As PE crowds out RIA buyers, here’s what sellers need to know

Jess Polito of the M&A consulting firm Turkey Hill Management thinks the private equity capital financing many industry acquisitions presents an ethical quandary to RIA sellers.

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Many may feel they have an obligation to their clients, employees and even themselves to go with a purchaser offering something more than the largest payout. But the difference between what private equity firms and other buyers can pay is often too great to ignore.

“It becomes a little bit of a moral dilemma for a lot of sellers because no one wants to believe they’re choosing the dollars,” Polito said. “But sometimes it’s the difference between making sure you can retire yourself and making sure your grandchildren can retire.”

Deep-pocketed private equity furnished evidence of its continued appeal in the  investment bank and valuation firm Echelon Partners’ latest RIA M&A Deal Report. Of the 120 RIA acquisitions Echelon identified as completed in the second quarter, private equity firms played a role in nearly 76%. That marked a record high for PE involvement.

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Echelon also noted that nearly 90% of the deals were completed by “seasoned acquirers” — firms with at least three previous acquisitions. In another sign that small buyers might struggle to compete, the size of firms being bought is also moving upward.

On average, RIAs purchased in the second quarter had $2 billion in assets under management. That was the highest such figure since 2021, when the average was $2.1 billion.

Dan Seivert, the CEO and managing partner of Echelon, said the report shows that “activity is concentrating among a smaller group of repeat, well-capitalized buyers. That’s where the industry is heading.”

Corey Kupfer, a lawyer specializing in M&A work for registered investment advisors, said he has looked at consolidation cycles in other industries and found that private equity-backed buyers tend to crowd out other acquirers. That’s because PE can offer more money.

“They have sophisticated deal teams,” he said. “They know how to do deals. They know how to source deals. They know how to move them forward. They know how to underwrite them. They know how to close them. They know how to finance. It just becomes hard to compete.”

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Can deal prices go up indefinitely?

RIA valuation and M&A consultant DeVoe & Co. released a report suggesting that sales prices in the industry may soon level off. Polito said she thinks the strong interest private equity firms still have in RIA deals will prevent prices from collapsing, even if they cease rising as quickly as they have been.

“I don’t know if valuations are going much higher than they are currently,” she said. “They’re quite high now. But I don’t see them tanking either.”

One effect of rising valuations has been a reduction in the number of buyers that have the capital needed to meet sellers’ expectations. Of the 120 deals Echelon tracked in the second quarter, 62.5% were completed by just 24 firms with two or more deals to their names.

The most acquisitions by a single firm, 11, were credited to Stratos Wealth Management. Rather than private equity, Stratos is backed by SEI Investments Company, a publicly traded asset manager. And the largest deal in the second quarter, LPL Financial’s purchase of Mariner Advisor Network, was also undertaken by a firm without private financing.

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With private equity, it’s not just the money

Still, Echelon’s report leaves little doubt that private equity remains the dominant force in RIA mergers and acquisitions. Echelon noted that rising credit costs are pushing more sellers to finance their growth through equity deals rather than loans.

Polito said RIAs can have a difficult time borrowing money simply because their businesses tend to own few tangible assets that can be used as collateral. That also has an effect on firms’ ability to pay.

Whereas private equity-backed firms can often provide a large portion of a purchase price as cash upfront, buyers operating without PE funding may only be able to put down 20%. The rest usually comes in the form of “earnouts” that a purchased firm can’t secure without meeting certain performance measures.

The need to hit those goals over time can force sellers to non-PE-backed buyers to put off retirement plans. For many, such considerations only add to the attraction of private equity.

“Often sellers are selling because they don’t want to work for seven more years,” Polito said. “So the idea of having to stick around to, you know, accumulate slowly over time what you could have just received — it’s just not appealing when you have the other option available to you.”

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Are buyers becoming more selective?

Despite the strong interest in M&A still shown by private equity firms, Echelon’s latest report recorded a slight slowdown in dealmaking: The 120 transactions recorded in the second quarter was down slightly from 142 in Q1. Still, Echelon predicted the number for the year would approach 500, which would be an annual record.

Polito said she does see the numbers as a sign of flagging demand. She believes buyers, both PE-backed and non-PE-backed, have become choosier. But for the right firm, they’re also likely still willing to pay top dollar.

“Buyers are becoming more selective about who they are willing to submit offers for, but they are more competitive when they have decided to participate,” Polito said.

With so much M&A taking place, RIA owners are almost certain to know someone who has gone through a sale. But because of changing market conditions, previous deals are poor guides to what sellers can expect today.

Still, some traits will always be valued. Primary among those are a firm’s ability to achieve organic growth — or bring in assets from new or existing clients rather than market gains.

“So you may receive fewer offers,” Polito said. “But you know if you have been growing organically, and you’re not trying to get out of the industry as soon as possible, all of those things still drive valuation.”