Matt Crow: M&A Secrets, Revelations, and Ticking Time Bombs

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Mergers and acquisitions in the RIA space have had a great run for the past 15 years. Is this going to continue, and what should buyers and sellers be watching out for? Hi everyone, I'm business coach Steve Sandusky for Barron's Advisor, The Way Forward Podcast. My guest today is Matt Crowe. Matt is the CEO of Mercer Capital and leads the investment management industry team. In today's conversation, we explore the M&A business— what's working, what's not working, how some of the tailwinds of the past 15 years may be turning into headwinds, the financial model behind these deals, how deal structures are evolving, and why the headline valuation multiples you hear about are often higher than what will actually be realized by the seller. With that, please enjoy my conversation with Matt Crow. As you reflect back on the past 15 years, what would you say are some of the key things that we've learned as it relates to M&A in the RIA space?

I guess number one, maybe that it's possible, but I would take a step back from that to say that there has been a particular backdrop for the M&A environment in the last 15 years, which has made it particularly conducive. If you think about it, the leading edge of the baby boom generation, which were founders of many of these RIAs, were hitting about 60 years old 15 years ago, and now they're 75. And so there's kind of the thick of needing to do some kind of a transition for that group. And then you also had cheap debt. Credit crisis was 15 years ago. It's the first time that the Fed really cut interest rates down to an incredibly low level. And once liquidity loosened up a little bit from banks and other funding sources coming out of the credit crisis, you had access, or rather consolidators had access to quite a bit of inexpensive capital to pursue M&A. So that backdrop really got things going and created the, I guess you'd say, created the environment that made it possible. To do M&A at the level that it's happened, but we're probably just getting going.

Well, and I would add a third one there, which is the AUM model, the recurring revenue model, which made these businesses super profitable. And with the high retention rates upwards of the mid to upper 90% range for retention of clients and assets, I think that made these businesses super attractive and super predictable. Would that be a fair third piece as well?

It would. And there's so many things to talk about on this topic, we could probably devote the entire podcast just to this. But I guess the extension of the issue of low interest rates not only facilitated transaction activity, but it also kind of necessitated it. You had a big segment of the market kind of looking for quasi-fixed income coupon-generating investments. And the investment management space has that steady stream, as you point out, the AUM model, high retention rates among clients, sticky revenue pushed forward by market tailwinds when the market's going up, that generate reliable streams of distributions to cover financing costs and to provide returns to investors. So The low rates, I guess, worked a couple of different ways, both on the push and the pull. They, they gave us an environment that made it possible to do quite a bit of transaction activity, but they also necessitated it.

Now, you also said here a moment ago that you think we're just in the early stages still of the M&A business, yet you talk about some of the tailwinds that we've had here, the low interest rates. We don't have low interest rates anymore. The leading edge of the baby boomers. Are now in their 70s. We've got a few more years of baby boomers turning 65, but a lot of the founders of the big firms are up there in age, and a lot of them have already done their transactions. And we've had great financial markets since the financial crisis, so we've had a lot of tailwinds. In light of those not necessarily being tailwinds, and now some of them turning into headwinds, you still think that we've got a pretty long runway here for M&A business?

I do. Founders of these firms often work, you know, later into life than people in other professions do. So ownership transitions happen later for them than they might in many other businesses. So you've got your, your younger end of the boomers today are, let's say, just about hitting 60. So they've still got probably a zone over the next 15 years of wanting to do transactions, and that'll be active. I would add to that, one thing that fuels transaction activity in the RIA space is the alternative, which is internal succession, which despite what I'm about to say happens quite a bit. Internal succession is hard to do. And in many situations like we're in today where you've got a lot of professional capital looking to get into the space by way of private equity firms and such. It's a lot easier to sell a company to an outsider oftentimes than it is to an insider, not to mention oftentimes more lucrative. So the environment is both, I guess you'd say, internal and external. The internal realities of doing succession from founding generation to second generation it's always tricky. That's not going to change. And I think that the professional investment interest in the RIA space, the names involved in it change over time, but the aggregate interest in the space never really seems to wane.

Now, you mentioned that doing an internal succession is difficult. Well, doing a sale, an acquisition, a merger is obviously very difficult as well. What are some of the biggest challenges and pitfalls that you've seen in M&A business here?

