Succession Planning: RIAs Have Options

Practice Management

Succession planning has been an area of increasing focus in the RIA industry, particularly given what many are calling a looming succession crisis.  The industry’s demographics suggest that increased attention to succession planning is well warranted: a majority of RIAs are still led by their founders, and only about a quarter of them have non-founding shareholders.

While there is growing recognition of the importance of succession planning, it often lags far behind other strategic initiatives with more immediate benefits like new client and staff growth1.  In the long run, however, firms with a well-developed succession plan have a distinct competitive advantage over those without.

Fortunately, many viable options exist for RIA principals looking to solve succession planning issues.  In this post, we review several of the more common options.

  1. Internal transition to the next generation of firm leadership. Internal transitions of ownership are the most common type of transaction for investment management firms and for good reason.  Many RIA owners prefer working for themselves, and their clients prefer working with an independent advisor.

Internal transitions allow RIAs to maintain independence over the long term and provide clients with a sense of continuity and comfort that their advisor’s interests are economically aligned.  A gradual transition of responsibilities and ownership to the next generation is usually one of the best ways to align your employees’ interests and grow the firm to everyone’s benefit.  While this option typically requires the most preparation and patience, it allows the founding shareholders to handpick their successors and future leadership.

  1. Debt financing. Debt financing has become a readily available option for RIAs in recent years as the number of specialty lenders focusing on the sector has increased.  External debt financing is often used to finance internal transactions as an alternative to seller financing.  Such arrangements avoid introducing a new outside equity partner and can work well when the scope of succession issues to solve is limited to financing the transaction.

There are potential drawbacks, however.  For example, debt financing for RIAs typically requires a personal guarantee, which many borrowers oppose.  Borrowers are also more exposed to their own business by levering up to purchase an equity stake.

  1. Sale to a consolidator or roll-up firm. RIA consolidators have emerged, promising a means for ownership transition, back-office efficiencies, and best practices coaching.  The consolidator model has been gaining traction in the industry in recent years.  Most well-known RIA consolidators have grown their AUM at double-digit growth rates over the last five years, and acquisitions by consolidators represent an increasing portion of overall deal volume in the sector.

For RIA principals looking for an exit plan, a sale to a consolidator typically provides the selling partners with substantial liquidity at closing, an ongoing interest in the firm’s economics, and a mechanism to transfer the sellers’ continued interest to the next generation of management. There’s a wide spectrum of consolidator models, and they can vary significantly in terms of their effect on the day-to-day operations of the acquired RIA.  RIA owners considering selling to a consolidator should think carefully about which aspects of their business they feel strongly about and how those aspects of the business will change after the deal closes.

  1. Sale to a private equity firm. Drawn to the industry’s typically high margins, low capital expenditure needs, and recurring revenue model, private equity managers have sharpened their focus on investment management firms in recent years.  Private equity can be used to buy out a retiring partner, but it is not typically a permanent solution.  While PE firms provide upfront cash, remaining principals must sacrifice most of their control and potentially some of their ownership at closing.
  1. Minority financial investment. Minority financial investments can provide existing ownership with liquidity while allowing remaining shareholders to maintain control and an ongoing interest in the firm’s  Minority investors typically do not intrude on the firm’s operations as much as other equity options, but they will seek deal terms that adequately protect their interest in future cash flows.
  1. Sale to a strategic buyer. A strategic buyer is likely another RIA, but it could be any other financial institution hoping to realize certain efficiencies after the deal.  On paper, this scenario often makes the most economic sense, but it does not afford the selling principals much control over what happens to their employees, clients, or the company’s identity.

About Mercer Capital

We are a valuation firm that is organized according to 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, and related investment consultancies.

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