Trends in Financial Services: The Evolving M&A Landscape

When it comes to trends in financial services, the evolving M&A landscape is a major part of the discussion, as it has become more complex for both buyers and sellers. But with change comes opportunity for those looking to complete a successful transaction.

Let’s take a look at some of the M&A trends that have emerged over the past year and how they could affect the purchase or sale of your business.

1

Valuations Remain Consistent

Regardless of which side of the transaction you’re on, it’s important to understand the value of the business. The first step in the valuation process is to look under the hood: examine your cash flow and expenses. Do you know what you’re acquiring? How will you pay for the practice without affecting your current revenue stream?

With little to no slowdown of deal flow in the industry, we also didn’t see much of a change in valuation multiples. Practices primarily composed of recurring revenue were sold for ~2.5x–3x, with multiples going even higher depending on the competitive nature of the transaction (according to 2021 SRG data).

That said, it should be noted that the levers behind the multiple are what drive it. In other words, focusing too much on the multiple itself doesn’t tell the true story. You’ll want to look at asset concentration, client demographics, and multigenerational client relationships, for example. All of these factors will affect the value of the practice.

With several legacy practices going up for sale (both within Commonwealth and on the national level), there is also likely to be some nonrecurring revenue included, where the multiple has remained consistent at ~0.8x with an average blend of ~2.15x. So, regardless of where you are in your business life cycle, it’s important to understand the value and drivers of optimization that will benefit you in the long run, no matter which side of the table you’re on.

2

Sellers Want to Exit on Their Own Schedule

Not all sellers want to make an immediate exit upon retirement. For deals within Commonwealth, we have seen sellers remain licensed for an average of two years before officially retiring. Some prefer to tuck into an office for a few years to either take advantage of additional infrastructure support or complete a partial sale while continuing to manage the remainder of their book independently.

Sellers who want the opportunity to exit on their own terms and timeline should begin planning for their retirement at least 10 years in advance. This time can be used to strategize and negotiate a seamless exit, as well as prepare clients for the next generation of advisors who will continue their legacy.

Here, it’s important to note that when a seller stays on, that decision could translate into a significant benefit for both the buyer and the seller: clients are ensured continuity and a trusted partner to work with in the future. As client retention is a key driver of a successful acquisition, this method has resulted in increased client retention and overall satisfaction.

3

Deal Terms Reign Supreme

In a competitive landscape, deal terms often become paramount over anything else.

Role of the buyer. As a potential buyer, you’ll want to ask yourself the following:

• Can you meet the seller’s requests as a buyer?

• Do you have the capital to support the acquisition?

• Is the seller’s client service model similar to your firm’s service model?

• Have you analyzed your book to understand where cash flow sits and what size practice your existing infrastructure can support?

• Do you have a clear acquisition strategy that you can articulate to a seller?

• Remembering that organic growth entails client acquisition, how does that tie into your inorganic growth strategy?

All of these items are key when submitting letters of intent that outline your proposed terms.

If you’re thinking about buying, it’s important to find a funding solution that works for you. Visit the Entrepreneurial Capital page to learn how Commonwealth supports our advisors’ strategic growth goals.

Down payment. Typically, deals have remained consistent with about a 30 percent to 50 percent down payment, with the remainder paid out via promissory note, revenue share, or a mixture of both. That said, buyers involved in a competitive situation, both within Commonwealth and on the national level, have seen an increase in the down payment that hovers closer to 50 percent or more. This increase puts more risk on the buyer since it is cash up front and not included in any potential lookback provision.

Deal adjustments. When it comes to lookbacks (an adjustment made to the final purchase price or promissory note at a defined date), 10 percent has been—and continues to be—the industry benchmark. This figure could be based on assets, revenue, or households, although the most common lookback structure continues to be assets and revenue. Further, it can be structured to include both downside and upside protection.

Role of the seller. Equally as important to the economics of the transaction is to clearly define the seller’s role. Will the seller support the transition effort? If so, in what capacity? How frequently? And if you’re a seller, have you thought about a strategic plan to ensure that you’re not selling your practice at the last minute? Are you preparing your clients for your ultimate exit and positioning them to take advantage of continued support from your successor?

4

Virtual Environments Expand Opportunities

For many, one of the positive trends in financial services that has emerged over the past couple of years is the transition to a virtual or hybrid work environment. Because of this shift, sellers have become more flexible when considering buyers outside of their immediate geographic location. Plus, clients are now more accustomed to meeting virtually, giving sellers the opportunity to look at buyers nationwide. Additionally, more buyers are willing to set up satellite offices to acquire practices or to take over leases that existing sellers may have in place.

It should be said that competitive location is still a major factor in the overall M&A landscape. But being amenable to a virtual working environment on both sides has been a key to success for those buying and selling practices.

One Size Does Not Fit All

There is no one-size-fits-all M&A deal, and qualitative elements tend to trump the economics of the transaction. Still, with increased awareness around M&A—and with one-third of advisors expected to retire in the next decade—it’s important to keep abreast of prevailing trends in financial services and understand both parties’ needs in order to capitalize on the opportunity when the time comes.