Models & Taxes: The Path to Higher Firm Valuations 

The mergers and acquisitions (M&A) market within the RIA space has been white hot for the last few years and there are no signs of it markedly slowing down. Given the convergence of several trends – thousands of advisors retiring in the coming years, an influx of growth-challenged registered investment advisors (RIAs), and more advisors seeking the independent model – we’re apt to see a large number of deals for the next decade, according to Cerulli¹. As advisors near their sun setting years or hit a capacity wall in their existing practices they begin thinking about ways to either increase the valuation of their practice or re-accelerate growth. While there are some things that can be done to course correct in the late innings, the true key is a consistent process throughout the RIA’s lifecycle. 

While the influx of private equity dollars has created a fast-flowing river of M&A activity, the notion of “RIA Aggregation” has remained a key focus of the known national RIA wealth platforms. But it has broadened outside the known industry leaders to many others pursuing bolt-on, tuck-in, or aggregation strategies. According to the Dimensional Global Advisor Study², nearly 10% of RIAs will have participated in some form of M&A in 2024 – up from just over 4% in 2020. Driven by purchasers searching for top advisor talent, the ability to gain prominence or enter certain geographic markets and, ultimately, to grow their firm’s assets, an intermediate M&A strategy has become just as essential a part of running an RIA as delivering high-quality investment outcomes or organic client acquisition.  

But that doesn’t mean any standard acquisition will do. According to the 2023 Fidelity M&A Valuation study³, 52% of acquiring firms have walked away from the deal table. Given that, acquisition targets need to make themselves look as attractive as possible and ​acquirers​​     ​ need to have the infrastructure​ to​ generate attractive ​return on investment (ROI)​ even when valuations may appear to be premium.  

The quicker a new firm can be integrated into its acquirer, the faster that acquisition can deliver value to the purchaser and lower the potential of account leakage. To best achieve this, firms need to ensure their client’s account moves and are invested in quickly as to not disrupt client outcomes, but importantly, be intentional to ensure that speed does not come at the sacrifice of scale. More often than not, model portfolios powered by tax-smart technology can help break through the barriers, facilitating positive outcomes for all stakeholders.  

Validation of Models as an M&A Tool 

It’s well known that models and other managed accounts continue to increase in popularity for advisors looking to deliver customized investment solutions. Cerulli found that more than half of top-ranked advisors are using models in some fashion in their practices and that assets for model portfolios are expected to reach $2.9 trillion by 2026¹ as these structures can help save time and allow advisors to make more efficient use of their time.  

In addition, there is tangible evidence that the intentional use of ​a ​models-based framework within an advisor practice can increase a firm’s valuation by providing both differentiation and ease of ​implementation​. Utilizing models not only aligns and scales the investment management process firm wide, but when accompanied with a scaled process, enables ​“​portability​”​ of the investment platform​,​ even when the investments change. Processes, particularly related to investments, that can continue and indeed expand once the firm has new leadership are a key differentiator when acquisition firms are looking for a fresh target. Advisors have demonstrated that models can easily align them into the acquiring firm’s existing investment strategy or make change much simpler and more efficient.  

Both Parties Benefit 

While ​it’s​ clear there are strategic benefits for advisors in utilizing models, there are benefits for the acquiring firm as well. Si​gn​ing a purchase agreement is just the beginning​.​ ​T​here is much work to do to complete an acquisition and it is in the best interest of both parties to integrate quickly to reduce friction for the end investor and to monetize the cost of the purchase.  

However, there are barriers to this process that must be overcome, including proper account paperwork to be signed, custodial integrations to connect, and investment strategies that need to be aligned. By utilizing a models-based approach, the acquiring firm can create consistent, repeatable and durable approach to their investment ​strategy ​during the all-important transition period and help boost its valuation post-acquisition while creating the organization confidence to move to the next target.   

All of this makes these transactions more productive and economically beneficial for both parties. Having an acquisition target that can more easily and securely be monetized not only makes it a more attractive purchase, but it also moves the transition process along much faster. Arguably, supporting and justifying higher multiples in newly originated deals.  

Get Smart 

The vast abundance​ of​ investment strategies like model portfolios gives advisors significant opportunities to transform and grow their practices while improving client outcomes. But often taxes are a major obstacle that prevents firms from efficient implementation – particularly at key moments when money is in motion. Wealth managers must be able to solve the tax transition problem at scale to facilitate the movement of investments, without ​compromising​ the after-tax impact to client​s​. Advisors should leverage tax-smart technology to quantify the tradeoff between taxes incurred and how closely their clients’ portfolios are sticking to their targets.  

Weaving in tax-smart tech and services throughout a firm’s platform will not only provide stronger client results but will also help to unlock operating efficiency and bottom-line results pre- and post-acquisition process. To see the full benefit of these services, they should be foundational to strategic planning. Tax-smart tech is also an area that, while growing, still hasn’t seen full adoption, so firms that opt to go this route have another differentiator between themselves and other acquisition targets.  

What You Can Do Now 

In too many cases, differences in investments or tax considerations act as barriers to driving beneficial outcomes to clients and firms. However, the firms that can find ​scalable​ solutions to work through these elements rather than around them by applying appropriate investment rigor and tax-smart tech – can create meaningful ​differentiation​​.

For those firms that have been acquired or completed acquisitions, it is not too late to extract meaningful value from these transactions by beginning to work with models and tax-smart tech as soon as possible to achieve the best outcome. 

This article was originally published in Wealth Solutions Report in November 2024. 

1- Cerulli: US Managed Accounts, Q3 2024 
2- Dimensional Fund Advisors: 2022 Global Advisor Study
3-Fidelity Investments: Unlocking Opportunities: Management Consulting Insights into M&A Dynamics 

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