Expectations, I think, as much as anything. There was an article I saw recently which didn't surprise me, which said basically a lot of deals in the RIA space collapsed over the last couple of years because seller expectations weren't being met by what buyers were offering. I think a lot of that has to do with the trade press trumpeting very high multiples for transactions that aren't actually typically realized in these deals, meaning the headline number that's put out there is a number that makes several assumptions about the consideration being offered, the earnout payments being made, et cetera. And it puts out a pretty high multiple. The reality is more nuanced and a little more balanced. And so sellers, you know, come into this thinking that they're going to get, say, 15 10 times and they're not willing to sell for 11. And, you know, the mismatch of expectations there sort of puts them back on the shelf. They'd rather go back and run their business for a while. So that's been, I guess you would say, a fairly recent phenomenon that has gummed up the M&A works. You know, the other thing is really just all the usual stuff that gives you heartburn in M&A. You know, is there a cultural mismatch? Can you actually maintain the active and interested efforts of successor generations of leadership in the firms being acquired. Are clients happy about, you know, the character of the firm changing by the founders selling and eventually leaving the firm? It's a tricky asset to transact because ultimately professional services, of which the RIA business is one, professional services have for millennia been an owner-operator business. And so we're still learning the extent to which third-party ownership can successfully participate on a sustainable basis in the space.

So the example you just gave here about a lot of these deals falling apart before they ever get consummated, so that's one part, but then there's the second part of deals that actually do get consummated but maybe don't turn out as good as expected on the front end. So I'd love for you, if you could even make an estimate here, if we think about for every 100 deals that are done here in the space, if we categorize them into 3 outcomes. So outcome number 1, yeah, it was marginal at best. Outcome number 2 is it did okay, you know, sort of met expectations. And then outcome number 3 was it was a home run. Do you have any sense for, for out of every 100 acquisitions in the RIA space, what percent would fall into those 3 buckets?

I would say maybe a quarter meet expectations and a quarter turn out okay, and about half are marginal.

I think it's also interesting that you said that we're still trying to figure out if third-party ownership of professional services firms works. So we've got the CPA business and we used to have the Big Eight. Now what is it, the Big Three or the Big Four through a variety of different permutations over the years? Is there any comparison between how the CPA industry has functioned and the consolidation that took place or lack of consolidation that took place there to the RIA space. Is that an appropriate analogy between the two in terms of how we might think about the future of our industry?

Probably quite a few. Believe it or not, the accounting firm business or profession is late to the game, but there are several of not the Big Four, but the kind of the next tier down, let's say players 5 through 20, that several have accepted money from private equity firms and are pursuing acquisitions and transactions in a way that is not dissimilar from some of the RIA consolidators. In a way, accounting is easier to consolidate than the investment management space because it's not as personality-driven. You know, accounting's core businesses are obviously, right, tax and audit, and they're regulatory-driven, and you you get a bunch of bright 23-year-olds out of their master's in accounting programs, and you hand half of them the U.S. tax code, and you hand the other half GAAP, and you tell them to go follow the rules and do their job. And they can. And people aren't as wound up in the personalities of their accountants as they are in their investment manager. That said, you know, when you bring it up, it reminds me that one thing Focus Financial founder Rudy Adolf would frequently cite in his design of their model was his father's background as an accountant and wanting to bring in other senior-level accountants and doing things in the, in the way that they paid them and brought their businesses in that would treat them as entrepreneurs and not as employees. There's a lot of laudable things to be said about that. The tricky thing I see about drawing parallels between the two industries is that investment management is necessarily, it's a stronger relationship business. It is a much more of a qualitative relationship. So the character of the individuals involved are very key to the success of the business. And that's not so much the case in accounting. Maybe a better way to put it, think about the major investment management firms. So Franklin Resources used to be called Franklin Templeton, right? And if I asked you, you know, what are the first names of Franklin and Templeton, you and probably all the listeners of this podcast could tell me, right? Ben Franklin and John Templeton. And most people could even say Sir John Templeton. Now, the largest accounting firm in the world is Deloitte. What was Mr. Deloitte's first name?

No idea.

I don't know either. I should look it up sometime. And so, you know, the accounting community, the types of services they offer and the relationships they have with clients are different than investment management. They are nonetheless trying to do some private equity style M&A, and it's very early, so it's kind of hard to know at this point whether or not it's going to ultimately be successful.

