Monday, June 12, 2017

Industry Focus – Registered Investment Advisor Firms (RIAs)

The transfer of ownership of Registered Investment Advisory firms is being driven by the same mega-trend that is impacting a large majority of privately held businesses; the aging of the baby-boom generation.  Many of the owners of RIAs are simply aging out or will be over the next several years and as a result will be looking for a way to monetize the value of their business.  Unfortunately, many of them will come to find they “own a job” with very little enterprise value to sell.  Depending on the number of years remaining until retirement, it may not be too late to focus on certain key value drivers that will increase enterprise value. 

Let’s start with the end game in mind.  What are purchasers looking for?  Generally, purchasers are looking for RIAs that have the following attributes:
  • $500 million of Assets Under Management (AUM), or more
  • A consistent investment process that is applied consistently across all accounts
  • Consistent internally-driven growth
  • An efficient, technology-driven business model
  • Profit margins (after a reasonable owner’s salary) of at least 20%
  • No compliance issues
  • 100% fee-based business model
If this does not describe your firm now, what can you do now to head in this direction with the time remaining?  There are a few operational steps you can take quickly that will make a big difference.  First, migrate all of your clients to a fee based business model and get rid of your broker/dealer affiliation.  Being affiliated with a B/D detracts from value.  Adopt a standard, technology-driven approach to customer reporting that can be leveraged across an ever-increasing client base.  Do not agree to any customized client reporting, no matter how large the client.  Adopt a consistent investment process that utilizes as few CUSIPs as possible.  Also, limit the number of custodians you will work with to only 3 or 4.  The fewer custodial relationships you must manage and utilize for trading, the better.  Efficiency is the key in all of these areas.

Next comes growth.  Purchasers like to see a firm that is consistently generating annual growth of 10% or more.  This type of year over year growth takes a structured and consistent marketing effort.  It is imperative that you tell your story to as many potential clients as possible.  Set goals for yourself, and your other producers, for the number of meetings per week, month, quarter, etc.  Use a firm-wide customer relationship management (CRM) system to track and facilitate this marketing effort.  The mere existence of this CRM system will add value as it demonstrates a systematic approach to marketing that can be transferred.  Make sure your marketing materials are up to date, this includes your website, your blog and your collateral material.  Develop a PR campaign that positions you and your firm as the expert.  This can include speaking engagements, white papers, a blog, etc. 

Lastly comes financial and legal considerations.  I give this advice to every prospective client, regardless of industry; do not run personal items through the company.  Whether these are family members on the payroll or your college alumni association dues, take them off the company’s books.  In many transactions, these personal expenses are shown as proforma add-backs but many buyers to not give full credit to these add-backs.  This can be an expensive adjustment; potentially losing 5-10X the expense amount in your ultimate enterprise value.  From a legal standpoint, consider revising your client agreement so it is assignable.  In every transaction, the buyer will want to make sure that the existing client agreements can be assigned.  If they are not assignable you may have to go to every client and have them consent to the assignment before the transaction closes.  Maybe not a deal killer but certainly a difficult and time-consuming closing item. 

The value of an RIA comes down to three main items; size, efficiency and growth.  Value multiples vary over time but generally firms with $100 million of AUM will trade for 4-5X cash flow (after the owner’s salary) while firms with more than $1 billion of AUM could trade for more than 10X.  Firms with an efficient operating model that can be leveraged by a bigger firm or with a consistent growth track-record or both; will move themselves up within their respective multiple range.

Alan D. Austin, CFA

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