I really enjoyed this conversation with Elizabeth Nesvold, Managing Director and Head of Asset & Wealth Management Investment Banking at Raymond James, about the raging party that is consolidation / Mergers & Acquisitions (M&A) across our industry.
Liz provided some astute insight into this booming landscape, as well as to how financial advisors are turning to M&A as a way to bring the resources they need to continue to grow their business.
- How & why M&A has accelerated this year after an initial slowdown
- How advisors are leveraging M&A to move beyond the “Valley of Death”
- Behind-the-scenes intelligence on valuation pricing and how it works
- What qualities command a premium valuation for an advisory firm, and what can drive down a valuation
- Areas within our industry in which Liz sees potential value at lower multiples
Liz Nesvold, Derek Bruton
Derek Bruton 00:00
Friends and colleagues, welcome to can you hold my attention? My goal with this podcast is quite simply to drill down into topics, which I understand from hearing directly from different constituents in this industry are the most important to them. . .
Liz Nesvold 03:48
Thank you, Derek, that is quite a welcome. Ready to be here.
Derek Bruton 03:53
I'm betting your backhand is better than Serena's knowledge of Ra multiple.
Liz Nesvold 04:00
I'm not sure she's a pretty tough smart cookie.
Derek Bruton 04:05
Well, let's just jump right in that. You know, I pointed out that we saw indications in March and April this year that this pandemic it's stunted m&a activity. But it seems like every day, every single day I reading and any one of the publications about a new acquisition that was announced, and that activity is strongest ever now, what are your overall thoughts on the space right now?
Liz Nesvold 04:31
Oh, my goodness, well, you hit the nail on the head, it really did come roaring back from the second quarter. And it's been quite a busy industry for let's say, at least the last four or five years where in many of those years we've hit record breaking numbers in terms of the number of firms that have transacted. But a bit of what we saw in the third quarter, I'd love to say let's analyze that and that's the new pace going forward. But a fair bit of that was pent up demand from a very slow second quarter. So the year, I'm not sure that we'll break any records this year, given the second, the second quarter slowed down, but there are a lot more eyeballs on Myspace than ever before, it's probably the best way to say it. And there are a number of new entrants coming into the space, there's a lot more capital. And there is certainly a lot of continuity planning need. So I don't expect the pace to abate dramatically at any mere point soon.
Derek Bruton 05:41
I don't I agree with you. And you know, I was reading a report by Ashkelon partners who a lot of people know this base is doing a lot of work. And they said the average deal size in the third quarter was about was nearly 2 billion in assets under management. So is this party, are you seeing this party really just reserved for the larger firms out there?
Liz Nesvold 06:02
And no, not at all. Not at all those that data point that will be skewed by some larger transactions that occur. So for instance, you you make reference to one in your opening and velocidad inverno unfolds, that was a good size transaction. So for every $5 billion firm, that transacts, you can have some firms that are a billion to 2 billion, it's still an even lower and still end up with a $2 billion average. But I think we're seeing firms across the spectrum transact there in terms of need, there are probably more firms below a billion that need to think about this. But certainly, we're seeing some larger firms either seek capital, maybe recap the business, because they've had an investor who's been in there a little long in the tooth. Or we're seeing some first time firms transact that had grown organically and gotten to a point where they want to institutionalize the business and take it to the next level. And that may include a partner.
Derek Bruton 07:14
Well, let's hit on that, because that's a good point. I was talking to an advisor the other day who's contemplating this, and he goes, Derek, you can't run a marathon on an empty stomach. And, you know, he was referring to the fact that he doesn't have the resources, he doesn't have the people and the talent really, to scale up his business right now. And he's at this inflection point where he's saying, you know, do I do I sell? Or do I make investments and maybe take a hit to my margins, and grow my business? So at what point in the evolution of a business is an owner? Just say it, you know, it's time to sell my business?
Liz Nesvold 07:51
Right? That's a good question. And it it comes down to the ownership makeup, and really, where are they in their business evolution. There are many owners and in our as, as you rightly pointed out, that have had wonderful practices, small businesses, and to take your practice into what we call the valley of death, I have to give a nod to David Patrick who taught me that term, and bring it back out reinvesting heavily forgoing compensation distributions as owners to get to that next level of institutionalization is scary. That is not it's not for everybody. And it's certainly not for somebody who might be a sole owner, or two owners who are in their early 60s, who have not started the continuity planning phase of pushing equity down or even bringing in their next lieutenants to succeed them. So sooner is better than later. In terms of thinking, what I do find often is that in an industry filled with practitioners, who work so earnestly to help people plan for family business events, family life events, financial planning, estate planning, they don't do enough of their own planning in the time horizon that they might want to, and sometimes it's some event that nobody ever plans for. We're in a pandemic. Now. That's certainly one of them. But sometimes a health scare prompts people to sit up and take notice.
