By Steven Levitt and Annie Tronoski, Park Sutton Advisors, LLC
Access to capital is critical to business owners actively seeking to grow their firms for a multitude of reasons. Increasing competitive advantage requires a commitment to providing forward resources, whether they be talent, technology or other sources of sustainable value. Whether building or buying these capabilities, capital is required and the quality of that capital source has future impact. For those pursuing acquisitions, for example, an acquirer’s access to high quality, at-the-ready funding will be one of the criteria on which they are evaluated by an acquisition target. For those RIAs who are eager to be part of the expected future consolidation in the wealth industry, their candidacy as one of those counted as a “legitimate buyer” is directly impacted by the profile, including both quality and flexibility, of their capital sources.
In the past, independent Registered Investment Advisers (“RIAs”), especially those with less than $3 billion in assets under management, had limited options for capital and were compelled to borrow from banks, often feeling the impact of arduous rules and regulations. Today, a credible array of equity partners have emerged as willing and eager sources of permanent capital and private equity to the wealth management industry. Below, we will delve into some nuances between private equity and permanent capital partners, and those factors that advisors need to be mindful of when considering their options.
Private Equity investors agree to invest in a firm and typically take control stakes in their investments. There are approximately 20 to 30 private equity firms in the U.S. of all shapes and sizes with a dedicated investing strategy in financial services companies. These groups include TA Associates, Lee Equity Partners, Hellman & Friedman, Lovell Minnick, and Lightyear Capital, among others. They generally seek to put equity capital to work in the range of $25 to 300 million per investment. RIAs seeking lesser amounts of equity capital (e.g. $5 million) will have fewer options.
Private Equity Key Factors
While each private equity transaction is unique, most deals contain the following aspects:
- Sophisticated structures proposed by parties who have completed dozens of transactions.
- Occasionally investors will invest along the same lines as any other investor at the RIA (i.e. common equity).
- Others require preference amounts (i.e. they receive a certain % return on their capital invested before profits are distributed to other shareholders.
- There can be a liquidation preference that they receive on their invested capital upon the sale of the company.
- Governance provisions are highly influenced by structure of the investment.
- They are seeking investment returns of greater than 20% by the end of their investment hold and often encourage the use of additional leverage by their portfolio companies to enhance investment returns. This will involve their generating 3x initial invested capital over their investment timeframe.
- Time horizon of the typical private equity investment is four to seven years.
- Aggressive investment return expectations combined with a limited hold period generally require an ambitious acquisition program at the invested company.
- Some private equity groups offer more post- transaction strategic assistance and value-add to targets than others.
- Some will consider making smaller initial investments if they see a path toward placing the minimum target (e.g. the $25 million) to work over multiple investments, as the target accesses further capital in order to finance acquisitions.
Recently, there have been a flurry of private equity transactions in the RIA arena. A number of national RIAs, such as Mercer Advisors, Hightower Advisors, Wealth Enhancement Group, and CAPTRUST have been quite successful identifying supportive private equity partners.
The distinguishing factor the Permanent Capital investor offers is equity capital with very long hold periods – i.e. eight years and beyond. Park Sutton is aware of up to 20 groups that fall under this category who actively invest in the wealth management space. National permanent capital investors included in this group are Kudu Investment Management, Temperance Partners, Emigrant Partners, and Wealth Partners Capital Group. Often the source of capital here is ultra-high net worth individuals, family offices, or insurance companies – all of whom take a very long-term, almost perpetual view to investing.
Sizable RIAs who have taken permanent capital include: Sequoia Financial, Savant Capital, RegentAtlantic, Bingham Osborn, and EP Wealth Advisors. Focus Financial and CI Financial also indicate to the marketplace they offer permanent capital.
Permanent Capital Key Factors
Some common characteristics of a permanent capital transaction:
- Similar to any other private equity deal, investments are usually sophisticated structures with parties who have completed transactions across multiple industries with governance provisions being highly influenced by structuring.
- Time horizon of the typical permanent capital investment is beyond eight years and more typically between ten and fifteen years and beyond.
- Expected investment returns might be slightly lower than a typical private equity investor, but because the capital is patient, investment performance may be delivered through yield (i.e. ongoing cash flow from the investment) with less emphasis on exit value.
- Some of these groups try to differentiate themselves by offering strategic benefit to the RIA, generally in the form of help with inorganic growth initiatives; not just additional capital but also possible assistance to identify targets for acquisition.
Often, Park Sutton finds private equity investors offering higher multiples than permanent capital groups, but this is not always the case. One reason is due to the amount of capital that private equity firms require to put to work in a single investment. Many private equity firms are chasing a relatively small pool of larger RIAs, namely those with $3 to $5 billion of AUM and greater. In these cases, simple supply and demand demographics influence pricing.
As the wealth management industry continues through significant consolidation over the near and longer term, those advisory firms seeking to survive will benefit from understanding all of their available sources of capital. A wealth management business should be attractive to many investors as it offers a highly steady, recurring cash flow stream in an environment where capturing yield is very difficult. Further, any RIA seeking to participate in the oncoming consolidation in the industry can offer additional accretion to an investment through gaining consolidation efficiencies and diversification through future acquisitions.
Park Sutton Advisors can be a resource to any looking to explore these sources of institutional capital. A growing portion of our transaction deal flow every year is dedicated to these types of capital raises and will likely hit a high of almost 30% of our advised transactions in 2020. Being current in the market with these investors is critical to successfully navigating and negotiating the often complicated structures and terms suggested in this space. We remain committed to serving our clients with the most current and relevant advice.
Steven Levitt and Annie Tronoski lead Park Sutton Advisors, LLC, a boutique investment bank specializing in mergers and acquisitions within wealth management and the broader financial services industries.