Private equity continues to make its presence felt in industries as diverse as technology and infrastructure and, of course, wealth management. For an older advisor demographic coming out of the independent RIA space, the resulting increase in prices and multiples has been a boon. Will it last? If it falls on Shakespeare”what has passed is prologue” camp, history shows that our industry has already seen PE come, make a splash, and then go—think robo-advisor madness—and I expect that while PE will remain an active player for years to come, PE consolidation activity may fade in the next 10 to 15 years.
Here's what we know about PE investors. They are shrewd investors with a set and regimented modus operandi: get in early in a company's growth cycle and get out as it begins to mature. When investing, they are equally disciplined in their buying and selling decisions, which positions them to capture what can be massive multiples in invested capital.
In wealth management, where are we in the current cycle of consolidation and growth? More specifically, when will it start to ripen and when will it finish? It is important to note that for many investors, a bullish growth cycle is synonymous with one that is ending. For example, a firm sees its growth rate of 20% or 30% year over year drop to 10%. Despite still solid, double-digit growth, that company will see its value decline. Look at Tesla, a company that has already enjoyed tremendous growth, with its projected growth driving its stock price to record highs. However, discussions about the rate of adoption of electric cars have led investors to believe that its growth rate will be slower. The result: over the past year, the stock has fallen and is currently trading in a fairly tight range.
Firms that are growing faster will trade at higher multiples, which translates into higher prices. In wealth management, this means buyers and consolidators are executing transactions at inflated prices, creating an opportunity for sellers. Like most industries that experience higher than normal growth, this is not sustainable forever and will eventually mature to a more normalized growth rate.
When will this happen?
Clearly I don't have a crystal ball. However, I have often said that you can read the tea leaves. The limitations of this approach center around the lack of specificity. “Leaves” simply provide an understanding of trends going forward and an indication of when things may change in the future. For the wealth management space, the current trend is consolidation. I cannot predict when it will end. But I think you can look at this trend and what's driving it to make some predictions about when you might see a slowdown or a reversal.
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 with some of the largest firms representing just 6% of total advisors. Compare this to banks, where the top three banks (JPMorgan Chase, Bank of America and Wells Fargo) together have over 31% of the market.
If we look to the future (barring black swan events or other external factors that may affect the wealth management space), it is fairly safe to say that this bias towards consolidation will continue for the next five years. . But let's look at the next five years and even the next five years after that, so we're looking at 10 or 15 years from now.
The Power of Organic Growth Skills
I believe that consolidation will continue apace over the next five years. As we approach the 10-year mark and beyond, it is increasingly likely that the rate of consolidation will slow. If this should happen, it will also have a major impact on growth rates. What does this mean for a counselor? Yes, it's hard to base today's decisions on something that may or may not happen 10 years in the future. Regardless of the environment, however, advisors considering a sale should look to firms best positioned to continue growing even if the largest source of growth slows. Firms with optimal organic growth capabilities are not as dependent on PE to increase valuations.
Today, multiples on wealth management firms are based on size and growth rate – no wonder. However, maintaining strong and diversified growth paths now and in the future will drive growth, as well as sustainable valuations, at all stages of the growth cycle and in all environments.
Be sure to look for firms that are not only growing through acquisitions, but have also developed a structure to drive 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 the Chief Executive Officer and Co-Founder of Bridgemark Strategies