Derek Bruton 09:36
Yeah, health scare, you know, 2008 2009 financial crisis. These things are, you know, service Wake Up Calls, but you mentioned hard work, you know, I talked to a lot of advisors, they're working hard with their clients and working hard to take care of their their staff. But But oftentimes, you don't see advisors working hard on their business and what we're talking about here is working hard to, to grow your business to make decisions that put yourself in a position to take it beyond a billion or 2 billion in assets. And, you know, it takes some work. Speaking of work, though, let's step out a second, you know, you you've got to be busier than you've ever been in your life right now, with, with everything going on. But are you having fun?
Liz Nesvold 10:26
My team and my clients in this crazy pandemic have given me an opportunity to really enjoy what I do. It's a strange time for sure. But we've got the most amazing clients and team to service them. So I am, I love what I do. I thank you for telling the world that it's three decades now. But you know, I'm so passionate about this environment, and in particular, this space where it's all intangible assets and those intangible assets, people serve their clients. So thoughtfully and thoroughly. It's a great, great space. So I love it.
Derek Bruton 11:10
Oh, good, good. Well, that's, that's most important. I said, nearly three decades, it could be 20 years in the business, so you can round down there
Liz Nesvold 11:17
Derek Bruton 11:22
So let's talk about valuations. Because I know it's a hot topic, everybody, you know, if you're a buyer, you want to learn what you can sell for if you're a seller, you want to know what you can buy people for at this point. But, you know, valuations, particularly with IRAs have they gotten to the point where it just doesn't make true financial sense for an acquire?
Liz Nesvold 11:43
Oh, my goodness, we have definitely heard from some acquires that they're stepping out of the market, because pricing seems a little lofty. But I would really break that down. And hopefully, for your listeners, give them a little intelligence that most people don't appreciate until they get into the nuances of the deal. It is not a price tag meaning and multiple of EBITDA, that really tells us if this is a full valuation or not, it's a function of the structure. So often, when clients come in, you know, they have a number in their head. And we talk about that number. And everybody always says, you know, 10 times, nine times, even 11 times EBITDA, whatever that number is, they pick a number as a multiple of EBIT, da, and then I'll give them an example and say, to two firms, the first one is, the buyer says, I'm going to give you 10 times. The second one buyer says different buyer says the same thing. The first firm gets nine times they're either pay to close and one time guaranteed in 12 months, the second firm gets 10 times paid five times they're even close and one times over each of the next five years, assuming they grow at 5%. Are these two deals exactly the same? In terms of the implied multiple? And the answer is no. If you look at it on a time basis, so financial planners spend a lot of time projecting and discounting, we do the same. If you look at these two examples, the first deal is pretty close to a 10 times multiple. The second one is maybe 8.7 or 8.8 times EBITDA, if you look at a discounting at maybe a 10% growth rate. And then you layer in something else. So let's say the buyer says if you don't grow at 5%, I'm going to give you a haircut on what is called an earn out. And let's say they give you 50 cents on the dollar if you grow at half the growth rate. Now, what we're really talking about is a multiple of 6.9 times EBIT versus the other one who got nearly 10 times EBIT, da, those are radically different valuations. And it all comes into play through structure.
Derek Bruton 14:21
Interesting, okay. Interesting. So, so if
Liz Nesvold 14:25
I so do you want I'm so sorry to interrupt you, do you want me to layer in a little bit more on you know, any aspect of that valuation because i, this thing popped in my head. So I sort of went on a tangent with
Derek Bruton 14:42
it, because what I'd like to know Yeah, I would like to know that and maybe think about it in terms of what what adds premium to these valuations. And then where where do you see valuation suffer a bit depending on the structure or the size of a firm.
Liz Nesvold 14:59
Good. I like ask me that.
Derek Bruton 15:01
Okay, go. What are those? What are those those qualities that, you know, command a premium? And likewise, you know, what are the qualities that take take down evaluation?
