Wealth management M&A boom continues amid changing dealmaking environment

M&A activity in the wealth management sector entered 2022 on a high with experts forecasting this wave of dealmaking to carry on, potentially long term. Not long ago, we wrote about a “rush to complete” deals in the financial advice and wealth management sector. The dealmaking environment has changed since then, but factors such as a high degree of fragmentation, ageing company owners, rising sale multiples and the relentless acquisition strategies of industry consolidators and private equity firms are continuing to generate deals.

Last year, factors such as impending new regulations, pent-up post-COVID demand and, perhaps most significantly, the possibility of significant increases in Capital Gains Tax, were pushing many owners to sell. In 2020 and early 2021, coverage of the wealth management M&A environment was peppered with terms like “rush” and “race”, implying a short to medium-term surge in dealmaking that could slow down as rapidly as it sped up.

However, over a year later, dealmaking in the sector remains robust and looks like it could carry on in this way for the long term. Here, we’ll take an in-depth look at the factors driving wealth management M&A away from the “rush to completion” and towards a scenario in which strong dealmaking activity could sustain for years to come.

Has the urgency vanished?

Perhaps the two most important factors we cited as driving urgent wealth management M&A last year were regulations – with several important new regimes set to come into effect during 2021 and 2022 - and potential increases in Capital Gains Tax (CGT) – which, at the time, were widely viewed as imminent.

Since that point, many of the regulations we named have come into force. These include Environmental Social and Governance (ESG) reporting regulations, which were introduced in March 2021 and climate-related financial disclosures, which came into force for larger advisories on April 6 2022 (although such rules are yet to be brought in for smaller IFAs and will be introduced in 2023).

As a result, while regulation still forms a major driver of M&A activity, the desire to complete disposals before a raft of new compliance is introduced may now seem less urgent. While many may still be looking to sell as a result of the greater regulatory burden, those that were desperate to complete sales may be likely to have already done so. Other owners, meanwhile, particularly those at larger firms, will have had time to prepare for and get to grips with new regulations.

In July 2020, Chancellor Rishi Sunak commissioned the Office of Tax Simplification (OTS) to review Capital Gains Tax. The following November, the OTS released its findings, which claimed that CGT’s current form was “counter-intuitive” and that it presented “opportunities for tax avoidance”.

In response, the OTS recommended a number of changes, most significantly that CGT be increased to levels similar to income tax (which is charged at a basic rate of 20 per cent, rising to 40 or 45 per cent for higher/additional taxpayers). The report also suggested cutting the £12,300 CGT allowance to between £2,000 - £4,000 and scrapping Entrepreneurs’ Relief, which enables owners to pay a 10 per cent CGT rate up to a lifetime limit of £1 million in company disposals.

These changes would have had a direct impact on business disposals from a tax perspective and lead to some advising that those with plans to exit their businesses should accelerate these strategies in order to avoid the potential increases, which were expected by some to be announced at the spring 2021 Budget.

In the wealth management sector, in which factors such as greater regulation and an ageing population of owners mean that many have one eye on the exit door, these fears were particularly pronounced. Faced with higher rates and the loss of certain valuable tax advantages, it’s no wonder many owners would have been seeking to accelerate their exit strategies.

However, in spite of the OTS’ recommendations, the government has not acted to increase CGT or reduce tax advantages for those selling their businesses, instead opting for a 1.25 per cent increase in National Insurance Contributions to help raise funds for health and social care. In late 2021, it was confirmed that plans to increase CGT had been shelved for now.

These issues haven’t disappeared, of course. Financial advisory and wealth management firms still face greater regulatory burdens than ever and there remains the possibility that CGT could be increased at some point over the coming years. However, these factors – which were such prominent concerns for advice firm owners 18 months ago – are now perhaps less time-intensive, meaning that owners seeking an exit from their firm needn’t be as rushed as they might have felt in late 2020 and early 2021.

What are the forecasts for M&A?

The consolidation that the wealth management and financial advice sectors have seen over recent years has attracted considerable coverage. This coverage is now increasingly turning to the issue of how long this period of strong dealmaking will continue for, with a range of forecasts made over recent months.

