The hidden risk that can sink any RIA deal

David Bahnsen, founder and managing director of $2.5bn RIA The Bahnsen Group, on what is being missed in the M&A discussion.

It is no secret that the wealth management world has been besieged by mergers and acquisitions over the last several years, and as a plethora of recent press reports attest, not even the Covid economic slowdown can derail the M&A momentum. Whether it be companies growing through inorganic acquisitions, or ‘roll-up’ type models with private equity backers ‘accumulating cash flows,’ there is no shortage of buyers and sellers looking to transact.

Though the $2.5bn RIA I run has grown almost entirely organically, with just limited reach into M&A, I still understand and appreciate the industry’s focus on dealmaking. Whether it be succession planning, creating better scale, or just generally optimizing financial structures in what is a highly fragmented industry, M&A is a net positive, and I am sure will be for some time. I have no advice to offer the private equity investors or the aggregator corporate entities – my focus is only on fellow peer advisors and their firms. Because I think for all of the really good advice that exists out there, one key piece is consistently being missed.

Yes, a firm merging with another must obsess over cultural compatibility. Yes, the advisors must all be a good fit. Yes, the economics must be structured so to be mutually beneficial. All of that is true, and all of that is known by buyers and sellers, I am sure. Yet it seems to me that for every 100 mentions of ‘advisor compatibility,’ there are, well, zero mentions of client compatibility. And I think this must be the crux of consideration for any advisor growing by acquisition.

Many would take what I just said to mean some version of ‘make sure the transaction adds value to clients.” Fair enough. Yes, adding estate planning talent to a firm devoid of such is a good idea.  Yes, one advisor strong in stocks joining with one strong in bonds may be a good addition. All of that is just fine, but it is not what I mean. The clients will know and vote real quickly as to whether their firm transacts in a way that benefits them or not. But my warning to any advisors transacting in this new environment is this: Beyond making sure the advisor(s) you bring in fit your firm, make sure their clients fit your firm.

I know this seems obvious, but I ask you – when is the last time you read anything about this? I have seen countless discussions in industry M&A circles about client concentration risk, portfolio exposure risk, attrition rates, and other such pragmatic concerns that may impact the buyer. But what about their ‘fit’? I honestly do not believe I have ever seen it covered at all. 

Do the clients of the firm you are folding in have a similar understanding of your investment beliefs and philosophy? Are they comfortable with your processes and decision-making criteria? Are you a fully discretionary firm, while their clients are used to sharing in that decision-making burden? Do they love indexing while you love active management? Do they love benchmark comparisons while you favor goal-based monitoring? Are they opposed to illiquid investments, while you have strong exposure there? Are they used to a communication plan that is compatible with your own? I could go on and on, as really this barely scratches the surface of what could matter here, but I hope you get the idea.

My own view is that the more compatible the advisors are, the more likely the clients may be compatible as well. Clients tend to be a reflection of the advisor who built the practice. But it strikes me as entirely reasonable to do this due diligence – to really consider what makes your business unique, and stress test whether or not the new clients will be comfortable in your unique philosophy and operation.

It is not a perfect analogy, but one of the great advantages to dating before one gets married is that you have built rapport, familiarity, and compatibility ahead of time. Marrying someone who instead dated someone else first adds a little bit of risk to the transaction, wouldn’t you say? Many of us built our businesses with distinctives that made our businesses what they are (for good or for bad). Asking clients who are not comfortable with these distinctives to fit in is asking for trouble culturally, and economically.

M&A will continue in our business for years to come.  The more client-centric our thinking can be here, the better off the clients will be, and the better off we all will be – since we are each stakeholders in the RIA industry.

This article originally appeared on Citywire.


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