Recently, our friends are Ruffer have explored the negative impact inflation can have on advice businesses. This is part three in the series (you will find links to the first two below), and looks at the role private equity firms have played in IFA consolidation.
The level of buying and selling activity amongst financial planning firms is naturally high. In this country, financial planning is still a small-scale activity and some would argue it is much the better for that.
The latest PIMFA report (Personal Investment Management and Financial Advice) suggests that the average number of advisers in a single firm has been steady over the last 10 years at around 5. Underneath this relatively stable number is strong anecdotal evidence that, in terms of value, the pace of consolidation is quite high. There seem to be more, larger firms of various kinds acquiring smaller rivals.
There are countervailing currents at work and identifying the longer term trend is difficult. The Retail Distribution Review and pension freedoms are believed to have driven increased professionalism and the asset pool available for financial planning.
While this may be the case, it is far from clear whether any large scale players have significantly benefited from these trends (the advised platform market seems to have).
This has not stopped numerous firms battling to establish themselves as large-scale financial planning businesses in the UK, generally through acquisition. The revived interest of the UK banks (see Santander and Lloyds) in the advice market is surely an indicator; at the very least there is perceived to be an opportunity to establish a large brand in a space that has seen very few.
Something that interests Ruffer is the involvement of private equity in the financial planning market in the UK. Private equity money has had a longstanding relationship with the sector, since at least the early 2000’s. There was a lull in the aftermath of the 2008 financial crisis but by 2010 the resurgent availability of debt financing had begun to revive this trend. Since then there seems to be a pattern of steadily growing involvement. Numbers are difficult to come across regarding current activity. If one observes the financial planning trade press, there is a lot of anecdotal evidence that private equity backed consolidators are particularly active.
Ruffer look at this phenomenon through the prism of a wider search for yield. As interest rates have stayed historically low for a long period, investors have been pushed further up the risk spectrum to achieve what they see as an acceptable return. The boom in private equity is one of the results.
What does that mean for owners of advice businesses, be they buyers or sellers?
As a seller of an advice business you will undoubtedly be thinking about the best price you can get for your firm but you will also be thinking about where your clients will be best looked after. This can sometimes feel like it involves compromises.
Furthermore, if the ‘financial repression’ environment of higher inflation and low interest rates does come to pass, this will translate in to lower valuations for financial planning businesses in two main ways:
First is a simple function of discount rates. Typical methods of valuing financial planning businesses involve a multiple of EBITDA, a percentage of assets under management or a multiple of the annual amount of recurring revenue. We have already looked at the impact to AUM and profitability of this kind of environment. But most valuation methods of any company, small or large, currently factor in a very optimistic assumption about future growth. Under worsening conditions this optimism will evaporate. For example, this could mean a 4% of AUM valuation becomes a 2% AUM offer.
The second point calls in to question whether there will be any buyers out there. A broad reversal of the bidding up the risk curve that we have seen over the last decade will see the riskiest elements, like private equity, suffer first. Private equity funds already have historically high amounts of ‘dry-power’ – funds that have been committed but not invested, suggesting a difficulty in finding good investment opportunities. In a downturn the main source of backing for UK financial planning consolidators will likely disappear. Those firms with investment in place already will likely be leveraged making them fragile to a cessation of future injections of capital.
So if the world has gone to hell in a handcart, what are your options?
Consolidators backed by simple shareholder capital may be a bit more robust. The large insurance companies and banks now building financial planning brands may be more likely to survive and may continue to build their empires in the downturn. Beyond this, another option is employee ownership. Passing the business on to employees might not be as profitable for the principal of the business, but it may be the only option if high inflation and low interest rates have severely decreased the attractiveness of financial planning business models. Some would see this as a better guarantor that your clients will be well served.
It is worth considering too, that if selling your firm is a fundamental part of your own life planning, perhaps a bird in the hand is worth more than two in the bush.
If you would like to read the first two article in the series, use the links below:
A limited liability partnership, registered in England with registered number OC305288 authorised and regulated by the Financial Conduct Authority © Ruffer LLP 2019. The views expressed in this article are not intended as an offer or solicitation for the purchase or sale of any investment or financial instrument. The information contained in the document is fact based and does not constitute investment advice or a personal recommendation, and should not be used as the basis for any investment decision. References to specific securities should not be construed as a recommendation to buy or sell these securities.