Speaking to the FT in January, Jason Hollands, Managing Director of Tilney, Smith & Williamson, said that he expected 2021’s levels of dealmaking in the sector to continue throughout 2022, although did not make any predictions beyond the end of this year.

Hollands commented: “This is a sizeable industry, that collectively looks after circa £1.7 trillion of assets, but it remains highly fragmented with more than 5,000 firms, most of which are small in size. The rising regulatory burden and need to embrace new technology are pressures on the industry that are not going to go away and are driving the need for increased financial and operational scale.”

More recently, a survey indicated that M&A in advice and wealth management could be set to carry on strongly well beyond the end of 2022. The survey, from Gunner & Co., found that 60 per cent of owners at financial advice firms are planning to exit their business within the next three years.

Making an exit from an advisory firm can be a complicated, drawn-out process and, in light of this, it seems that many owners are increasingly seeking to put a strategy in place now with a view to exiting in a few years’ time. This trend is something that should encourage a steady stream of deals over the next few years and help to keep strong M&A activity going for the medium to long-term.

The most optimistic prediction, however, came in a May 2022 report from LEK Consulting, which asserted that factors driving dealmaking within the wealth management industry meant that there was sufficient headroom to support “at least another 10 years of consolidation activities”.

While such a forecast will inevitably take a long time to be either borne out or disproved, the fact that it was made at all is indicative of the confidence dealmakers and market observers have in the capacity for M&A in the wealth management industry to, not only carry on at its current pace, but potentially accelerate even further.

What factors are encouraging M&A?

Perhaps one of the core reasons that predictions around M&A in the wealth management sector are so ambitious and long-ranging, is the simple fact that there are a huge array of different factors helping to drive the dealmaking trend.

The bulk of the trends identified in our last piece remain relevant, even if some of them are no longer as pressing as they were 18 months ago (CGT, for instance). Regulation remains a huge burden on owners at financial advice firms (particularly smaller businesses), while the possibility that CGT reforms could still be made over the coming years will no doubt be a factor encouraging some owners who are considering bringing exit strategies forward slightly.

On top of this, a range of other factors have become prominent in the interim, leading to a multitude of reasons why dealmaking in the advice and wealth management sector is expected to remain so strong.

Fragmentation remains
With such a high degree of consolidation in the wealth management space over recent years, it should stand to reason that the industry would have become significantly less fragmented. However, despite an extended period of solid dealmaking and numerous large-scale consolidators, this has not proven to be the case.

The number of firms in the wealth management sector fell by just 0.9 per cent between 2016 and 2019, despite M&A activity accelerating considerably in that time. According to Gunner & Co managing director Louise Jeffreys, fragmentation may not have diminished since then, with the sector having seen the entry of a growing number of new startups.

Overall, Tilney Smith & Williamson Managing Director Jason Hollands estimates that there are in excess of 5,000 firms operating in the UK wealth management sector, most of them relatively small companies. Clearly, when combined with other factors and pressures impacting the sector, this bodes well for continuing dealmaking over the coming years.

Consolidators have scope to ramp up
One of the major drivers of M&A activity in wealth management has been the presence of several large consolidators, who have sought to take advantage of widespread exit plans and the pressures impacting owners at smaller financial advice firms.

Interestingly, Louise Jeffreys of Gunner & Co argues that the dealmaking environment is moving away from large consolidators dominating acquisitions. As a more diverse array of buyers are now present in the wealth management space, it is certainly true that owners looking to exit now have far more choice when exiting than they might have done a few years ago.

However, that’s not to say that consolidators do not still have a major role to play in keeping M&A strong in the advice sector. In fact, while the firm’s MD argues that consolidators are becoming less dominant in the market, Gunner & Co’s research in fact reveals that 51 per cent of owners who are planning to sell their firms would prefer to deal with a consolidator (up from 43 per cent in 2021), while 30 per cent would prefer to sell to a consolidator startup.

