Advisers face new M&A reality after COVID-19

An aging workforce may not be able to postpone retirement until valuations bounce back

MAR 25, 2020

By Ryan W. Neal

This article is part of a series of special reports entitled “The New Normal” appearing in the March 30, 2020, edition of InvestmentNews.

Just a month ago, advisers nearing retirement looked to cash in on record-high firm valuations and record-level merger and acquisition activity.

Independent broker-dealers and registered investment advisers completed 139 transactions representing $781.1 billion last year, a 43% increase in the number of transactions and a 38% increase in assets compared to 2018, according to data from Fidelity Investments. There was every indication the rapid pace would continue through 2020, and the month of February saw seven RIA transactions totalling $6.2 billion.

Then COVID-19 came to the United States, bringing with it a stock market crash and voluntary self-quarantines that covered much of the country.

The M&A market flipped upside down in a matter of weeks, and would-be sellers face a market they haven’t seen in nearly a decade.

The most obvious impact is compressed firm valuations. With most firms’ value tied to assets under management, the 23% drop in the S&P 500 Index is forcing some advisers to accept that they may not get the price they hoped for. Even though client assets aren’t completely tied up in equities, DeVoe & Co managing director David DeVoe said many advisers are staring at 15% to 20% drops in revenue, and the situation continues to change weekly.

The pace of M&A is also expected to slow down. Not only are buyers holding onto assets, but advisers are busy these days working with clients, said Scott Slater, vice president of practice management at Fidelity Clearing & Custody Solutions.

“When you’re in a crisis, sometimes strategy has to take a little bit of a backseat while people are reassessing,” Slater said.

He expects some advisers will stick it out a few years longer than planned to help get clients through the downturn, as many did following the 2008 global financial crisis. “An awful lot of players who thought they were close to retirement didn’t want to leave because they wanted to do the right thing for their clients,” Slater added.

Prolonging retirement

The difference is fewer advisers have the luxury of sticking it out as they did in 2009, DeVoe said. The average age of firm owners is older, and many can’t wait if it takes several years for valuations to return to 2019 levels.

Beyond forcing some advisers to stick in the business longer than perhaps they wanted to, Smart Concepts Group founder and CEO Tom Titus believes adviser character and client engagement will become more important than they have been historically.

“You’re going to want to do business with people you believe created good foundations with clients,” Titus said. Especially as a market correction makes investors more willing to change firms, buyers will be looking beyond just price. “You’re going to care a lot about that client relationship and loyalty.”

The coronavirus outbreak is also impacting how M&A deals are being structured. Sellers can no longer expect to see the same level of upfront cash as many deals in recent years. And with more leverage than they’ve had in years, buyers are looking for more protections against downside risk.

That doesn’t mean advisers should accept a permanent price reduction for what will likely be a temporary situation for buyers, said Advisor Legacy director of M&A Todd Doherty. Sellers can structure a deal to capture upside as the market returns.

“It doesn’t need to look like a fire sale,” Doherty said.

There is also opportunity to demonstrate a firm’s value beyond AUM and revenue. For example, a firm that successfully shifted to working from home in response to the coronavirus outbreak can prove to buyers that it has a modern technology infrastructure that can survive a future crisis.

“We’re all realizing the fragility of day-to-day life as we know it,” DeVoe said. “The power to be flexible and agile and respond to unexpected situations … that’s an asset.”

Merger mania

While advisers may worry about the optics of selling a firm during a market downturn, Doherty believes it can be an opportunity if it’s presented as a merger that brings additional resources to clients during a volatile time.

“That could be a pretty positive message. It looks very proactive on the part of the selling adviser to make a move like that,” Doherty said.

Ultimately, M&A consultants urge advisers to take the advice they give to clients: Think strategically and don’t try to time the market.

Even if valuations are no longer at all-time highs, there are still more buyers than sellers, low interest rates allow for more purchasing, and the technology and compliance outlook isn’t getting any easier, said Advisory Legacy CEO Anthony Whitbeck.

“Every year you wait, your client base is a year older, and client age plays a significant impact on practice value,” Whitbeck said.

If the coronavirus pandemic becomes the trigger for the large population of baby boomer financial advisers to finally retire, they could face a dramatically smaller pool of attractive buyers in a few years. “There’s almost more risk in delaying,” Whitbeck added.

But advisers looking to go forward with a sale must accept that the M&A market, and the entire world, has changed.

“The reality is that valuations are lower,” Slater said. “Once you accept that, you can engage realistically with where the market is right now.”