of that value with the seller. The multiple gets most of the attention, but the post-closing cost structure often explains how the buyer arrived at the price.
About Mercer Capital
We are a valuation and advisory firm organized by industry specialization. Our Investment Management Team provides valuation, transaction, litigation, and consulting services to a client base consisting of asset managers, wealth managers, independent trust companies, broker-dealers, PE firms, and alternative managers.