I think back to John Chambers at Cisco Systems, and I think he had said one time that during his tenure, Cisco did 180 acquisitions. And during that time, they went from 400 employees to 75,000. And oftentimes I think we think that technology acquisitions are really difficult, and yet somehow Cisco for the most part was able to make it work. And Chambers used to talk about how they had playbooks for acquisitions and they had teams that whenever they did an acquisition, they'd fly the team out and they basically would try and convert everything over to the Cisco system pretty immediately. So they got really adept at doing these acquisitions. Are there any analogies in that area as it relates to the RIA space in terms of what are the real benefits of doing these big acquisitions? Because we've got some firms now that have done 5, 10, maybe 15, 20, 30 acquisitions over time. They've become mega billion-dollar RIA firms. Are these highly profitable financial plays? Are these great strategic plays? And on the outside, when we read about these big deals, it sounds like, wow, this is, this is really cool. But I've been on the inside of some of these as well, and what you see on the inside isn't always as pretty as what you might read about on the outside. So are there any ticking time bombs out there, or what are your thoughts on that?

I'm sure there are ticking time bombs out there and we read about them from time to time. You know, technology develops its worth around an intangible asset, which is, you know, the code, the functionality of the tech. It's not dependent necessarily on the individuals involved. People don't know the engineers behind the Excel or Word that they use on a day-to-day basis. And everyone's okay with that. So it's very, very, very scalable. Professional services, you can add a lot of them up and make it a lot bigger. But I think a lot of times you've got in the RIA space, there's a search for scale without a real clearly defined ambition. You know, can scaling an RIA be strategic? Well, I mean, it's such a fragmented business. Investment management in general is such a fragmented business that it's a little bit difficult to imagine that anybody would put enough of it together to develop a brand on a sort of a national scale. And if they do, well, then they've kind of got, you know, what the big wirehouse brokerage firms have had for years, and people talk about those like they're dinosaurs. So, you know, the scaling in the RIA space, you frequently— the bullet points cited are, you know, access to technology and centralization of compliance and, and those sorts of things. I think one thing tech probably gives us is it gives the small RIA the ability to handle clients and to present and provide services that are similar to a large firm. It doesn't necessitate scaling up as much as it does enable people to avoid it. So why do people do it? Well, I think they do it again because to a great extent, I think it is largely a financial play. There are a lot of opportunities for institutional money to get involved in the space. And if they've got access to inexpensive financing, obviously not as much access today as 24 months ago, they can put together a whole series of investment management firms and develop a pretty good return on that. It's really not unlike having a really, really, really good fixed income portfolio because it is a great business model and it's a business model that you want to own if you can.

You raised a number of really interesting issues there in what you just said there. One of them is that a lot of this M&A is largely a financial play. And I want to go back to Chambers here for just a second. And he did a little reminiscing about his tenure at Cisco and acquisitions. He said there were a couple of keys that he always thought about with acquisitions. One was that you should only do acquisitions that really provide a strategic benefit to you. And he said, don't fall into the trap of pursuing an acquisition just because you have the resources to do so. That sort of gets back to this idea that some amount of this M&A was driven by the low interest rates, was driven by the plethora of institutional capital that was out there, which ultimately bid up prices and valuations to levels that may not pan out financially. So I think that's kind of interesting. You also talked about this idea of scaling in terms of can you actually scale an advisory practice, and I think we'd have to define, well, what does it mean to scale a business? It doesn't just mean, oh, well, we can get bigger, we can grow revenue, we can add more advisors, we can add more assets. But if you're doing that and your level of service is not increasing, then you're not really scaling. You're just putting more people together. And if your profit margins are not rising as your business is getting larger, you're not scaling. And I think the industry data— I'm thinking the Schwab benchmarking data— would suggest that these multi-billion-dollar RIAs are not more profitable than a $500 million RIA firm is. So I think that's an interesting thing to think about. And then perhaps another piece to think about is when you acquire an RIA, what are you actually acquiring? Is it the clients? Is it the talent? Is it a methodology for doing business? Is it an investment management strategy? Again, it all comes down to people, and people can leave. So do you have any thoughts or reactions on what I just said there?

