LAS VEGAS — While many advisers think an outside sale will tend to generate a bigger windfall for a founding principal than an inside estate, RIA lenders argue that’s not necessarily the case.
Panelists at M&A advisory firm DeVoe & Co.’s Elevate conference in Las Vegas on Wednesday argued that with good forward planning and a multi-year time horizon, moving equity from the business to second-generation leaders may result in a bigger payout for an owner than a one-off sale to a serial acquirer.
Session moderator and DeVoe & Co. managing partner Brad Grubb (pictured, far right) kicked off the panel by sharing data showing that around two-thirds of RIA owners are unconvinced that executives of the next generation of their business have the financial ability to buy them. outside. He noted that even if successors can afford to buy, internal transactions are usually at a considerable discount to a company’s technical valuation. Meanwhile, with fierce competition among acquirers pushing sale prices up, RIAs can reasonably expect to receive a premium of 20-40% above their valuation via an outside transaction, it said. he declares.
So why would an RIA owner choose to transact internally? PPC Loan managing partner Dustin Mangone (pictured, second from left) explained that for some, ‘it’s an opportunity to reward those who have helped grow the business where it is today, as it is unlikely that this assessment would exist without this team in place.’
Contrary to popular belief, it doesn’t have to be expensive for the owner, he said, as long as the owner takes proactive steps to put successors in a position to meet the required terms of sale.
One such measure is to assign small amounts of “workability” over time to leadership-minded employees who participate in the growth of the business.
“The ability of these people, the next generation, to maybe earn a little sweat over the years, it shows on their personal financial statements,” Mangone said. Holding a few percentage points of debt-free equity can bolster an inside buyer’s cash flow to support ongoing debt repayments when borrowing ahead of a more substantial equity buyout, he said.
Live Oak Bank Head of Investment Advisory Loans James Hughes (pictured, second from right) chimed in to note that issuing shares over time helps employees start thinking and thinking act like business owners. This traditionally manifests itself in an increased focus on organic growth, which ultimately pushes the company’s valuation even higher.
The option for successors to buy shares over time in “slices” can also bring more cash to the seller, according to Mangone.
“If I have three next-gen buyers approaching us to buy 100% of a business, they are probably looking at a large amount of self-financing – 20% to 40% in some cases, depending on the strength of the borrowers,” he said, noting that lenders won’t want to make loans that leave borrowers over-leveraged and unable to make payments.”If these three buyers have been chipping away at and buying stocks in installments over time, the seller gets all the money through those first tranches. Then, five to 10 years later, you’re probably looking at a cash payout, potentially, for that buyout as well. And since they’ve created a debt-free equity position, they’re able to pay a higher price.
This type of positioning also helps to protect against possible cash shortages that may result from uncontrollable external factors, such as, for example, a prolonged market downturn.
However, to realize these benefits, RIA owners must begin developing a succession plan long before they are ready to execute it.
“This kind of process and discussions need to start early – as early as 10 to 15 years old for a full transition to capital,” Mangone said.