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Even the most casual observer can see that private equity (PE) firms have discovered the registered investment advisor (RIA) profession. Over the last five years, PE firms have been incredibly active acquiring or investing in large RIAs.
Research from Fidelity noted the number of M&A transactions increased by ~400% from 2016 (55) to 2022 (222) with over 60% completed by private capital-backed acquirers. That number includes only reported transactions, with the number of private transactions spiking the number even higher. And according to my firm’s research published in The RIA Deal Room, in 2022 private capital continued to invest in the independent wealth management space and PE-backed RIAs with their partner firms closing multiple acquisitions.
Some may wonder why RIAs are so attractive to PE, given most RIAs that are considered “large” are still small on a relative basis compared to other financial services firms. PE firms have invested in RIAs because the profession is still emerging and larger, fast-growing RIAs have significant upside to scale. Those greater economies and consolidation result in PE-backed RIAs unlocking value that benefits the RIA and its clients.
On a macro level, over the past decade the independent advisor space has gradually taken market share from larger institutions. Despite this success, the profession is still nascent with more than 10,000 RIAs operating nationally. It wasn’t that long ago that a billion-dollar RIA (in terms of AUM) was a big deal, but the introduction of outside capital has partially contributed to several RIAs with more than $100 billion in AUM, and dozens of RIAs approaching $50 billion in AUM.
Fast forward to today. The largest RIAs have a demonstrable investment track record with increased sophistication and technology, which helps expand the attractiveness of RIAs to PE. There’s also been tremendous AUM and revenue growth fueled by success in growing organically and by the longest running bull market in history (2009-2020). Successful PE-backed RIAs formed a winning playbook of professional business management and durable organic and inorganic growth strategies.
RIAs are valuable relative to other industries because they provide two qualities that PE firms find attractive – a recurring fee-based revenue stream and extremely loyal clients. The best RIAs have excellent client retention, usually 98% or higher. For a PE investor, recurring fees, which most firms continue to increase as assets under management rise in normal markets is a calculable recurring stream of revenue and therefore a valuable asset.
Most PE investments are structured with a definitive time horizon, usually five to seven years, with certain firms seeking longer horizons. There is some concern about what that might mean for the RIAs they invest in and for clients of these firms. But there has been no evidence of PE firms pressuring RIAs to create disproportionate returns or violate their fiduciary duties. The opposite is true. PE firms want to be helpful with governance, leveraging the knowledge and capabilities of their other portfolio companies, and providing support to firm leadership.
Beyond capital, private equity brings more structure and accountability. Accountability is typically a result of installing a board of directors of contributors within the RIA and outside partners. Successful PE firms also provide management expertise to help RIA owners make their businesses more efficient and profitable.
PE money will continue to influence the profession with differing desired outcomes for their investments. Certain PE firms want their RIA partner to run their businesses profitably and deliver distributions to owners. Other PE firms want their RIA partner to plow profits back into the business to create maximum enterprise value through high growth rates. There are two programs available: one is more permanent capital for PE firms looking for a yield and the other gains a multiple of invested capital at PE exit. Regardless of approach, RIAs need to be aware of the goal of the PE firm when deciding whether to partner. This is also true of RIAs that are thinking of doing a deal with a PE-backed firm.
PE will remain a factor in the RIA space for years to come, but it’s not for everyone. An independent RIA is typically owned by its founder, or its founders and employees, which gives it consistency but unpredictable outcomes in terms of growth. But, as numerous RIAs have discovered, taking outside money may mean shared control over decisions, which can be a good exchange for the benefits PE offers.
John Furey is managing partner of Advisor Growth Strategies, a management consulting and transaction advisory firm founded in 2009 to help owners advance their financial advisory firms.
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