James Poer of NFP Advisor Services talks about some of the factors behind increased M&A activity in the US advisor space.

NFP and Aite Group recently published a study looking at practice acquisitions by US financial advisors, defining an “alpha acquisition” as one that the buyer regards as having been successful. The findings brought to the surface many of the issues faced by buyers when acquiring a book of business and also reaffirmed the notion that a slowdown of industry M&A activity is unlikely.

The financial crisis meant that many individuals working in the US independent financial services sector had to re-build their business from a revenue standpoint, James Poer, president at NFP Advisor Services, told Family Wealth Report.

Poer said the industry would probably have seen a much more radical shift earlier had the financial crisis not have occurred. Perhaps not “radically so,” but he believes there will be a solid pace of increased transactions between business owners in the coming years. His insights resonate with those seen in Schwab’s 2013 RIA Benchmarking Study, in which 25 per cent of firms with between $100 million and $250 million in AuM reported to be actively looking to acquire another firm.

Perhaps the most notable driver behind this trend relates to the highly talked about aging advisor population that is edging closer to retirement, although recent studies have drawn attention to how individuals generally - including financial advisors - are choosing to work for longer, for personal and practical reasons. Other factors include advisors simply looking for growth as well as rising regulatory costs, forcing some firms - although perhaps more relevant at the institutional level - to build economies of scale. 

Poer believes there is an opportunity for more industry advice in helping financial advisors leverage the growth potential of their businesses, specifically when it comes to M&A. Indeed, NFP and Aite Group's study (see here) revealed that just a quarter of the deals made by the 100 advisors who had previously made an acquisition qualified as “alpha acquisitions,” while 45 and 30 per cent fell in the “near-alpha acquisitions” and “non-alpha acquisitions” categories respectively. (“Near-alpha acquisitions” were defined as those where the advisor is “satisfied” and thus would make such a move again. “Non-alpha acquisitions” represented those acquisitions for which the advisor would not do the acquisition again as well as those for which they would but were not “very satisfied” or “satisfied” with the move.)

The types of deals covered in the study included those carried out by employees at some of the biggest US wealth management firms as well as at large regional broker-dealers and among independent RIAs. To give a sense of volume, it emerged that every ten financial advisors in the wirehouse channel were responsible for 5.9 acquisitions on average, compared to 2.6 among RIAs.

“The fact that wirehouse advisors are organized in a large-firm structure and their employer (i.e., the wirehouse) is interested in successfully transitioning client assets to a successor in order to keep these assets at the firm could explain the difference in acquisition volume,” the study said. “No such overarching asset preservation interest exists in the independent RIA space, and advisors in that channel are less often coached when it comes to practice acquisitions.”

Key takeaways

Indeed, many of the M&A points flagged up in the study are likely relevant to any firm in any industry. But it is the sensitive and somewhat elusive nature of wealth management that make many of the issues raised even more crucial.

For Poer, one of the main takeaways from the study was that many of the alpha acquisitions exited the prior owner in 12 months.

“There has long been a sense that you need to keep an owner around for three to four years in order to successfully transition a business,” he said. “But through thoughtful communication, planning and strategy, someone can acquire a business, exit the owner and maintain a very high percentage of, or even grow, that book of business moving forward.”

He added that keeping the prior owner around for too long can “create confusion” among clients in terms of who is in charge and who is going to manage their wealth long-term.

“This is such a relationship-based business. People want to know who is behind helping them make their wealth decisions,” Poer said. “Clients want familiarity and trust – those are very hand-in-glove.”

He said clients will often “happily accept” a new trusted advisor, but the communication has to be “consistent” and the introduction thoughtful. Indeed, the study reinforced the notion that personal contact with clients is “critical in order to build trust.” For example, only 24 per cent of advisors making non-alpha acquisitions held meetings with clients during the transition period and almost two-thirds said they prefer to inform clients via letter mailing.

Similarly, in some cases, acquisitions may lead to a re-brand or change of strategic direction, which Poer acknowledged can cause some concern.

“But, if it's reinforced through a thoughtful and trusting communication strategy, it's very manageable,” he said. “Advisors have a tendency to over-think branding, which is actually less important than the communication and the trust factors.”

When asked what he thinks are the main business transition pitfalls, Poer cited rushing into a deal, not understanding the client service model, and not knowing how to properly value - these “can cause failure”, he said.

“So it's someone who has planned and decides what they're looking for rather than just jumping on the first opportunity that presents itself,” Poer added. “They take their time to find it and are intentional about the profile of the client, the service model etc. and they're patient in finding the right acquisition. They are strategic.”

The study showed that one of the most difficult aspects of deciding to acquire a practice is determining and agreeing on the value of the acquisition target. That said, practice valuation can be done in various ways and can take into account an array of data points.

Assets under management, client service model and revenue mix were ranked by advisors as the three main factors to consider when valuing the acquisition target at 60, 56 and 52 per cent respectively. (In joint third at 52 per cent were business longevity and cash flow from operations.)

“While there are certainly exceptions, it is safe to assume that advisors have to pay a higher revenue multiple to get their hands on a higher-quality practice,” the study said.