Consolidation among the most prominent players in the RIA space is “highly likely,” according to a managing director for private equity firm LightYear Capital.
Max Rakhlin said the return on dollars that aggregators spend on finding smaller subsidiaries still makes it an attractive route for the industry's top firms. But these circumstances will not last forever.
“At some point, that calculus is going to change, especially when the bigger firms are no longer growing at the same rate that they have been growing,” he said. “I don't think any of us can predict right now when that will happen.”
Chief executive of privacy and digital protection Mark Hurley also expected consolidation at the top, predicting the industry will evolve to include 30-50 “mega-firms” with $500 billion to $1 trillion in assets. But he said these big firms will look less like aggregators and more like Schwab or Fidelity.
“They will own other ancillary business lines,” he said. “But no one knows who the winners are. We think it will be an incumbent aggregator because there are so few mid-sized firms to buy.”
The impact of private equity on consolidation in the RIA space and whether the M&A “music” will continue to play were constant touchstones during discussions at RIA Edge, part of Wealth Management EDGE at The Diplomat Beach Resort in Hollywood Beach, Fla., this week. According to Marshberry Managing Director Kim Kovalsi, 68% of 2023 deals were completed by PE-backed buyers, and of the 108 transactions announced this year, PE buyers accounted for 75%.
Hurley said PE's money mostly comes from sovereign wealth funds, which are getting wise to interest in the space, so he expected the firms to be “brokered” at some point.
But Khalan doesn't believe the field of PE-backed firms and deal scale is too crowded, noting that there are $60 trillion in investable assets in the U.S. (which will double by 2030), with 15,000 independent firms (approximately 10,000 of which had less than $100 million in assets).
“There are many options to choose from to ensure that the firm with which the smaller RIA connects meets the requirements of clients, is a good home for their employees and has the right level of service,” he said. “I strongly believe that we're probably in the early middle of consolidation, which is not that surprising.”
But as the aggregators consider the deals to grow more and more, Hurley predicted more leadership changes at the top. In the five months since he published a report on the state of the industry, Hurley noted significant turnover in firm management, particularly among aggregators.
“I think it's because, frankly, the people who built these businesses are not the right people to run them,” he said.
For Hurley, the ability to run a business with 10% annual market growth differs from one where firms feel pressure to compete for customers and grow aggressively. The pressure would only increase as the most important firms grow more prominent through consolidation.
The other loudspeakers issued (measured) alarms for continuous PE violation in space. Earlier this week, Rise Growth Partners CEO Joe Duran said PE firms (and the demands they bring) can sometimes make large, PE-backed RIAs look more like wires.
During a morning conversation like hot wings early Wednesday, industry insider Michael Kitces said PE funding can make a firm more successful. However, the “worst-case scenario” involved companies cutting customer support “to the bone” to increase profitability at the expense of customer relationships.
“By the time someone notices how far down the company is going, they will have sold it for a good amount and it will be someone else's problem,” he said. From the outside, it's really hard to tell which one it is.
It is even more challenging for the founder of a firm, mainly because a PE firm may have done up to 100 transactions (or more), while it is likely that a firm founder is having this conversation for the first time. So it becomes much harder to know what to look for (and watch out for), Kitces said.
“My real challenge to it is that our industry is so big. We're not a thing where if you put money in, you can create the next multi-billion dollar unicorn company because 50 million people approve of it,” he said. “I'm very concerned that PE is trying to squeeze more out of industry companies than they can. indeed.”