I think that, you know, at the nucleus of an RIA is the advisor-client relationship. And most of the consolidation that we've seen in the space over the last 15 years is just adding together lots and lots and lots of advisor-client relationships. You can consider margin projections in the wealth management space, the asset management space, independent trust companies. They're all kind of a limit function, and they max out at some point, and they max out at a much, much, much lower AUM level and a much, much, much lower revenue level than people would imagine. The tech space, you know, you can kind of expand margins forever thanks to the scalability of the business. Not so in professional services. And if you look at— to go back to your point earlier about the accounting community, I probably could do a similar analysis for, for the RIA space. A very, very simple, you know, numerator denominator equation you can do in the accounting community is to look at the top firms globally in accounting and look at revenue per employee and look at the Big Four, look at the 10th largest, the 25th largest, the 50th largest, the 100th largest, and there is shockingly little difference in revenue per employee for the 100th largest accounting firm in the US versus Deloitte. You can create mass through all this consolidation. The question is, is it critical mass? Is it actually additive ultimately? I think it's tough. One question I had, I remember when delving through the S-1 when Focus was going public in the summer of 2018 was it's like, okay, so here's this idea. You band together under their model, all of these wealth management firms. Let's say all these wealth management firms on their own generate a 25% EBITDA margin and you consolidate them where you consolidate, and the folks at Focus would say that they're not a consolidator. So you take the interest, these sort of preferred stake interest in RAs, and you put them under the Focus umbrella, and then you'd create, you know, shares in that and you sell them to the public. Well, okay, so what's the Focus umbrella consist of? Well, it consists of a lot of people, office space, you've got an M&A team, you've got compliance groups, you've got legal, you've got investor relations, you've got the executive management function. A lot of overhead and it just sort of sits on top of all of these RIAs. Well, can the parent effectively in that case, can it provide any kind of efficiencies or access to growth opportunities for all of those firms that they can't do on their own such that it can pay for the financial drag, I guess you would say, of the parent organization? And it's asking a lot. I mean, it really is asking a lot. And I think you can see if you look over the history of the financial performance of Focus since they went public, you know, back in the '18 timeframe, they were generating kind of a 23-24% adjusted EBITDA margin. And I think today it's basically about the same. It's about 24%. It's not quite gotten to 25%. So, you know, it's difficult to overcome the burden of the parent company to actually provide value to the overall organization that pays for itself. Yeah.

And Focus is an interesting example as well when we think about the valuation of a publicly traded RIA firm versus the private valuations. And I know they've ebbed and flowed over time, but I think historically the private valuations, and you'd know this, not me, but the private valuations of the advisory firms has been higher. Than when they're traded publicly. Has that changed? Have those sort of equaled out over time, or what caused a potential discrepancy there?

It's a good question as to what causes the potential discrepancy. I think that might be the $500 billion question, is just exactly what is going on out there that makes people so uninterested in publicly traded RIAs. I don't actually candidly understand it myself. You know, Focus went public, 5 years ago at $33 a share. 5 years later, and an awful, awful, awful lot of headlines and earnings calls and press releases and deals and financings and debt financings and refinancings. 5 years later, it's going private at $53 a share. Well, that's, you know, about a 10% compound annual growth rate. And if you peel back the fact that most people probably didn't get in at the IPO, and if they didn't get in until the end of the day or the following day, they were paying closer to $40 a share. And now you're— now your rate of return over 5 years is like 5%. Not super compelling. iFinancial has had a hard time generating enduring interest in its business as well. And you can see why in like the asset management space, like Going back to Franklin Resources, you've got a business that has been struggling with asset runoff for several years. And so they took out Legg Mason a few years ago and now Putnam, and they're all trying to bind together to make something out of the asset management industry that's left over after it's been ravaged by passive investments and ETFs and such. The wealth management space, shouldn't be exposed to those kinds of concerns. But for whatever reason, the public markets have just not been receptive in general, I think, to consolidation models, the old roll-up IPOs of the late '90s, which burned a lot of people. For some reason, that notion has lingered in folks' minds. And so they've just not been compelled to get involved in public RIAs. Why does it work better on the private side? I guess arguably it shouldn't, but it might be that, you know, 10-year money, you know, fund money can take a longer view of this. They can see a pathway to growing profitability that the public markets cannot and are willing to go for it. It also might be, Steve, that again, the cheap debt that not only facilitated this deal activity, also kind of compelled it, was a driving force behind the private equity community's interest in the RIA space. And that's not necessarily going to prove durable as interest rates go up, if they go up and stay up for an extended period of time.

Yeah, one other thing I wanted to touch on here as it relates to the M&A business, and I think you touched on this a little bit, but As we put all these firms together and we get some of these RIAs that are over $100 billion now, do we run the risk that we're just recreating the wirehouse model from which a lot of these leaders initially fled? I mean, are we just— Absolutely.

—deja vu all over again? Absolutely. I mean, we write a blog at Mercer Capital about the space, and what inspires a lot of the blog posts are these conundrums, these sort of analytical cul-de-sacs that are hard to get out of. You know, the whole point of being an RIA was the independence movement. It was getting out of that institutional culture, product-driven culture, heavy compliance, identity lost in the, in the maze of Merrill and all the other big names. And so people went out on their own to control their own destiny and they did it and good for them. And then eventually they get subsumed into larger organizations, sometimes losing their own brand. Branding and their own identity in the process. But I think it's important to keep in mind that consolidation probably needs to be viewed on a net basis. And the reality is the number of RIAs in the US, despite all the consolidation activity in the last 15 years, the number of RIAs in the US grows basically every year. So on a net basis, we don't have consolidation. We've got, in fact, a flourishing of independent models. Yeah.

