RIA M&A activity set new records in 2022, even as macro headwinds for the industry emerged throughout the year.  Fidelity’s December 2022 Wealth Management M&A Transaction Report listed 229 deals through December 2022, up from 215 in 2021.  However, deal volume was most significant in the first half of 2022 and began to cool in the second half of the year, particularly in the fourth quarter.  Fidelity reported 58 deals in the fourth quarter of 2022, down 27% compared to the same period in 2021. Although transaction volume is still up over the prior year, there has been a decline in the size of these transactions. These transactions represented $283.8 billion in AUM, down 18% from 2021. Additionally, the median deal size declined 32% to $478 million in AUM.

The fourth quarter decline in M&A activity could be viewed as a delayed reaction to market conditions that emerged early in 2022.  Inflation, rising interest rates, and a tight labor market have strained the supply and demand dynamics that have driven deal activity in recent years.  Rising costs and interest rates coupled with a declining fee base have put pressure on highly leveraged consolidator models.  A potential downturn in performance has left some sellers on the sidelines until fundamentals improve.

Despite these pressures, demand for RIAs remained strong throughout 2022, with professionalization of the buyer market continuing to be a theme driving M&A activity.  Serial acquirers and aggregators increasingly drive deal volume with dedicated deal teams and access to capital.  Mariner, CAPTRUST, Beacon Pointe, Mercer Advisors, Creative Planning, Wealth Enhancement Group, Focus Financial, and CI Financial all completed multiple deals throughout 2022.

While serial acquirers continue to be a major driver of M&A, market conditions in 2022 prompted several of these firms to temper their pace of acquisition activity and become more selective in their acquisition targets.  CI Financial’s CEO Kurt McAlpine remarked on the company’s first-quarter earnings call that their pace of acquisitions has “absolutely slowed down.”  Despite this, multiples in the industry remain high relative to recent history, although the upward pressure on multiples has reportedly leveled off.

On the supply side, the current market environment is likely to have a mixed impact on bringing sellers to market.  On one hand, some sellers may be reluctant to sell when the markets (and their firm’s financial performance) are down significantly from their peak.  On the other hand, a concern that multiples may decline if the current market environment persists may prompt some sellers to seek an exit while multiples remain relatively robust.  This dynamic has prompted many sellers to hedge their exit by pursuing a partial sale now with an eye for a more complete exit once market conditions improve.

Although the decline of M&A activity in the fourth quarter could indicate that market conditions have led to the cooling of the M&A market, it is yet to be seen if this trend will continue into 2023.  While market conditions play a role in exit timing, the motives for sellers often encompass more than purely financial considerations.  Sellers are often looking to solve succession issues, improve quality of life, and access organic growth strategies.  Such deal rationales are not sensitive to the market environment and will likely continue to fuel the M&A pipeline even in a downturn.  Despite years of record-setting M&A activity, the number of RIAs continues to grow—which suggests the uptick in M&A activity is far from played out.

What Does This Mean for Your RIA?

For RIAs planning to grow through strategic acquisitions:  Pricing for RIAs has trended upwards in recent years, leaving you more exposed to underperformance.  While the impact of current macro conditions on RIA deal volume and multiples remains to be fully seen, structural developments in the industry and the proliferation of capital availability and acquirer models will likely continue to support higher multiples than the industry has in the past.  That said, a long-term investment horizon is the greatest hedge against valuation risks.  Short-term volatility aside, RIAs continue to be the ultimate growth and yield strategy for strategic buyers looking to grow their practice or investors capable of long-term holding periods.  RIAs will likely continue to benefit from higher profitability and growth compared to broker-dealer counterparts and other diversified financial institutions.

For RIAs considering internal transactions:  We’re often engaged to address valuation issues in internal transaction scenarios.  Naturally, valuation considerations are front of mind in internal transactions, as in most transactions.  But how the deal is financed is often a crucial secondary consideration in internal transactions where buyers (usually next-gen management) lack the ability or willingness to purchase a substantial portion of the business outright.  As the RIA industry has grown, so too has the number of external capital providers who will finance internal transactions.  A seller-financed note has traditionally been one of the primary ways to transition ownership to the next generation of owners (and, in some instances, may still be the best option).  Still, there is an increasing amount of bank financing and other external capital options that can provide the selling partners with more immediate liquidity and potentially offer the next-gen cheaper financing costs.

If you are an RIA considering selling:  Whatever the market conditions are when you go to sell, it is essential to have a clear vision of your firm, its value, and what kind of partner you want before you go to market.  As the RIA industry has grown, a broad spectrum of buyer profiles has emerged to accommodate different seller motivations and allow for varying levels of autonomy post-transaction.  A strategic buyer will likely be interested in acquiring a controlling position in your firm and integrating a significant portion of the business to create scale.  At the other end of the spectrum, a sale to a patient capital provider can allow your firm to retain its independence and continue operating with minimal outside interference.  Given the wide range of buyer models out there, picking the right buyer type to align with your goals and motivations is a critical decision that can significantly impact personal and career satisfaction after the transaction closes.