Indeed, the fact that two of the UK’s leading consolidators, Perspective and Fairstone, have both recently hit the 50 acquisition milestone (with no signs of slowing down their activity) demonstrates that, while wealth management consolidators may now face more competition, they are not slowing their activity.

Clearly, given the continuing fragmentation of the market, the scope for consolidators to acquire at scale remains huge. Furthermore, according to LEK Consulting, by more efficiently harnessing resources such as technology and private capital, there is ample opportunity for consolidators of all stripes to ramp up their activities even further and fully take advantage of the diffuse nature of the wealth management sector.

Fairstone Financial Management is among the UK’s most prominent wealth advisory firms and with good reason, as the company’s downstream buyout (DBO) acquisition model has established it as one of the UK’s leading IFA consolidators over recent years.

The DBO model sees Fairstone acquire a minority stake in target businesses and integrating them over time before ultimately completing the acquisition. This method enables the target firms to optimise the value of their business, boost their profitability and grow their client base prior to the acquisition, which can then be completed with minimal disruption and integration risk.

The model has proven highly successful so far, with Fairstone recently reaching 50 acquisitions. Earlier this year, the company announced that it would be bolstering the DBO model, with changes that it claims will help target companies generate overall value equivalent to 12-18x their current profits.

The enhanced model aims to help new and existing acquisitions generate greater long-term value and will see Fairstone provide funding and support prior to completion, as well as capital for target companies to make their own acquisitions. Other features include agreed income and bonus levels for 10 years post-sale and a new profit-sharing scheme.

The move clearly signals Fairstone’s intent to not only continue with its ambitious acquisition model, but to scale it up even further and enhance its offering to potential acquisitions in an increasingly competitive marketplace.

Ageing population of owners remains
The fact that owners at many wealth management firms are approaching retirement age was discussed in our last piece on the sector and it remains just as relevant to M&A activity now. Figures we cited at the time showed that the average age of owners at independent financial advisers (IFAs) in the UK in 2019 was 58, with one in five at that point planning to retire within five years (i.e. two years from now).

Given the ongoing fragmentation within the wealth management market and the huge number of smaller firms, this situation has only intensified in the interim, with the average owner likely even older than in 2019.

Indeed, this is clearly demonstrated by Gunner & Co’s survey highlighting the fact that two-thirds of advice firm owners are planning to exit within three years. According to Gunner & Co’s report, 61 per cent of owners eyeing an exit within three years are doing so because they plan to retire, with a further 14 per cent targeting a sale as part of a longer-term plan leading up to retirement.

Rising multiples pushing hesitant owners to sell
Our previous piece looked mainly at reasons why owners were being pressured to sell, as external factors impacting the wealth management industry made it more difficult for them to operate as owners and made a sale seem like a more attractive option.

Now, however, it seems the popularity of wealth management firms among buyers has shifted the market more towards sellers, providing them with genuine incentives to sell, rather than just a list of reasons why they might rather exit.

According to Gunner & Co’s report, one of the factors driving owners to plan exit strategies is the simple fact that they can now attain higher valuations for their businesses. Gunner & Co’s survey showed that wealth management and financial advice firms this year are regularly being sold at multiples of over 4x their recurring income, up from an average multiple of 3.4x recurring income in 2021.

Gunner & Co attributes the increase in valuations for financial advice firms to the diversification of potential buyers. Over the past 18 months, the popularity of the wealth management market has only grown, resulting in a slew of new entrants. Whereas the larger consolidators that previously dominated the market may have sought to take advantage of the pressures pushing owners at smaller firms to sell, a broader pool of potential buyers has given owners more power and driven valuations up accordingly.

According to Gunner & Co’s Louise Jeffreys: “With new entrant buyers offering partial equity purchases, growth funding and more autonomy for the selling business – the M&A market is moving away from the dominance of consolidators we saw a few years back.”

