Over the last few years, we saw massive consolidation in the industry, and M&A was on track to pick up every year. It peaked in the fourth quarter of 2021, when markets were very strong. On top of normal reasons for consolidation—advisors getting older, the marketplace becoming more competitive, people seeking out a firm with stronger technology, compliance and services—we had gone through the brunt of the pandemic and many people saw how quickly their business could turn. The capital gains rate looked like it was going to increase substantially, which likely gave owners yet another impetus to sell. Adding all those factors together created a very intense environment.
Relative to last year, M&A has slowed down quite a bit in 2022, but you still see the normal reasons for consolidation in place: advisors are getting older, internal succession planning is becoming more difficult and firms recognize that they need to become more competitive in the marketplace if they want to continue to grow. Nothing about the industry itself has fundamentally changed, so the trend toward consolidation continues, and we are probably only in the second or third inning of that trend.
What Drives Valuations?
When you look at a firm’s worth, you can't take two firms with the same assets or even the same revenues or earnings and say they are worth the same. All those things being equal, if you have one firm that's growing, adding new clients, and the other one is losing clients, the former firm will be worth more in the long term. If you have a firm where the average client is 40 years old versus a firm where the average client is 80, the firm with the folks that are 40 is obviously going to be worth more. A firm with a higher turnover of clients versus one that has very strong retention is another differentiator.
The major factors are:
• What does the client base look like?
• Is money coming to you or away from you?
• Are you going to grow on your own?
Those kinds of things have a significant impact on value. Obviously, the credentials, background and age of the people involved are large factors as well. When determining the value of a company, earnings play a much smaller role than most people realize.
Going To Market: What Sellers Should Consider In This Environment
When a seller is looking to go to market, they should ask themselves three things:
1. What’s best for my clients? If your client came to you because they really value hedge funds or active management, you probably shouldn't be looking at firms where those elements are not a part of their core offering. If you have clients who value a planning-led approach and holistic services and alternative investments, be sure to plug into a place that's going to give your clients what they came to you for in the first place. Think about the client, the client's expectations, and ask yourself: Can I give the clients what they expect from us and hopefully more?
2. What’s best for my team? From an advisor’s perspective, you want to offer your advisors security and ensure that they feel like they are going to have a role in this new firm. You also want to offer them opportunities for growth. Are you selling to a firm where that seems feasible? Is your new firm growing? Is there natural room for progression or not?
3. What’s best for me? Do you want your brand to stay the same? Do you want to integrate completely? Do you want to partially integrate? Are you looking for liquidity? Are you going to be working a lot longer? Are you set to go off in the sunset? All these things will dictate the type of firm that you go to. There are firms that allow you to carry your own brand and get liquidity and don't integrate at all. Then there are firms that require complete and total integration, where your brand is absorbed into the newer firm and the offering of the new firm becomes the total offering. Ask yourself what you want to ensure you are going to the appropriate place.