Before World War 2, Alfa Romeo developed a successful brand building limited numbers of large, powerful cars for wealthy Italian buyers. That business model didn’t survive the war, however. By the 1950s the company realized that, in order to survive, it needed to create smaller and more practical vehicles that could be produced and sold in large volume to the mass-affluent. The second iteration of the new Alfa Romeo was the 750-series, which included not only a sedan and coupe but also a beautiful Pininfarina-designed convertible that Alfa Romeo romantically dubbed the Giulietta (as in Romeo and Juliette). The Giulietta was light, mechanically robust, and very sophisticated. Orders poured in, and Alfa Romeo’s future was assured.
As the wealth management industry matures, we are sensing a similar shift to mass-produced wealth management services, building extensive technology platforms and centralized investment management to support broad networks of client service representatives. What was once the wild-west of commissioned brokers living off the “5% rule” is transitioning to salaried staff and ETFs. The transition is slow, but industry trends like fee pressure, regulatory upheaval, and partner demographics are persistent motivators. Ultimately, these industry trends can only lead to one thing for the wealth management community: more M&A.
For now, the investment management industry is highly fragmented both in number and in business model. Even though the 12,000 or so individual RIAs operating in the U.S. mostly derive their revenues from a percentage of assets under management and have expense streams characterized mostly by personnel, office space, and strong coffee, we rarely see two business models that we think are similar to each other. Investment management firms are reflections of their people – from the approach to investing to the types of clients they attract. Consequently, putting two firms together is more difficult than a lot of people imagine.
Hardly a week goes by that we don’t get asked what we think are optimal qualities of an RIA merger partner. Answering that always feels a little like giving dating advice: different partners suit different partners. No one disputes that the industry is ripe for consolidation, but there’s no easy way to “swipe-right” on a target company’s ADV, and it’s pretty unlikely that sec.gov is going to have its own version of Tinder anytime soon.
Nevertheless, in honor of today’s holiday, here are a few thoughts on what to think about when considering a merger partner.
No amount of committee meetings, reporting metrics, or other disciplined management feedback mechanisms can guarantee how your new co-workers will behave when you aren’t around. If your trust of their actions is conditional, or grounded in things like incentive compensation, the relationship won’t work for you or for them. People do not even change for their spouses – certainly not for their business partners. Walk away.
Does your prospective merger partner see the industry the same way you do? Is their approach to investing, staff development, and going after new business the same? Assuming that you and your merger partner have both been around long enough to develop your own way of working, you might learn a thing or two from each other, and you might have some influence over each other – but mostly you will be you, and they will be they. Make sure you’re okay with that.
I think an underrated due diligence metric on a merger partner is their client demographics. The type of client served by a merger partner is very telling as to what kind of firm they really are. If you and your prospective merger partner have similar clients, then you’ll probably have a lot in common after the merger.
Vegans don’t like seeing bacon in the refrigerator, even if they’re not forced to eat it. In our experience, firms that favor passive investing do not mix well with avid stock-pickers. On the front end, it might look like such a merger expands product offerings and investment approaches to the clients of both firms, but in the end your portfolio managers won’t understand each other and will confuse the message for your clients.
If you want four kids but your fiancé doesn’t want any, having two kids will not constitute a workable compromise. If you want to grow your RIA into a large business and sell it, but your merger partner wants to operate his as a practice until he’s too old to work, you’ll have conflict from day two. Life can change certain individual and business goals, but it helps to have a common baseline at the start.
A Good Pre-nup
In our experience, the only thing more contentious than a marital dissolution is a “business divorce.” Your buy-sell agreement needs to offer a valid “out” that enables the parties to the merger to preserve at least some of their economic substance while maintaining the core business of providing investment management services to clients. Not only do the partners depend on a good buy-sell agreement, but your employees and your clients do as well. Granted, the best agreement doesn’t supplant the need to build a mutually beneficial relationship every day, but offering some certainty as to how to wind-down the relationship won’t hurt either.
Notice I didn’t say anything about money. Fee schedules, compensation plans, commitment to IT spending, and all of the numbers matter, of course; but that’s the easiest part of a merger to make work. The real currency of work is people – so focus on that and the numbers will be what the numbers will be.
The best RIA mergers aren’t necessarily composed of “like” firms so much as “like-minded” firms that have different strengths to supplement different weaknesses. If you can see genuine opportunities with a potential target or acquirer that you cannot see alone or with another firm, then you might have a mutually beneficial relationship.
Oh, and if by some chance your merger partner drives an old Alfa Romeo, skip the roses today and give him or her a dozen quarts of motor oil. It won’t go to waste.