And I think what we've seen, though, is even though the number of RIA firms has increased over the years, despite the consolidation, we've seen like a decline in the number of broker-dealers out there. I think we've seen a decline in the number of registered representatives. So we've seen a lot of people that were securities licensed decide to either become hybrid or actually just drop the securities license and set up an RIA and do it that way. So net, I don't think there's been a huge increase in the number of financial professionals over the years that are providing one-on-one services to clients. And maybe you can correct me on that, but I think from the data I've seen, that would be fair.

And I think therein lies actually a very significant rub. I agree with what you said. Now, we do have mechanisms and technologies today that enable advisors to handle more clients and more AUM. Than was once the case. So the efficiency per advisor is higher than it was 10 years ago, 15 years ago. So the industry can grow even without a growth of the population to a point. But, you know, a persistent issue in this business is whether or not there's real organic growth taking place. And I think an unspoken issue in the RIA community is the lack of organic growth is driven by a failure to, by many firms, to recruit and train up new advisors. One thing that I find interesting in a lot of these consolidators is that they offer a lot of assistance to firms that they acquire with investment services, products, consolidating compliance, tech stacks, marketing assistance, all those sorts of things. They don't really reach out to their subsidiary organizations to work on recruiting. And in addition to, I would say, you know, one way to characterize the investment management space is an owner-operator business. Another significant component to it, and this again is a, is a very old, old aspect of professional services. It's an apprenticeship model and apprenticeship models, you know, go back thousands of years and they require a couple of things. They require one, the recruiting of and training up of apprentices. So that's new advisors coming up through the ranks. And then they also require some path to ownership. For those same folks so that they will one day be the successor leadership ownership generation. And that aspect of the industry, I think, is in many cases being neglected.

Yeah, and I've been very vocal about the organic growth issue in the industry and the way that I view it. And I know there's a lot of variables in here, but I think one of the key variables for the lack of organic growth is that because of the AUM model, that if you've been in the business for 10 years, 15 years, and you've got $100 million, $150 million, $200 million, whatever the number is, you've got a really nice recurring stream of income. You know that when I wake up on January 1st, I've got probably 90 to 95% of my revenue is booked solid for the year because I'm not going to lose my clients. And sure, I've got clients taking distributions, but I've also got existing clients adding new assets. I'm going to get a few referrals. So I probably have close to 100% of my income for the year guaranteed. And then if the market goes up 5, 10, 15%, I'm going to get a nice raise this year. And so if I'm very comfortable making $500,000 or $1 million a year, it's a really high bar for me to say I'm going to work even harder so that I can make $1.5 million this year, or I can make $2 million this year, or maybe I'm going to work harder so I can go talk to 50, 100 advisory firms this year and see which one or two I might want to acquire. So there's only a small percentage of people out there that have that drive and determination to want to put that extra effort in to make more money beyond what is already very, very comfortable for them. So I think this AUM model has caused a lot of folks to get to a point of very, very comfortable and they don't have to work a lot harder. And then your point about the apprenticeship model, I think, is a really interesting one to think about as well, in that a lot of advisors that are the lead advisors making all this good money, they bring in another advisor as, quote, sort of a service advisor. And a lot of the clients that I work with on a coaching basis, they have way too many clients, and they're like, I've got too many people that I'm working with. So we have to talk about bringing in additional advisors and moving clients from the lead advisor to, to the associate advisor. And so that's a whole process as well. And so a lot of these younger advisors are not cutting their teeth on business development because they're getting their clients handed down to them from the lead advisor who's got way too many clients, and they want to focus on their, their largest clients, and they're still going to get income from the clients that they move over to the associate advisor. So I think there's not necessarily the incentives in place for that apprenticeship model to really bring in young new advisors who really want to cut their teeth on business development. Of course, since we went away from the commission model, you know, the eat what you kill model, you don't have those incentives anymore. You know, once you bring in one client, again, the recurring model means they're going to be sticking around for a long time.

