For an owner of a Registered Investment Advisor (RIA) business, selling the practice can be one of the most significant financial decisions of a career. In selling an RIA business, the fundamental M&A concepts still apply (e.g. valuation, purchase price, representations and warranties, indemnification, employees and closing conditions), but an RIA transaction has an additional layer of regulatory and client-transition considerations that can materially affect both the structure of the deal and the ultimate proceeds received by the seller.
The Purchased Assets
For an RIA, the purchased assets are less straightforward than in a traditional business. The real value is often the firm’s client relationships, recurring advisory revenue, assets under management, investment professionals, referral relationships and reputation.
Accordingly, buyers will spend significant time analyzing the quality and reliability of the revenue stream. They may look at client concentration, recurring versus non-recurring revenue, fee rates, client tenure, AUM by client, organic growth and the extent to which relationships are tied personally to the selling advisor.
That last point can be particularly important for smaller practices. A business where clients are loyal primarily to the individual owner can present more transition risk than a similarly sized practice with a deeper team and institutionalized client relationships.
The Client Consent Issue
Investment advisory agreements generally contain restrictions on assignment, and a transaction that constitutes an assignment may require client consent. The precise requirements depend on the advisory agreement, transaction structure and applicable federal and state law. Since the value of an RIA business is inherently tied to the clients, obtaining these consents is paramount in any RIA deal.
The seller’s ability to retain clients through the transaction can directly affect value. Purchase agreements frequently address minimum client-consent or retention thresholds; AUM or revenue-based purchase-price adjustments; and earnouts or other contingent consideration.
Client consent can be addressed in several ways. A transaction might be structured so that the seller obtains the required consents between signing and closing. Alternatively, the parties may close the transaction while holding some or all of the purchase price in escrow until the required consents are obtained. For example, a purchase agreement might provide for the transaction to close on a particular date, with the buyer funding the purchase price into an escrow account. Once the agreed client-consent or retention threshold is satisfied, the funds are released to the seller.
The result is that the headline purchase price isn’t necessarily the same thing as the amount the seller receives at closing, or ultimately receives from the transaction. The purchase agreement should be reviewed carefully to ensure a seller fully understands the consideration it will receive and the consideration that is ultimately at risk.
Rollover Equity Is Often Part of the Deal
RIA transactions typically feature a rollover component, particularly when the buyer is a larger RIA platform or a private-equity-backed consolidator. In these instances, a portion of the sale proceeds comes in the form of equity in the acquiring platform or combined business.
A rollover can be attractive to a seller because if the acquiring platform continues to grow and ultimately has a successful liquidity event, the seller’s equity can appreciate substantially. But rollover equity should not simply be viewed as “extra upside.” It reduces the cash at closing and is a new investment that carries risk, same as any other investment.
Critically, in any rollover, the seller should understand the capitalization of the acquiring company, the rights associated with the rollover securities, dilution, future capital requirements, preferred equity or liquidation preferences, governance rights, transfer restrictions and the anticipated path to liquidity.
In other words, a dollar of rollover equity is not necessarily equivalent to a dollar of cash at closing and any rollover should be reviewed carefully.
Don’t Overlook the IARs
The other critical component is the people.
If the owner is also the primary investment adviser representative (IAR), the buyer is not simply purchasing an enterprise, it is potentially purchasing a business that is heavily dependent on the seller’s continued involvement.
A buyer may therefore require the selling advisor to remain for a transition period, enter into an employment or consulting agreement, or participate in client introductions following closing.
This also creates an important distinction between purchase price and compensation. A portion of the economics may be structured as consideration for the business, while another portion may be tied to continued employment, consulting services or post-closing performance.
For sellers, that distinction matters from both a negotiating and tax perspective.
The Deal Structure Matters
There is no single “RIA deal structure.”
Depending on the circumstances, the transaction may be structured as an asset purchase, equity purchase, merger or other transaction. The parties may use a combination of cash at closing, escrow, contingent consideration, rollover equity and post-closing employment or consulting arrangements.
The right structure depends on the buyer, the seller’s objectives, the regulatory considerations, the client-consent requirements and the economics of the particular business.
For an owner, the most important question is therefore not simply what is the purchase price, rather the questions should be: what am I actually receiving, when do I receive it, and what post-closing obligations must I fulfill in order to receive it.
The Takeaway
Selling an RIA is an M&A transaction, but it is an M&A transaction with an important difference: the value being sold is inseparable from the client relationships and the regulatory framework governing those relationships.
For that reason, an RIA owner should think about the transaction well before signing a letter of intent. And sellers should look beyond the headline valuation. The real economics of an RIA transaction may depend on client retention, contingent consideration, rollover equity and the seller’s continued involvement after closing.
For an RIA owner, the best time to identify those issues is before the buyer does.
Contact
Considering the sale of your RIA? Contact Alex Jones (AEJ@kjk.com), Chair of KJK’s Corporate & Securities practice group.