More Lessons From Record M&A Action Backed by Private Equity

It is well established at this point that 2021 was a record-breaking year for adviser industry merger and acquisition (M&A) activity.

According to researchers and M&A consultants, the possibility of tax code changes helped industry deals set a quarterly record in the third quarter of 2021, which saw 78 deals announced. The previous record was 76 deals, set in the first quarter of 2021. During the year, large strategic acquirers, many of which are backed by private equity firms, maintained their status as the most active dealmakers in the wealth management and advisory industry.

Beyond the headline numbers, however, there are some emerging trends playing out that are likely to have a big influence on M&A transactions in 2022 and beyond. Echelon Partners explored these themes in its recently released 2021 M&A summary report.

According to Echelon, one of the largest contributing factors to higher M&A activity has been an influx of capital from financial sponsors and private equity (PE) investors looking to establish a presence in the wealth management ecosystem. These buyers see an opportunity to “consolidate a somewhat fragmented space,” the report explains.

“Comparing buyer composition to five years prior, financial acquirers have become much more active in deal volumes, which were previously dominated by strategics,” the report says. “In 2021, there were 209 deals that were either direct investments from financial sponsors or deals involving acquirers with backing from private equity firms. This represented 69.7% of 2021’s total deal volume.”

Going forward, it appears interest from financial buyers will remain high and potentially continue to strengthen, according to Echelon’s analysis. By way of background, a financial buyer is “a type of buyer in an acquisition that is primarily interested in the return that can be achieved from the purchase,” according to Investopedia. Such a buyer, broadly speaking, is interested in what cash flow the investment will generate and what kind of exit strategies it will offer in the future. As defined on Investopedia, a financial buyer is different from a strategic buyer, which evaluates an acquisition primarily in terms of how it fits with the acquiring company’s strategic goals.

“With more outside capital looking to get involved, sale processes will likely become even more competitive and supportive of current valuations,” Echelon’s report suggests. “Buyers that are able to articulate a compelling value proposition to sellers while executing on a carefully developed M&A strategy will likely have the greatest success. Buyers that are also able to cultivate direct relationships with firms looking to sell will have an inside track to consummating acquisitions.”

Echelon’s analysis shows that PE interest in the U.S. wealth management industry is so high that some American private equity firms have in fact turned their attention to wealth managers in the U.K. in search of a less competitive M&A environment. The report cites Lightyear Capital’s investment in Wren Sterling Financial Planning as an example of this trend, as well as TA Associates’ and Synova Capital’s investment in Fairstone Financial Management, among others.

In Echelon’s view, private equity firms impact wealth management deal volume in two primary ways. The first impact comes through direct investments in large, established wealth managers that PE firms likely plan to use as a platform for future M&A activity. The second is via sponsored transactions, where one of the private equity firm’s portfolio companies acquires a firm with the financial support and dealmaking advice of the private equity backer.

The Echelon report suggests there are some important caveats to keep in mind regarding the role of private equity backers—including both their opportunities and challenges.

“While financial buyers do bring some fundamental capabilities to the table, they often lack those offered by strategic acquirers that are actually in the business of wealth management,” the report suggests. “Sellers that are looking for or require significant operational support may favor the platforms strategic buyers are able to provide. Buyers that are proficient operationally and are seeking growth capital may favor the independence and flexibility financial buyers present.”

Another important consideration is the fact that private equity firms may come to the table with structured investment horizons.

“Most private equity firms have defined time horizons with respect to entering into and exiting investments,” Echelon reports. “This can relate to dynamics of the specific fund an investment is made from or the overarching strategy employed by the financial firm. Many sellers would prefer not to have their business managed or influenced by a party that is most concerned with short- to medium-term growth. This element of a partnership with a financial sponsor would likely be most exacerbated during a time of sustained contraction of the company or macro conditions.”

Given recent strength in the economy and financial markets, though, wealth managers have thus far avoided much of the hazard presented by this dynamic.

According to Echelon, an increasing prevalence of minority transactions is yet another effect of private equity’s increased role in wealth management M&A.

“Traditionally, most M&A activity in the industry involved succession-related deals with other wealth managers or strategic acquirers,” the report notes. “Today, many wealth managers that have adopted aggressive inorganic growth strategies in an attempt to gain the benefits of additional scale will sell a minority interest in their business, often to a private equity investor or a long-term capital provider.”

Echelon’s report says this strategy helps provide the capital and dealmaking experience for a successful M&A campaign, while allowing the current owners and management team to retain control—with a significant interest in the firm that will allow them to realize the benefits of the firm’s ongoing long-term growth.

The report concludes that the “key theme” of 2021 was large, pure-play wealth managers growing their presence in the retirement planning space, which is a trend that emerged in 2020, accelerated last year and is expected to continue being a major driving force for M&A activity in 2022.

“There are natural cross-selling synergies across private client wealth management and retirement plan advice, and we believe it will continue to make strategic sense for this transaction type to occur,” the report says.