So you've touched on a number of things there. 200 years ago, if you were a blacksmith, you knew that your body wasn't going to be able to handle the hard work of being a blacksmith forever. And so you brought in somebody young to teach them how to do it, and they could provide physical labor as you aged to enable you to sort of maintain your income level. And the trade-off for that was that the associate, the apprentice coming up in the profession or in the business, would be able to take over. I don't think it's a problem that young associates for advisors cut their teeth on the learning the technical aspects of the business, basically how to be a really effective advisor and be able to provide high-quality advice and services to clients before they become marketeers. But you've got to get, you know, one step beyond that and say, well, now that you've learned the trade, so to speak, you've got to go out and find people to to do it for, or at least be available and understand the client relationship part of it well enough to pick up the relationships from the senior advisor when they want to retire. I think one aspect of the last 15 years in the consolidation movement, you know, frankly, the institutional capital that's flocked to the space providing an alternative to internal succession It's given a lot of firms an out to not have to deal with the difficulty and complexity of training advisors to become marketing relationship people. And as a consequence, there is a, a lack of internal succession thinking at a lot of firms that is effectively counting on there being a way to put the business at some point to the private equity community. If for some reason the private equity community withdraws from the space, it's going to be a difficult situation for a number of firms. You know, private equity is kind of done in many ways by coming in and making this a financial play as opposed to a career development path, is it's increased the bid-ask spread between founding generation and second generation. And, you know, the quip we sometimes have here in the office is that these RIAs have become so valuable nobody can afford to own them. If you can't buy your way into the firm that you're supposed to be growing into, it's kind of hard to figure out what your long-term opportunities are. And that creates leadership issues and business continuity issues that at this point I think we're seeing play out in many firms.

Yeah, and this next generation is another thing that I think is an issue that Evan Simonoff actually brought up here in a recent article in Financial Advisor Magazine. I think it was published on July 14th. And he talked about how as the founders of these firms sold their firms to the PE firms or did some kind of merger or whatever, they made out really well. So they're financially doing quite well. But then the next generation that is supposed to run the business after the founder rides off into the sunset, they may be saddled with being part of a company that has a fair amount of leverage on it. They might have non-compete agreements that they had to sign in order for the transaction to get done. And so they may not have it nearly as good as the founder of the firm, and granted, they shouldn't because they didn't found the firm. But he was, I think, trying to argue that it makes it difficult for this next generation to feel like, well, what kind of future do I have when I'm with a firm that has a fair amount of leverage? I've got these non-competes. Yet on the other hand And you touched on this a little bit earlier, because of technology, it's so much easier today for a solo advisor just to go out there and start their own firm. And we've seen the XY Planning Network has done a phenomenal job in creating an infrastructure for advisors that want to start their own firms. We've got friendly custodians out there, we've got the technology available, and so it's relatively easy for an RIA to start up and have resources that look like they're a big firm. And so there are some options out there. So yeah, this whole succession issue, I think, is certainly a big issue. And we know the industry is spending a lot of time talking about it as well.

And if it's not solved, then at some point the institutional capital that's buying, that's doing this RIA consolidation, as their employees that they were expecting to run the business profitably and grow it for them as they leave, Then they find out what they've really bought is a wasting asset that's just kind of in runoff mode. Well, that's not in any discounted cash flow model. That's not nearly as good as a high retention rate business with strong margins and revenue uplift from market behavior and maybe even some organic growth here and there. It's not nearly as good. So it's got the potential to have a chilling effect. On even private capital's interest in the space, but I don't expect to see that in the near term.

So let's talk a little bit more about valuations in the space, and a lot has been written about this here in the past year or so in particular. What are you seeing right now happening with valuations? Are they flatlining? Are they declining a little bit? And I know every deal is different and there's different structures and everyone's trying to position it such that the seller feels like they're getting a high EBITDA and the buyer feels like they're paying a very reasonable price. So everyone's going to try and position this in the way that's going to make them look best. But you obviously are really under the hood, deep in the weeds in valuation. So what are you seeing in that area?