Liz Nesvold 15:15
That's a good question. The firms that I see that generate the highest market premium tend to be firms that have both the qualitative and the quantitative factors in mind, as they're presenting themselves to the market. So when I say qualitative, we think about the depth of the team, the skill sets that they bring to bear, maybe brand recognition, a local market, a happy growing clientele. When I think about the quantitative side of the equation, it is logical things like have their assets been growing at a fast pace. That's not a perfect correlation to value, but it's certainly a helpful indicator, are they profitable? Are they nicely profitable? So firms that if I had to boil it down into two factors, one qualitative and one quantitative, the people, the human capital matters the most in terms of engagement with a third party. And not everybody clicks the same way with another party. So it's that click factor, and it's hard to gauge upfront. That's why it's really important to find cultural fits between buyers and sellers. And then on the quantitative side, it's organic growth. That is the single most influential factor when you think about valuation, because a lot of these firms sort of hit terminal velocity, they get to a certain point, we use a billion all the time, you get to a billion, and then you sort of grow in dribs and drabs. And more often it's market helps you clients using their assets hurt you, and maybe you're stuck at a billion. But organic growth, the ability to develop business independently, is a very, very influential factor. In terms of the negatives, you know, there pretty much isn't any negative that somebody can have that wouldn't still generate some interest by the right type of buyer. So somebody could be unprofitable, that's could be solved through a partnership, they could be losing clientele on the back door, you got a risk mitigate structure still could be solved, you could have a CEO succession dilemma could be solved. You know, if somebody's going to jail, maybe that's the one we can't solve. But that being said, sometimes firms are too profitable, and they just simply haven't reinvested in the business. That's actually a negative to buyers. People always talk about my margin is this my margin is that, but this is a pretty sophisticated acquiring community, both within the industry, and then with external capital sources coming to market and parsing through a business to see that somebody has a 50% EBITDA margin and they have a staff that is, you know, barely able to breathe, because they're so under resourced. You know, that will definitely be a negative on valuation.
Derek Bruton 18:31
Right. Make sense? It's, you know, I've so many times in my career, I've talked to advisors who talk about investments in their business or talk about money they're spending, it's either categorized as an expense to them, or as an investment to them, in many cases, and those that characterize it as investment have really focused on the growth of their business and, you know, are willing to look at some margin devaluation because they're looking at the growth of their business, and they're investing in it. And so many people just don't think that way. But, you know, going back to your point about positives, and I look at distribution, you know, firms that have some sort of way to grow through distribution, I've seen people with newsletters or Radio TV shows or, or perhaps they are doing, they have a niche in their business that they really want to amplify and go after. And those firms seem to, you know, when you start hearing granted, you have inside knowledge, but when you start hearing about valuations that get above that 12 x even multiple, it seems like they have that quality in their business, go to your organic growth point.
Derek Bruton 19:50
Were there I mean, if you look across the industry today, where are there and I'm not just holding you to the RA space but also in other parts of the The industry FinTech, or wealth management, the asset management side, where do you see some potential value out there? Perhaps some some areas of the industry that just have been overlooked, that there's potential and buyers can get in perhaps at lower multiples?
Liz Nesvold 20:17
Sure. That's, well, that's a good question. Let me think on that for a second. And I guess I would say, in terms of firms that may have been more on the money management side, so they could have been managing money for individuals and institutions. Number of those firms who really aren't known as, you know, a product specialist, but really high quality money manager have begun to pivot into wealth. So they might be the the old name for this business might have been investment council might be how they describe themselves. But there are a number of these firms that are starting to push a little bit more into wealth and adding some capabilities adding planners. And this is an area where somebody might have said, Well, that's a large cap core manager, I'm not interested. But they actually do a fantastic job on an after tax basis driving for tax efficiency for their clientele, you know, bringing in a blend of open architecture. But they again fell in that category where it looks more like a product manager than a service provider in the wealth space. This is a really interesting opportunity to look at firms that are making the pivot. There are a number of firms, I would say in the consulting space that might have been more traditional pension fund consultants that pivoted their model into OCI Oh, outsourced Chief Investment Officer model, and then also into consultancy for family offices. That's a very, I would say up and coming in attractive space. Let me think where else you could pick my brain. So everybody runs to it before I get there. My impact impact is starting to take hold. But there are actually some really high quality firms that are under the radar screen, that have these wonderful capabilities that can be brought to bear for some larger platforms that may have embedded distribution in their own high net worth clientele.
Derek Bruton 22:36
Right? Well, you've got such, you know, with with the 200 plus deals that you've done in your career, and largely most of these in, you know, private deals that were where folks like myself and the average viewer reader can't really understand what was what was paid for these businesses, you've got such a great sample size to go from. And going back to what you're saying earlier, when you've got clients either on the sell side or by side that are are looking to do a transaction, you can pull out so many examples of who's done it right, who hasn't done it right. And, you know, who's who sort of benefited from the outcomes? And I think that's great. And, you know, testament to everything you've accomplished over there.
Liz Nesvold 23:23
Thank you. Appreciate.