Private equity to spur dealmaking short and long term
While it would be a stretch to call them a new entrant to the wealth management M&A market, one of the key forces broadening the pool of buyers in the sector has been an influx of private equity firms. As we’ve discussed in numerous insights over the past year or two, private capital has flooded into a huge number of sectors recently as PE firms look to invest the sums they accrued during the pandemic. Wealth management has been no different.

Private equity acquisitions were a trend identified by Tilney Smith & Williamson’s Jason Hollands as one of the leading factors in wealth management M&A last year. In 2021, Hollands says, the financial services industry saw “a wave of deals throughout the year of various sizes” involving private equity buyers.

Of course, private equity acquisitions of UK wealth management companies will also spur dealmaking by providing the target companies with the financial firepower to pursue large-scale, acquisition-led growth strategies.

In April 2022, European private equity firm Nordic Capital sought to tap into the UK’s booming wealth management sector with the acquisition of IFA consolidator Ascot Lloyd. The financial advisor, which had previously been funded by Oaktree Capital Management, has over 500 staff at 17 UK locations, more than 20,000 core clients and close to £10 billion in funds under management.

Under Oaktree’s ownership, Ascot Lloyd established itself as one of the UK’s fastest growing IFAs, tripling its assets under management and executing over 80 acquisitions since 2016. Post-acquisition, Nordic Capital will aim to drive this further, focusing on developing Ascot Lloyd’s digital proposition to improve its client offering, increasing the advisor’s focus on sustainable savings and accelerating its organic and acquisitive growth.

Ascot Lloyd CEO Nigel Stockton said the acquisition would “give us substantial new firepower to accelerate our growth, enabling us to increase the ambition of our acquisition strategy and further invest in people and technology to support our organic growth."

Discussing the acquisition, Nordic Capital cited the growth potential of the UK’s wealth management sector, which it said is being driven by greater focus on savings and higher demand for personalised financial advice.

LEK Consulting also named private capital as one of the key disruptors in the industry, saying that the fragmented wealth management market had encouraged consolidation and triggered “a wave of private capital to bankroll forward-thinking management teams.” LEK Consulting also raises an important point about how private equity acquisitions will also encourage dealmaking in the longer term, as private equity owners inevitably seek to exit their investments in a few years time.

Technology poses challenges, but could level up dealmaking
Technology is another factor that could begin driving a greater amount of M&A within wealth management. In the wake of COVID-19, people are arguably more concerned with managing their own finances in order to plan for the future and gain financial security. Technology will enable companies to deliver services to a far wider audience and customers will increasingly be looking for digital and live dashboard solutions to their wealth management needs.

Fully embracing such digital possibilities will of course require a strong degree of capital expenditure on behalf of financial advice firms. While the demand for smaller, regional IFAs offering personalised, face-to-face services might not necessarily be diminished by this trend, it may be the case that some firms with ambitious growth strategies will view M&A as the best route to unlock the tech-capabilities needed to tap into greater demand for financial services.

This may be through a sale to a larger operator or private equity firm that can bankroll a strong digitalisation strategy, or through acquisitions of smaller, digitally native financial advice and fintech firms.

Finally, as pointed out by LEK Consulting, technology could also help consolidators within the wealth management space become more effective buyers. Given the level of fragmentation still inherent in the wealth management sector, LEK says that consolidators can “industrialise” their M&A processes using technology.

This could significantly accelerate M&A activity within the sector, with LEK saying that “very few” consolidators are currently set up to fully take advantage of the industry’s fragmentation. If consolidators were able to harness technology in this way, then they could reap major rewards given the huge fragmentation that persists.

While it is impossible to predict with the slightest degree of certainty what the M&A market in any given sector will look like in 10 years, all the indications suggest that dealmaking in the wealth management industry, already strong, is on an upward trajectory.

Another clear development is that M&A in wealth management has accelerated considerably since the early part of 2020, when it appeared set for a temporary dealmaking boom. With customers placing a greater onus on their savings, ongoing fragmentation and a range of buyers entering the market, wealth management looks set to be one of UK’s most active M&A markets in 2022 and 2023.

Also read:
Wealth management firms and small lenders turning to acquisitions

Search BSR for wealth management businesses for sale

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