Internal Sale vs. External Acquirers
Many advisors running a practice they founded would like to hand the business off to a younger generation of leaders within the firm, but often the economics of an internal sale simply don’t work out.
That is often because the valuation of the registered investment advisory firm has risen beyond what the staff can afford, so leaders are increasingly looking to outside acquirers for their exit strategy, according to a new report from DeVoe & Co., an investment bank and advisor consultancy.
The Benefits and Drawbacks of Internal Sales
“Most RIA founders have a bias to sell internally,” DeVoe says in its new report. “An internal sale is often viewed as the clearer path to continuity for clients, and—perhaps most important for many—provides a way for the founders to maintain maximum control until they fully exit.”
But soaring RIA valuations have created a rapidly accelerating “affordability gap” that has put internal acquisitions out of reach for most firms and threatens a looming “succession crisis” in the industry, DeVoe says.
The Growing Affordability Gap
Just 18% of the advisors DeVoe polled in its most recent survey said they believe the rising generation within their firm can afford to buy out the owners. That continues a trend: two years ago, 38% of respondents said an internal sale was within reason; last year the figure had dropped to 29%.
The declining rate of what DeVoe calls the next-gen affordability index is just one factor that could fuel a resurgence in mergers and acquisitions, which fell off slightly last year following more than a decade of unabated increases.
Factors Driving Potential Sellers
DeVoe’s survey found that 57% of potential sellers cited liquidity as a reason for potentially cashing out, followed by the prospects for growing the business that could come from joining with a larger organization (49%). Succession came in third, cited as a factor by 45% of potential sellers. Many advisors also say a sale of the firm could help the practice increase its scale.
Industry M&A Predictions for 2024
When considering the outlook for industry M&A in the upcoming year, a recent survey has unveiled an interesting paradox. Only 18% of survey respondents are expecting an increase in transaction volume in 2024, a significant drop from the 42% who foresaw a rise in the previous year's survey.
Factors at Play
According to DeVoe, advisors' perceptions of merger activity may have been influenced by a shift in paradigms. Many advisors witnessed a decline in M&A following several years of record highs, which likely tempered their expectations.
Firm-Specific Insights
Despite the overall industry outlook, when queried about their own firms, a notable 65% of respondents expressed intentions to pursue at least one acquisition within the next two years. This figure represents the highest level in at least four years, according to DeVoe.
Motivations Behind Acquisitions
For some firm leaders without an apparent successor in place, an external acquisition could serve as a strategic move to ensure the continued success of the firm post-retirement. Others may be driven by a sense of urgency to expand their business amid challenges with organic growth initiatives.
Cautionary Perspectives
While a significant majority of advisors have indicated plans for acquiring another firm in the near future, DeVoe remains cautiously optimistic about the forecast. Although 2024 may not be a "blockbuster" year for deals, the firm anticipates a gradual uptick in deal momentum over the next five years.
Realistic Expectations
In light of the survey data suggesting that 65% of RIAs are considering an acquisition within the next two years, DeVoe's calculations point to a potential total of 4,774 transactions annually. This contrasts with last year's tally of 251 transactions, which was slightly lower than the previous record of 264 in 2022.
DeVoe emphasizes that while such a drastic increase in acquisitions is theoretically possible, it remains unlikely in practice.
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