On the second afternoon of the 2024 Money Management Institute (MMI) Annual Conference, Larry Roth, Managing Partner of RLR Strategic Partners and CEO of WSR, joined Aaron Roome, Managing Director, Head of Market Structure and Wealth, Financial Institutions Investment Banking, Wells Fargo, to discuss “The Private Equity Playbook in Wealth and Asset Management.”
The ‘War Chest’
Roth began the conversation by pointing out that private equity (PE) firms in total have a “war chest” of approximately $2.6 to $3 trillion in capital, which is more capital than the firms can easily deploy, though they, of course, must deploy capital to earn income.
The “playbook,” according to Roth, begins with a PE firm deciding on an industry, then identifying targets through research. From there, the PE firm selects one or two firms to invest in. In the past, investments looked to both organic and inorganic growth, but today lean towards inorganic. Buyers will acquire many companies and determine how to integrate them, grow the top line, manage costs, expand margins, then sell.
While the “playbook” conventional wisdom is that PE firms will turn an investment around from entry to exit in three to five years, Roth has seen deals in which that timeframe was shortened to only two years.
Addressing why PE firms like to invest in the wealth management space, Roome said the fragmentation of the industry with many small practices makes it attractive to capital sources, which can build scale, modernize and institutionalize the businesses. He pointed to secular trends as factors, such as the Great Wealth Transfer. “We’ve also got an aging advisor force, with 100,000 advisors set to retire in the next five to 10 years, and all the capital that’s needed to buy those advisors out and replace them with technology or younger advisors.”
Roome added that financially, wealth management firms are attractive because they generate predominantly fee-based recurring revenue and substantial cash flow, which mean that returns can be enhanced. Finally, he noted that there’s many consolidation opportunities.
Indigestion
Roth said that many large players are becoming very aggressive with acquisitions, now making as many as two to three acquisitions each quarter, and sometimes the firms “get indigestion” as “many firms hoovered up all they could and want to know, ‘What now?’” He emphasized that some of these firms operate more like a holding company while sorting out their plans.
Roome said that some buyers will standardize their acquisitions, while others choose to focus on building communities.
Roome said that some buyers will standardize their acquisitions, while others choose to keep the acquired brands and entities, and focus on building communities in order to attract advisors who don’t want to feel like a “small fish in a big pond.” The latter type of firm will provide needed tools along with a community feel.
Addressing whether the “feeding frenzy” is over, Roome lightheartedly replied, “I hope it’s not over.” He presented a chart in which LPL Financial’s 2005 sale of a controlling stake to Hellman & Friedman and Texas Pacific Group was the first of its type in the industry. The chart continued with one to two deals per year through 2016. In 2017, industry M&A reached an “inflection point” as a “wall of deals” began. Roome concluded that there is “no end in sight” because of the amount of capital still in play and the number of consolidation opportunities remaining.
Advantage: Seller
Roth noted that in the current environment, sellers can be selective in choosing buyers, and have leverage to ask for special terms from PE firms, including being the exclusive wealth management firm in a PE firm’s portfolio. PE firms may now agree to minority stakes or investments without a path to an IPO.
Roth noted that in the current environment, sellers have leverage to ask for special terms from PE firms.
On the topic of minority stakes investments, Roth said that investors often realize that the investee is not ready to take to market and look for ways to not allow the assets to go stale. One method to do this is to find a second PE firm to buy a 10% to 20% stake in order to give validity to a valuation that lets them move the investment into a different fund within their own family.
Roome added that industry firms often do not need practice management solutions and consulting, but many need business management tools and consulting, in areas such as best practices and organic growth. PE firms that have learned good practices from investees in other industries may find low-hanging fruit in bringing those ideas to bear in wealth management investees.
Julius Buchanan, Editor in Chief at Wealth Solutions Report, can be reached at jbuchanan@wealthsolutionsreport.com.
