Private equity continues to make its presence felt across industries as diverse as technology and infrastructure and, of course, wealth management. For an aging advisor demographic exiting the independent RIA space, the resultant elevation in prices and multiples has been a boon. Will it last? If you fall into Shakespeare’s “what's past is prologue" camp, history shows that our industry has already seen PE come, make a splash and then go—think the robo advisor craze—and I expect that while PE will remain an active player for years to come, PE-driven consolidation activity may wane in the next 10 to 15 years.
Here’s what we know about PE investors. They are astute investors with an established and regimented modus operandi: get in early on a company’s growth cycle and get out as it starts to mature. When investing, they are equally disciplined in both their buy and sell decisions, which positions them to capture what can be massive multiples on invested capital.
In wealth management, where are we in the current consolidation and growth cycle? More specifically, when will it start to mature and when will it end? It’s important to note that for many investors, a maturing growth cycle is synonymous with one that’s ending. For example, a firm sees its 20% or 30% year-over-year growth rate fall to 10%. Despite still solid, double-digit growth, that company will see its value fall. Look at Tesla, a company that has already enjoyed enormous growth, with its forecasted growth driving the stock price to record highs. However, discussions concerning the adoption rate of electric cars have led investors to believe its go-forward growth rate will be slower. The result: over the last year, the stock has been down and is currently trading in a fairly narrow band.
Firms that are growing faster will trade at higher multiples, which translates to higher prices. In wealth management, that means acquirers and consolidators are executing transactions at inflated prices, thereby creating a trickle-down opportunity for the sellers. Like most industries experiencing greater-than-normal growth, this isn’t sustainable forever and will eventually mature to a more normalized growth rate.
When will that happen?
Clearly, I don’t have a crystal ball. However, I have often said you can read the tea leaves. The limitations of this approach center around the lack of specificity. “The leaves” merely offer an understanding of go-forward trends and an indication of when things may shift in the future. For the wealth management space, the current trend is consolidation. I can’t predict when it will end. But I think you can look at this trend and what’s driving it to make some predictions as to when you may see a slowing or a shift.
The Industry Is Fragmented
Currently, there are over 300,000 financial advisors, over 4,000 broker/dealers and over 15,000 RIA firms. Clearly this is a fractured industry where some of the largest firms represent only 6% of total advisors. Compare this to banking, where the top three banks (JPMorgan Chase, Bank of America and Wells Fargo) together have over 31% market share.
If we look into the future (excluding black swan events or other external factors that may impact the wealth management space), it’s pretty safe to say this bias toward consolidation is going to continue for the next five years. But let’s look at the five years that follow and even the next five years after that, so we are looking 10 or 15 years from now.
The Power of Organic Growth Capabilities
I believe consolidation will continue apace over the next five years. As we get closer to the 10-year mark and beyond, its increasingly likely that the rate of consolidation may slow. If that should happen, it will also have a large impact on growth rates. What does this mean for an advisor? Yes, it is difficult to base today’s decisions on something that may or may not happen 10 years into the future. Still, no matter the environment, advisors who are considering a sale should be looking at firms best positioned to continue to grow even if the greatest source of growth should slow. Firms with optimal organic growth capabilities are not as dependent on PE to elevate valuations.
Today, multiples on wealth management firms are based on size and growth rate—no surprise there. However, maintaining robust and varied avenues of growth now and into the future will drive growth, as well as sustainable valuations, in all stages of the growth cycle and in all environments.
Be sure to look for firms that aren’t just growing through acquisitions, but also have developed a structure to spur organic growth as well. Remember, if a firm’s growth rate slows, it will often have a direct impact on its stock price.
Jeff Nash is Chief Executive Officer and Co-Founder of Bridgemark Strategies