Great Expectations, Disappointing Realities
The credit crisis has spoiled the RIA M&A party-if only for a while
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Focus Financial Partners' CEO Rudy Adolph would not discuss specifics of the deals he does with RIA firms, or his own firm's financials — it is, after all, a private firm. But he did say that Focus more than doubled its EBITDA in 2008, and added $3 billion in net new client assets in addition to buying five new partner firms. In an email he added that the firms “continue to perform well … have experienced almost no client attrition and have in fact gained many new clients who have been disappointed with the level of service they received at their previous institution — usually the wirehouse.”
But even when the holding companies are financially sound, the RIAs they partner with may face trouble. According to market participants, a typical deal looks like this: An acquirer buys 40 percent (or sometimes as much as 50 percent, as was often the case at NFP) of an advisory firm that has $2 million in profitability. The $800,000 dividend paid to the acquirer (40 percent times $2 million) is guaranteed in the sense that the buyer is first in line and the contract stipulates that that dividend will not decline below the acquisition level. So, if profitability of the firm declines to, say, $1.5 million, the acquirer still receives its $800,000 distribution, but the selling advisors are now making less ($700,000 in this hypothetical example), bearing the burden of the declining market. Of course, on the upside, the buyer rewards the RIA with bonuses for earnings above the target earnings — alas, a possibility few firms will realize this year.
WHAT NEXT?
“Why do people sell?” asks Pershing Advisor Solutions CEO Mark Tibergien. “Generally for three reasons: to retire, to be part of a larger organization or because you need resources to grow.” What RIA sellers — their alleged sophistication notwithstanding — often don't realize is the risk they take on when they sell. “If you sell to a consolidator, part of the currency will be stock; so you have to have confidence the company will remain stable and continue to grow,” he says. Tibergien suggests potential sellers ask themselves, “If you weren't part of the deal, would you still buy the stock of the acquiring company on the open market?” For “Dave,” the principal at the RIA mentioned at the start, selling the acquirer's stock was “our first priority,” he says. “My income and my ownership give me the tiny exposure I want to this business. If you're an asset allocator for your clients, you should be shot for owning your own stock,” he says.
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