Despite industry media buzz about 2023 M&A headwinds pouring into this year, countless RIAs and broker/dealers are actively pursuing deals. Rather than an outright change of ownership, however, many are taking a closer look at minority stakes.
Minority stakes come with a host of special considerations, including determining a reasonable valuation, delivering income streams equally, and ensuring advisers and clients stick around. However, perhaps the most critical factor is whether the parties can work well together, not only now but in the future.
That's because most disputes about minority shareholding arrangements center around control. Naturally, sellers will want to manage a business the way they always have, while buyers will want a voice in how it operates. This makes it crucial for all parties to remain comfortable with the terms of the agreement throughout the life of the partnership.
Marriage Material
After all, contracts are pieces of paper. It's the people behind them that make the difference. Indeed, the reality of how—or whether—clauses regarding payments, restitution, mutual indemnity, and arbitration play out in the real world depends heavily on the beliefs and behaviors of each contracting partner.
This is why, in some respects, creating an arrangement like this is similar to marriage. Buyers and sellers must commit to each other through good and bad market cycles, knowing that a divorce can be messy and expensive.
In a perfect world, a retail stock transaction could satisfy the seller's need for liquidity and a continuity plan while supporting the buyer's desire for increased diversification. But our world is far from perfect, so there are two important things to remember before walking down the aisle together.
First, just because someone is a good advisor doesn't mean they run an effective business. Buyers need to understand the difference. Does your potential partner have a keen eye for P&L and cash flow management? Do they offer a competitive advantage? And do they inspire the people who work for them to go above and beyond?
If not, keep shopping. Remember, not every business will become stronger after having an influx of capital; only those who lead well do.
Second, sellers should only partner with buyers with a strong track record of deploying capital effectively. On the surface, of course, this means they have a history of increasing firm valuations and strengthening autonomy. But there is a lot of hard work for this.
Ask buyers about the transition process and what kinds of differentiating technology tools and platforms they would implement. Also, in this age when firms must spend additional resources to keep clients happy, ask which investment management and financial planning services have had success. Furthermore, what about succession planning, compliance and marketing support?
From partial to total
To be sure, some minority equity investments eventually give rise to a second deal—one that results in a total change in ownership. The salesperson may be ready to retire or pursue new ventures. They could have gained trust in the buyer after the initial investment. It is also possible that there is no other buyer.
Whatever the case, if the seller is ready to pursue a new venture, one path may be to take on increased responsibilities within the acquiring firm. Sophisticated advisors who have built their own businesses can often help others expand existing platforms or open affiliates for the buyer. This can pave the way for new geographies, products and services in the parent organization.
Agreement or no agreement?
Finally, you must be willing to say no. It's probably a cliché to say that the most important deals are the ones you don't make. But clichés gain steam for a reason—there's often more than an ounce of validity to them.
So in the end, for buyers and sellers, it puts a premium on finding the right partner with the right business at the right time. This is easier said than done.
Lou Camacho is President of Stratos Wealth Enterprises