Consolidation is one of the most persistently discussed topics among industry participants.
Whether within the advice, wealth management or asset management space, there is constant chatter around the prospect of firms being bought and sold.
Many firms have achieved extremely healthy valuations, based largely on the amount of business the adviser does. But questions have arisen over whether these same valuations can keep going, especially as we enter more challenging times.
Michael Bishop, who runs the wealth management arm of WH Ireland, notes the traditional valuation metric applied to advice firms is around 2 to 3 per cent of assets under management.
Certainly the valuations at which large wealth managers are being bought are broadly in line with that (Brewin Dolphin, which had £59bn of assets, was bought by RBC for £1.6bn, implying a valuation of around 3 per cent of assets).
But in the advice space, where consolidators have been able to access capital at very low rates of interest in recent years, valuations have crept higher, with figures as much as 8 per cent of assets being discussed in the market.
Rory Gravatt, head of distribution and product strategy at consultancy Altus, says the 8 per cent multiples and higher tend to be paid by consolidators rather than other trade buyers, “and those acquirers feel the 8 per cent multiple is justified if they are getting a firm where they can integrate it into the models and processes they have now, because then there are real economies of scale.
"It is actually quite a callous calculation; an adviser could build up a great client book and a quality business, but certain consolidators will have a strong view that advice business doesn’t have a model that is aligned, and in that case, they won’t pay the higher multiple.
"The other thing to consider is that it is more likely to be the relatively smaller firms that the consolidators see as more attractive from the point of view of economies of scale, because the larger advice firms may already have their own models and processes, and integrating that into a bigger firm can be quite a challenging job”.
Client integration
Ben Spratt, chief executive at Retiring IFA, a firm that helps advisers sell their firms, says he only knows of one IFA firm which has been paying 8 per cent of AUM for some acquisitions: True Potential.
He says: “They are looking for advice firms where they can integrate the clients into the rest of their business, so for example those clients would move to a different platform perhaps or to True Potential’s investment management function. That enables True Potential to earn fees on those as well, perhaps meaning the fees they earn from those clients rises to 1.2 per cent.”
Spratt says that while the 8 per cent figure is a relative outlier, another, new entrant into the advice consolidator market is paying a multiple of around 6 per cent, including for firms with AUMs of £300m, indicating the premium valuations do not just apply to larger firms.
Those consolidators are often backed by private equity funds, which themselves use mostly debt to acquire firms, with the recurring revenues from the fees paid by clients funding the debt repayments.
That model could be called into question as interest rates rise and markets fall, with the debt servicing costs going up. At the same time, the income from the assets under management will likely have fallen in line with drops in markets over the past year.
Olly Laughton-Scott, partner at corporate finance house IMAS, is of the view that higher interest rates will not generally cause the boom in advice firm deal making to end, but he says it does have the capacity to impact some among the current wave of buyers.
He says that in “sectors which are continuing to trade successfully, higher interest rates will only have a marginal impact on M&A activity. However, those companies unable to pass on increased costs to their customers will see margins squeezed and higher interest rates further undermine those companies and their ability to service their debt, leading to a reduced M&A appetite. “
Laughton-Scott says if private equity firms, which often seek to sell the firms they have acquired within a relatively short period of time, incur losses when they try to sell, this could have the impact of reducing the inclination of banks or other lenders to back private equity buyouts of advice firms.
He adds: “Much M&A activity has been driven by PE backed vehicles with access to cheap finance from debt funds. These funds will be looking very closely at the business they have lent whose operating model are stumbling. If the debt fund picks up significant losses this will then feed through to availability of funds to the wider market.”
He notes that 2022 has already been slightly slower in terms of deal flow as a result of the prevailing economic and political climate, but says this is relatively typical across all areas of financial services.
Claire Trachet, chief executive at corporate advice firm Trachet, says the availability and cost of debt financing is always a factor in the strength of the M&A market at any given time.
Weaker markets
Apart from debt costs, the other issue which could impact valuations is the relatively weaker performance of most markets this year.
For example, if a firm agreed to pay 4 per cent of AUM for an advice firm, based on the past decade’s market returns the AUM would have risen stoutly in the following years, making the price paid look cheaper. This would have created something of a margin of safety for making the debt payments, as the income rises in line with the AUM rise.
But if the AUM falls, then the price paid is automatically higher as a proportion of the new assets under management, while it will also take more of the income generated by the acquired firm to pay the debt, leaving much less margin for error.
Gravatt is more cautious on the potential for interest rate rises to disrupt the trajectory of the current M&A boom. He says: “Everything is going to be tougher for everyone. But higher rates definitely impact the commercial rationale for some of the valuation multiples being paid now, and one would think those valuation multiples will be impacted.”
Spratt says most advice firm acquisitions come with a condition around the level of assets under management in the year or so after the acquisition, offering the purchaser a measure of protection from market falls.
The market for advice firms has been in a highly unusual place over the past decade, helped by low interest rates, but also certain structural factors; the coming years will doubtless determine whether advisers looking to sell their firms can achieve the same sort of prices as have been the case in the past.
david.thorpe@ft.com