Derek Bruton 23:25
So let's move on. I want to I want to talk about maybe firms were not the the, you know, average listener doesn't think about, you know, Amazon was a bookseller that morphed into this, you know, the undisputed leader of commerce. Netflix used to send me DVDs in the mail, and they've totally revelation revolutionize the way we see video content today. Who do you Who would you say are potential disruptors in our industry? Maybe companies that aren't in retail Wealth Management today, but but have the potential to get there?
Liz Nesvold 24:03
Wow. That's a tough one. Oh, my goodness. Hoo, hoo hoo. You know what, there are a lot of tech giants that have VC investment vehicles. And they're making and, and again, I pride myself on confidentiality. But some of these giants with their CVC corporate venture capital funds, have actually made investments in firms where they're trying to understand the nuances of the business. And my guess is some of the big names that you know, we'll make a foray into this space. We don't know exactly how and through what medium but you know, and I'm sorry not to take You name but anytime people start an investing vehicle around, you know, wealth wealth pack, FinTech. And they study the space, often we see somebody enter the space. And so I'll give you an example. We represented a firm called advisor, ad VI, ZR wonderful, cool kid on the block, financial planning tool. And advisor took capital, we did two rounds. First one was with Franklin, and SCI, and the second one was with Western Southern. And interestingly, for Franklin, who had been looking at their own business model, and this is a very well run organization that may be still dubbed an incumbent firm, one of the legacy names that you know, in money management, but they brilliantly started to make some investments in firms to understand the shifting marketplace. They acquired from us, a firm called advisor engine, which I think you know, that CEO rich can CRO, you know, for an ability to start to pivot the model, leverage relationships that they have and think about different forms of distribution. You know, I, I'm going to wager a bet that this is going to be a homerun for them. But again, so much of their foray in was let's let's study the market, let's make some investments. And with an advisor that ultimately was acquired by Orion, but it was an early chance for them to enter as an enterprise user, figure out the model, understand where the leverage points could be, and get a toehold into some well, tech solutions that could be beneficial to their broader communities. Right,
Derek Bruton 27:03
right. Yeah, it's, you know, it's interesting, you mentioned the private equity firms. But there's, you know, a lot of firms out there like Amazon, for example, they've got the capital, they've got the brand recognition, the marketing muscle, and they have one thing that my daughter always reminds me of, they've got data. And data is king, as we know, in this business, what they're missing is industry experience, a track record relationships, and these are all things that they can acquire themselves right into. And, and, you know, I think we're going to see somebody like that, over the next three to five years that gets in in a big way, where, you know, you and I are just sitting there scratching your head saying, really them why them? And, and so and I think that's healthy for the business, I think it's healthy for the American investor. We've got time for one last question. And, and I and I'll, I'll just quickly ask you, when you've looked at as you've done a lot of transactions, you've seen the transition periods that people go through after the transition, or after the transaction is completed. And, you know, many, many sellers out there are fearful of selling because of exactly that the transition, what's involved, what's it going to mean to my clients, what it's gonna mean to my staff? So in your experience, Liz, is it you know, as firms go through transitions, is it more of a kind of let's, let's rip the band aid off and just move to the next level? Or is patience went out here and is better for the long game?
Liz Nesvold 28:41
That's a good question. I, you know, it probably is some happy medium between the two. But if it is a fully integrated deal, it is hard to dribble that out. And variably, you end up with some resistance and people saying, Oh, can I still continue to use this planning software for a little bit more, or my name brand is really important. We need to keep that on the door, let's instead of six months, let's do it for 12 or 18, or 24. It's one of those things where, I mean, the good news about today's market is there's so many different types of opportunities for transacting from minority to majority to wholesale fully integrated transaction. But if it is a fully integrated transaction, it is hard to do it slower. It's actually harder on people. It's harder on the clientele. And it would seem illogical, almost but I remember one of my early clients in the space. Wonderful old name that everybody will remember us trust. And that CEO and vice chairman Jeff Moore, Marybeth Ray said consistently, at closing, the brand changes at closing will begin to morph over to this system at closing. And it was a tough thing to have that conversation. But at the end of the day, they built a much more seamless national brand. And it enabled people to take advantage of the hub and spoke system. So it was much easier to build a national integrated brand in that model than to give people their own time horizon to come to the realization that an integrated solution as a better solution.
Derek Bruton 30:39
Yeah, and I can imagine that's tough. That's great advice, tough for some people to follow, especially if they've, you know, built their baby up in over the last 30 years and now to sell it but but I completely understand what you mean. Well, this thank you so much for your time this morning for your valuable time this morning. I wish you the best of luck this year. I think you will not suffer from lack of opportunity. But you will be successful and like I said earlier, making a lot of people happy. So thank you for your time and best of luck to you and enjoy the holidays. Thanks to you as well. Alright everyone, thank you very much for listening and we'll see you next time.
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