When you get the chance to buy a competitor’s book or lock down succession, few things are as painful as not being able to convince the bankers that the deal makes sense. Ambitious advisors looking for the funds to grow need partners who understand the business. Luckily specialized lenders have emerged to fill the gap.
Last year wealth management consolidators spent a healthy $67 billion to chase attractive acquisition targets, paying an average of $645 million per deal. Growth is obviously the goal — wealthy families either have advisors by now or don’t want them, and luring those assets in either scenario is hard, expensive work.
You may not have your sights quite that high, but even if you’re simply looking to buy out a colleague who manages $25 million, coming up with the cash can be tricky. Valuing that business at even 1-2 times annual revenue means coming up with as much as $500,000 without draining the combined firm’s operating funds.
Some of us have that kind of M&A war chest on hand. Most don’t. And with the big players tapping private equity firms and strategic investors, middle-market advisors need funding options in order to compete for high-quality acquisitions when they pop up.
That’s why I’m thrilled to see more specialized lenders putting capital to work for everyday RIAs that have everything they need — the vision, the opportunities, the ambition — but the money.
We talked about one advisor-oriented lender, Live Oak Bank, a few years ago. Maybe you’ve heard of them or even worked with them. They made a big splash writing $100 million in RIA loans across an 18-month period.
The proposition there was simple. About half the Live Oak team came out of the advisory industry – pedigrees from places like Schwab and Morgan Keegan – and the other half were small business banking types. Add it up, and the bankers know when the numbers make sense while the industry veterans speak up when an acquisition on the table makes sense.
Similar models are popping up everywhere. Some come out of the banking world. Others have evolved more along private equity lines, making their money ensuring that deals happen even if the bankers don’t understand.
One name to conjure with here is Oak Street Funding, a commercial finance company built back in 2003 to provide similar strategic liquidity services to independent insurance agents looking to buy rivals or sell out to someone who knew the business.
Since then, ironically enough, Oak Street grew into an attractive enough operation that Ohio’s First Financial Bank bought the company a few years ago, giving it the institutional foundation it needed to expand into other advisory channels — accounting firms, mortgage brokers and now RIAs.
What all these businesses have in common is, of course, an asset-light balance sheet that defies conventional underwriting models. It’s all about cash flow, not collateral.
Answering the unspoken question
Industry commentary tends to wax rhapsodic about how demographics and competitive pressure are colliding to push independent advisory practices together, but when the time comes for execution, the details haven’t always cooperated.
Sure, everyone in the business would love to just buy top-performing accounts at the right price as other advisors retire, die or simply quit.
But that “right price” means that acquiring another practice can easily consume all the revenue your current book generates, so unless your BD or custodian is willing to front the cash, other third-party funding sources are surprisingly scarce.
After all, a typical advisory business really boils down to a set of contractual relationships that can be terminated at any time, the revenue those accounts produce and the principals’ ability to keep the enterprise going.
Unfortunately, that’s not what bankers consider collateral. In terms of hard assets that can secure a business loan, an advisor has a few computers and usually a rented office. That’s not going to buy a lot of accounts.
Other professionals can draw on consistent capital sources but most community banks shy away from this space because advisors just don’t have the tangible collateral.
First, if aging advisors were going to be able to sell to anyone but their biggest competitors, somebody would have to figure out how to underwrite the deals.
And as many of you know, while investment advice is an asset-poor business, it generates plenty of cash when the quarterly statements go out.
Insiders run the numbers
Of course, before they write the check, they need to evaluate the deal. Oak Street just hired a new RIA sales lead who learned the business from the inside.
He knows when the numbers make sense and will speak up when an acquisition on the table deserves to happen.
If you already know what the accounts will do for your bottom line, you shouldn’t have to educate the lender. And if you don’t, think of this part of the process as a built-in consultation.
Does the potential acquisition have a lot of transactional revenue that depends on the current principals to keep the wheels turning, or are we really looking at perpetual fee income here? The underwriters know the difference.
Naturally, price is critical when it comes to determining whether advisors would do better bolting on AUM or stepping up their marketing efforts.
If you find someone selling on the cheap, you can pick up a lot of new clients at once instead of grinding out qualified prospects the old-fashioned way.
However, while the prospect of accelerated growth at a discount is tempting, true bargains are not as easy to find right now as many advisors think.
Fidelity’s regular survey of the industry indicates that good prospects are rare. Advisors just aren’t retiring as fast as anyone suspected.
That’s why it’s crucial to be able to jump on an opportunity when it knocks – even if you can’t pay cash and the seller won’t consider financing the deal on his or her own.
As a rough rule of thumb, an advisory practice may earn a bid of two to four times annual production, depending on how profitable the AUM is and what the accounts look like.
Want to roll up tiny competitors $1 million at a time? No problem. But I don’t think any of you relish the prospect of a local rival with 25% to 30% of your critical mass going to another buyer because you couldn’t scrape up the funds.
Crucial for the seller too
Liquidity is also critical when it comes to internal succession planning.
You might prefer to sell to a protégé instead of a rival, but if your hand-picked successor can’t afford to buy you out, you’d might as well never retire.
In the meantime, your clients will probably feel a lot more secure when they know that whatever happens to you, the business they trust will go on.