Pricing is off of the highs, but not as much as people might expect, maybe not even as much as we would have expected them to be given the movement in rates. And there are, you know, reasons that we should have foreseen that that's happened. A couple things are going on. One, you know, even though financing costs are higher today than they were a couple of years ago, if you break down interest rates kind of the way of the Taylor rule and say, well, rates are really a function of nominal GDP growth, well, rates are higher because we've got higher nominal GDP growth. That provides some support for all economic activity, and that's providing support for the equities that underlie the AUM of most of the RIA community. So revenues have not been hit by the increase in interest rates the way that, that we might have expected when they started going up a couple years ago. Beside that though, I think something that you gotta, gotta be aware of in terms of valuations these days are there's sort of the stated price and then the economics underneath the stated price. And the investment banking community has been very skillful skillful at developing terms that will support pretty good headline numbers on pricing and therefore satisfy the psychological needs of sellers to meet certain multiple expectations, but yet provide some safety for buyers. So you've got more stock being offered in transactions now where everybody is really the buyer and the seller participating in the same enterprise after it's over with, as opposed to just providing cash. You've got earnouts becoming a much larger percentage of the transaction and the hurdles for the earnouts being a little bit stronger and the terms of the earnouts being a little bit longer. And you can keep a deal price still looking very good, but provide some shelter and safety for the buyer from overpaying if things don't work out the way one would have hoped. So there's a lot more creativity in deal terms today than there was a couple of years ago. And while that is ultimately probably lowering any economic assessment of the deal price to the seller, they don't always see it that way. And so they're going ahead with transactions and taking deals as presented. So valuations are off. Not as much as you would expect. And one reason for that is they're being supported by both better market behavior than we probably would have anticipated a couple of years ago underlying the AUM of those firms, and because the buyers have found avenues to protect themselves in the event that we have a bad cycle.

Now, your firm, Mercer Capital, is in the valuation business. Now, I know we could do a whole graduate school course on how do you value an RIA firm, but just at a high level, what are some of the factors or ways that you think about when you're— someone comes in, says, hey, what is the value of my RIA?

Well, the valuation of really anything, any business, is just a function of cash flow, risk, and growth. With an RIA, we sort of look at or try to break down those three components into their key constituent parts, you know, cash flow, margin sustainability, compensation structure, leadership, ownership, what's the sustainability of the organization, what are client concentrations, do you have a recruiting program to bring in the next generation of advisors? An internal training process? Has it been successful in the past? Is there a real vision of kind of where that's going to go going forward? You know, risk, as much as anything, has to do with some of those factors as well. I mean, it's whether or not you've got business model. And at some level, all RIA business models are very similar, and in some ways they're all very different. Do you have a model? That is going to thrive over the next 5 or 10 years, kind of what we would consider the foreseeable future. And growth, you know, one thing we always try to do is disaggregate the historical growth of the firm into organic and market activity to see whether or not the company has an effective program to bring in new clients or bring in new assets from existing clients, or are they just sort of dependent on market behavior to provide that tailwind or uplift to revenue. So those are all variables, I guess, that go into it. At some level, Steve, what we're all really looking at is some kind of discounted cash flow model. And the particulars that go into that modeling exercise depend on the fundamental nature of the firm and the segment of the business that it's in and its relative success in executing a clearly defined strategy in that segment.

And would you say of the firms that are out there doing these acquisitions, and you mentioned earlier that a lot of these are financial players, is there anyone out there that you think is really doing this well in terms of being strategic about, well, we're going to make this acquisition because that's going to plug a hole in our service offering. And by acquiring that, we're now going to be able to offer this set of services, which is going to enable us over on this other side of our business to really accelerate the organic growth there because they've been clamoring for this service that we don't have today. Is there any firm out there that is really thoughtful and intentional about their acquisition strategy to really create a firm that's not just trying to get financial returns. I mean, they all are, obviously, but not just financial returns for shareholders, but they're really building a business of value that is first and foremost focused on what the client's needs are. And then if we can meet and solve the client's needs, then ultimately we're going to get the financial returns anyway.

The rub is that these firms reach critical mass at a smaller size than people realize. So they've really plugged all the holes at a scale that doesn't require the amount of consolidation behavior that you see. So by the time somebody gets big enough that they're, you know, let's say $20 or $30 billion and they're out there acquiring $500 million firms or $1.5 billion firms or that sort of thing, they're no longer filling holes in their expertise. They really are just trying to generate more scale through the number of advisors and advisor relationships and get bigger for financial reasons. So I guess the answer to your question is, for the most part, no. I think small firms— I'm talking the sub-billion-dollar kind of AUM wealth management shops that are banding together to do that very thing— they have strategic ambitions for what they're doing because they are trying to round out their if they're trying to build an ensemble practice, maybe trying to get people who can provide certain services to their existing clients that they couldn't get to otherwise. And so you've got that kind of strategic bent to transactions. Not really the case with the larger firms.

I love that point that the size that you need to be able to round out all the services is much smaller than a lot of folks might think. And you just, I think, mentioned like $20 or $30 billion. Do you think it— that That's roughly the range, or—

No, I think it's smaller than that. Much smaller. Okay, much smaller than that. It's sub-$10 billion. Hmm.

