For many registered investment advisors, private equity backing is the norm if they want to expand via M&A. Not all observers are pleased with this trend, but whatever doubts there may be, the involvement of PE finance in the space appears to be well established.
Five years ago, private equity was just beginning to establish a foothold in the financial advisory business. Today PE firms have a stranglehold on the industry’s biggest firms and most aggressive buyers.
The most recent example is Beacon Pointe Advisors’ acquisition of Altavista Wealth Management, a North Carolina RIA with $600 million in assets under management.
In January 2020, Beacon Pointe was a scrappy RIA buyer, punching above its weight while having made ten deals in the previous decade, but finding itself being outbid by private equity-backed rivals with deeper pockets. Since Abry Partners made a minority investment in March of that year, followed by PE powerhouse KKR last November, Beacon Pointe has gone on a tear, snapping up 18 firms in short order.
“Beacon Pointe is a good case study in the impact of private equity in the M&A market,” said Dan Seivert, CEO of ECHELON Partners, M&A valuation consultants and investment bankers. “They worked hard and developed a network of firms but were losing deals because they lacked two key elements: a deeper financial foundation and expert advice on deal structure and winning competitive bids. Partnering with private equity was an inflection point for them.”
No more holdouts
Beacon Pointe president Matt Cooper agreed.
“Private equity was critical for us,” he said. “It validated the viability of our balance sheet, enabled us to secure proper debt facilities and lending capabilities and helped us think through deals.”
In fact, in today’s hyper-competitive landscape, Cooper thinks it would be “really hard” for a major RIA buyer to be successful without private equity investment.
“It’s not just the capital,” he explained. “It’s having a plan, having a dedicated deal team and being able to do due diligence and integration. If you don’t have all of that in place to do at scale, ultimately you’re going to be a target.”
Indeed, the last two years have seen a slew of major RIA acquirers who had heretofore been holdouts accept PE investments, including Mariner Wealth Advisors (Leonard Green & Partners); Carson Group Holdings (Bain Capital); Savant Wealth Management (Kelso & Company) and Creative Planning (General Atlantic).
Not coincidentally, “nearly all the most active strategic acquirers in today’s market are backed by prominent private equity firms,” ECHELON’s most recent RIA M&A Deal Report pointed out, noting that “this has been a driving factor for the industry’s record-breaking M&A activity in the past few years.”
Seven of the ten most active acquirers last year had PE investors: Focus Financial, Wealth Enhancement Group, Mercer Advisors, Mariner Wealth Advisors, Captrust, Beacon Pointe and Hightower Advisors.
Is short-term bad?
The most common criticism leveled at PE investors has been the industry’s short-term time frame: private equity firms typically seek returns of greater than 20 per cent within four to seven years.
Seivert thinks the limited investment horizon “isn’t a big factor” anymore. He pointed to RIAs such as Mercer Advisors who have made multiple PR backers in the past decade but have maintained stable management and produced stellar results. What’s more, he noted, RIAs that haven’t accepted PE investments have “lagged in growth.”
Abry Partner’s investment in Beacon Pointe lasted less than two years. “That showed the business is doing great,” Cooper said. What’s more, he added, a PE exit can provide a liquidity opportunity for stakeholders and “make shareholders feel good.”
Cooper also noted that even if there is a turnover in PE backing, “management has a say in who the next partner will be because that investor wants management to be happy."
So what are the downsides of partnering with private equity?
“The biggest red flag is asymmetric information,” according to Seivert. “A PE firms’ experience and knowledge is way higher than the RIA they are investing in. An RIA can get taken in terms of the deal structure not fully understanding deal points like preferences and rights. There can be quite a disparity of power and returns if the deal isn’t structured properly.”
A 2020 post by Park Sutton Advisors, the New York-based investment banking firm specializing in RIA M&A also noted PE firms’ penchant for “sophisticated [deal] structures.”
Deal points can include requirements for “preference amounts,” where the PE investor receives a certain percentage return on their capital invested before profits are distributed to other shareholders. PE firms may also insist on a “liquidation preference” that they receive on their invested capital upon the sale of the company as well as governance provisions, which may be onerous.
Nonetheless, with as many as 80 private equity firms sniffing around the RIA market, no one expects PE involvement to abate anytime soon.
“PE’s influence on RIA M&A has never been stronger,” said Brian Lauzon, managing director of InCap Group. “The PE fund sponsors continue to be believers in the inorganic growth opportunities available to larger wealth management firms. And PE capital typically does come with an expectation of aggressive inorganic growth.”