A weekly update on issues important to the Investment Management industry
Consolidation is a theme that has a lot of traction in the RIA industry. The prevailing narrative is that a growing multitude of buyers are scrambling to compete for a limited number of firms. With the rapid pace of deal activity in the RIA industry, you might expect to see the number of firms decline. Despite consolidation pressures and record levels of acquisition activity, the reality is that the number of RIAs continues to increase, with new formations outpacing consolidation.
Fisher Investments has for many years been the Toyota Corolla of the RIA space. Not fancy. Not interesting. Not exclusive. Advertising for sales leads. Mass affluent customers. Meat and potatoes wealth management. Nothing remarkable, except for an exceptional growth story that led to a huge transaction.
For this week’s post we’re introducing our whitepaper on quality of earnings analysis in the investment management industry. For RIA buyers and sellers, commissioning a QofE report is an essential element of the due diligence process. In essence, a well-executed QofE analysis not only reveals why a firm is profitable but also assesses the likelihood of maintaining and enhancing that profitability after the transaction. This comprehensive approach ensures that both buyers and sellers make well-informed, strategic decisions in the RIA industry.
Just over 30 years ago, the Memphis Area Transit Authority (“MATA”) made the dubious decision to construct a trolley line traversing most of the city’s downtown area, and it hasn’t gone well. If MATA could do it all over again, I suspect they would permanently closed the trolley system altogether, given the issues they’ve had over the years. Last year, many RIA industry participants expected a similar cessation to dealmaking in the sector following the adverse impact of higher interest rates and inflation on investment managers’ AUM balances and profitability in 2022. Fortunately for the industry’s bankers, these economic headwinds haven’t derailed the sector’s M&A momentum.
Before parties to an RIA transaction can close, they must first agree on a price. Narrowing that bid/ask spread is tricky, which is often why negotiations between prospective buyers and sellers fail. Buyers and sellers naturally have different perspectives that lead to different opinions on value: Where a seller sees a strong management team, a buyer sees key person risk. Unsurprisingly, these different perspectives on the same firm lead to varying opinions on value, and the gap can be substantial. Bridging that gap is key to getting a deal done. We address five ways buyers and sellers can bridge a valuation gap.
More often than not, the formula prices we encounter do more harm than good. The simplicity of formula pricing equations means they don’t consider important factors like debt, non-recurring items, loss of key staff or large customers, market conditions, or offers to purchase. Formulas can ground expectations but may set expectations unrealistically low or high, provide a false sense of security, and encourage partner behaviors that do not support the business model.
We’ve written about the external headwinds facing asset managers relative to other sectors of the investment management industry with scant reference to what actually causes many of them to fail: toxic cultures. As valuation analysts, we’re more fixated on the quantitative measures of an asset management firm, like investment performance and client retention, so we often turn to actual industry participants to get the story behind the numbers. Paul Black, CEO of WCM Investment Management, a $67 billion asset manager headquartered in Laguna Beach, California, provides great insights on the impact of culture on the viability of a money management firm.
With a constant stream of headlines about M&A and near-daily inquiries from prospective acquirers, it’s easy for RIA owners to get the impression that external transactions are the norm. While internal transactions don’t generate headlines, prospective buyers (next-gen management) likely aren’t beating your door down to close a deal. While they may be less conspicuous, internal transactions are a viable avenue for succession planning and one that many RIAs accomplish successfully.
If you’ve been offered rollover equity as part of a sale of your investment management firm, this post should offer a few things to consider on your road to riches. Rollover equity has become a standard feature of deal consideration in the RIA industry. At one time, sellers were typically offered cash plus an earnout to sell their firm. Both of these forms of payment are still prominent, although cash consideration has waned. We expect rollover equity to remain a prominent feature of deal consideration for the foreseeable future.
RIA dealmaking remains fairly robust, with a near-record year in 2023 and a significant uptick in year-over-year total transacted AUM during the first quarter of 2024. In this environment, adequate due diligence is critical since the cost of corporate M&A failures is high for both buyers and sellers. A Quality of Earnings (or QofE) analysis is an essential component of transaction diligence for both buyers and sellers. Optimizing your transaction diligence requires assembling the right team. We discuss the five things RIA buyers and sellers should look for when evaluating potential QofE providers.