Okay, interesting. Now, we're also hearing rumors that at some point there's going to be a mega merger. So some of these firms that might be $50 billion or $100 billion in AUM are going to merge with each other. What would you think would be the impetus for that kind of merger? Is that again just— it's just purely financial? Yeah.

The fund life, a lot of these consolidation behaviors that are PE-backed, they need an exit. One way to do that exit that's a little bit different as opposed to flipping from one PE shop to another is to actually combine a couple of them and see if going from, I don't know, $80 to $100 billion to twice that by combining with a similar size firm, if it provides you with any oomph that you couldn't get otherwise. So no, I think there will be things like that. I think it's natural and I think it's going to be financially driven.

What would you say to an advisory firm owner? Let's say it's someone who, let's say, a $500 million to $2 billion RIA firm owner who is getting solicited day and night by these outside firms that want to acquire them or take a financial interest in them. What would you say to that advisor that they should think about before deciding whether or not to get married to one of those firms?

It tends to become a little bit of a therapy session about what do you really want? I mean, those opportunities are out there. They're out there for most firms and they work for many firms and they fit the needs and the goals of, of many firms. But they don't fit the needs and goals of everyone. If a founding-led firm of the scale that you're talking about is reaching a stage in life where they want to effectively plan the, the wind down of their own career, and they want to get a solid number for the business that they've built, and they don't have an internal succession path that makes sense. Then the decision is actually relatively straightforward and they should go and do it. Sort of the cornerstone of our advice to people being solicited by acquirers is just be realistic. You've got to keep your emotions in check, kind of on both sides. You've got to keep, you know, the, the, the spectrum that wipes us all out financially is when we get too far in one direction to the other on the hope and fear spectrum. They neither one of them have much of a place in strategic thinking and neither one of them have much of a place in financial thinking. A successful consolidator is going to have a very well-developed pitch about what they have to offer. And it helps, I think, sellers to have somebody like us come in and say, okay, well, they're saying these things, and what they mean are these other things. And so what are you really going to be netting out of this ultimate transaction if you decide to go through with it. On the other end though, it's important to not be caught stuck in your tracks by fear of the unknown. I think when advisor founder-led advisory practices start contemplating a transaction, selling their firm, they are very well aware that it is a small deal to the buyer and a huge deal to them. And that tends to stoke a great deal of concern in them, which makes it difficult to act even when they ought to. Nobody likes the unknown. They don't like all the baggage that come with a transaction, which is, well, what is my real involvement with the firm going to be after it's over with? If I retire, what am I going to do with the rest of my life, et cetera, et cetera, et cetera. A lot of things that are important maybe psychologically to resolve, but don't have a lot to do with the financial operational implications of a transaction. So what we try to do, talking to clients who are facing these kind of dilemmas, is just to peel apart the pieces of it into what's controllable, what's not, what's financial, what's psychological, and treat each one of them for what they Excellent.

Well, Matt, is there anything else that you want to share here that we haven't talked about yet?

The thing to keep in mind for all of this, you know, we're— I work with a bunch of analysts. Analysts tend to be a little overly deep in their own heads about these kinds of things, and we can't carry the banter quite the way that the investment bankers can. Even we recognize that, and you sort of pointed this out earlier, that The RIA space is a fabulous business model, and it's something that really provides individuals with the opportunity to build substantial enterprises that do a lot of good for a lot of people, certainly provide tremendous financial returns, and if taken care of and treated well, can do good things for all of the stakeholders in the firm, the founder owners, the employees, the clients. So if you keep the core opportunities inherent in the business in mind and a kind of a balanced view of the pros and cons of any industry behaviors that are going on, you can do very well with this.

And that's kind of what we try to do. And Matt, what's the best way for folks to connect with you if they want to stay in touch?

Well, I'm obviously on LinkedIn. We've got an industry landing page on Mercer Capital's website. Where you can learn all kinds of things about our thinking about the industry, newsletters, white papers, blogs, and the occasional podcast like this. And an email, croem@mercercapital.com. Our phone number is 901-685-2120. Great.

And I would encourage everyone listening to this to follow Matt because you and your team put out some great insightful blog posts and you don't hold back. And that's one of the reasons why I wanted to get you on the podcast is you really call it as you see it., and you're not mincing words there. So thanks for being on the show, Matt. Thank you, Steve. All right. That's all for today. Make sure you like and share this podcast through your favorite social platforms. And for more great podcasts, visit us at barons.com/podcasts. Take care and be safe.

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