The outlook for RIA M&A activity apparently has shifted dramatically from a year ago, according to a new report.
DeVoe & Company’s fifth annual M&A Outlook Report finds that expectations for M&A activity and valuations are the lowest in the survey’s history, as economic and political turmoil coupled with increasing market volatility are likely culprits.
Nearly 60% of advisors expect M&A activity to flatten or decline in the next year. Only 42% of advisors expect RIA M&A activity will increase, with 35% selecting “rise somewhat” and 7% believing it will “rise considerably.”
DeVoe notes that this is a 21% drop in expectations from a year ago when 63% indicated activity would increase. Strikingly different from last year—a quarter of respondents believe that M&A activity will be “somewhat lower” or “considerably lower” (23% and 2%, respectively). Last year, the report notes, only 4% forecasted that activity would decline.
Alongside these findings is RIA M&A activity for 2022, which DeVoe notes will finish as another record year, but the year-over-year increase is expected to be far less than the 50% year-over-year increase last year. More than 200 transactions were posted through the first three quarters, but activity dropped in the fourth quarter. DeVoe currently forecasts that approximately 260 transactions will be completed for the year, which would be an 8% increase over 2021.
“The prolonged economic and market downturn combined with interest rate increases conspired to drag down M&A momentum,” said David DeVoe, Founder and CEO of DeVoe & Company, who adds that Q4 is tracking at a 34% drop from the same period in 2021.
Valuations Outlook
Meanwhile, advisor respondents also believe that the record high valuations of the past few years will likely decline. “The optimism of yesteryear has given way to a more subdued expectation,” DeVoe remarks. In fact, 56% expect lower valuations over the next year, compared to just 8% in 2021. Moreover, only 8% of advisors expect higher valuations over the next year, compared to 39% a year ago.
The report explains that today’s volatile environment has many “similar hallmarks” to periods of lower valuations: rising interest rates, ongoing global turmoil and a looming U.S. recession remain significant threats. “They’ve already caused a sharp downturn in financial markets this year, depressing advisors’ assets under management as well as their revenues and profits. With these conditions, advisors expect valuations to decline,” the report emphasizes.
Yet, despite this outlook, advisors are mixed on how a significant increase or decrease in valuations from January 2022 would affect their timeframe for selling, DeVoe further notes. Notably, 47% said a 20% increase in valuations would change their timeframe for a sale, but a full 10 percentage points more (57%) said a 20% valuation drop would affect their sale timing — either by accelerating or delaying it. Pointing to the theory of loss aversion, the report observes that advisors also seem to be affected more by market losses than gains in their decisions on when to sell their firms.
Buyers and Sellers
The priorities for buyers and sellers appear to be shifting, according to the report.
Continuing to view inorganic growth as a fast path to reaching a new size or level of success, more than half of respondents said they expect to acquire another RIA within the next two years. But interest in this path has declined. According to the findings, 54% said they plan to acquire during that time frame, which is a six-point drop from last year, but in line with historical responses.
That said, a severe decrease occurred among respondents from larger firms ($1B+). Here, 59% of these firms expect to buy an RIA within the next two years, down from 74% the prior year. “These larger firms may simply be absorbing their recent acquisitions or assessing the impact of rising interest rates on their buying power,” the report observes.
At the other end of the spectrum, interest in acquiring from respondents of firms with sub-$1 billion in AUM increased five percentage points to 47%. Similarly, these respondents may view inorganic growth as a fast track to a heightened level of scale. To that end, the report explains that acquisition strategies appear to be rooted in multiple desired outcomes — talent, new geographies, scale, and expanding services and capabilities.
Meanwhile, the composition of RIA sellers has also changed. The number of large sellers with more than $1 billion in assets under management has dropped and been offset by a surge of smaller sellers (under a billion in AUM), the report notes. DeVoe predicts that this segment will remain among the most active seller segments over the next several years.
As to barriers for buying, identifying a “suitable partner” was the key reason respondents gave when asked about factors that would prevent an acquisition, with nearly 40% of respondents choosing that answer. Additional barriers to acquiring another firm included a disconnect in price between buyers and sellers and lack of time to work on acquisitions.
Regarding barriers to selling, the No. 1 obstacle for sellers to engage in a transaction is the same as for buyers — identifying a suitable partner. However, more sellers than buyers cited the challenge of finding a suitable partner as the key obstacle to making a deal — at 51% vs. 39%, respectively. Sellers also cited a disconnect on price between themselves and a prospective partner (20%) and risk of client attrition (15%) as key barriers to moving forward with a transaction, the report notes.
Succession, Readiness and Affordability
Succession planning is a growing problem for an industry whose average owner DeVoe estimates is over 62 years old. Nearly two-thirds (63%) of advisors this year see the lack of succession planning as a big problem for the industry, up from 56% a year earlier and near 50% in the previous three years.
Despite the current lack of planned succession, the firm found that 49% of the advisors it surveyed indicated they would prefer to sell internally to pass their businesses on to the next generation of advisors. In contrast, 31% indicated a preference for external succession with a larger firm, where they would gain resources or scale.
But a lack of succession planning “isn’t simply a matter of inertia or procrastination,” the report further observes. In fact, many owners don’t believe their NextGen are ready to take the reins. DeVoe’s 2022 RIA Talent Management Study found that 68% of RIA leaders believed that second and third generation employees were not ready to take over management and leadership roles. Additionally, many NextGen advisors cannot afford to buy out current shareholders, the report notes.
The “outlook” findings are based on a survey of 112 individuals conducted between June and October 2022. Respondents were senior executives, principals or owners of RIAs ranging in size from $100 million to over $10 billion in assets under management.
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