How Do I Grow My RIA with the Cost of Capital So High?

Winter was a bit dreary, and it wasn’t just the weather. Talk continued about a potential recession and the U.S. Federal Reserve has yet to drop interest rates. Things seem brighter in Spring: Pundits say most of the Federal Reserve’s interest rate hikes may be in the rearview mirror.

David Selig, Matt Rozen and Rob Morrow working on a client valuation

Still, with the cost of borrowing money higher, buyers who need capital for growth through M&A may question whether now is the right time for a transaction.

Our view: RIAs should absolutely consider M&A — and specifically acquisition as a growth strategy — no matter what the Feds do. (Read Are you Predator or Prey about why challenging times make RIA growth and succession strategies even more important.)

Three reasons why an acquisition strategy is truly worth the costs for your RIA.

1. Strategic fit = more revenue: The acquisition target may have a complementary investment strategy or expertise that would add value to your firm's portfolio. By combining the two firms, your merged entity may be better positioned to offer a more diverse range of investment options to clients, which could ultimately lead to increased revenue and profits.

2. Cost savings: Despite the high cost of capital, there may still be cost savings through an acquisition. For example, the acquiring firm may be able to consolidate operations or eliminate redundant positions, resulting in lower costs and increased efficiency.

3. Access to new markets and talent: The acquisition target may have a strong presence in a market that the acquiring firm is interested in entering. By acquiring the target firm, the acquiring firm can gain instant access to that market without having to build a new presence from scratch. Plus, the target firm may have talented personnel or specialized expertise in new markets that would be difficult for the acquiring firm to attract on its own.

The cost of capital doesn’t need to impede your growth strategy: There are many players in the market, all with varying borrowing costs, who may be interested in acquiring or providing capital to your firm. When you have the right strategic playbook, you can get creative with financing.

5 M&A financing strategies to mitigate the impact of high interest rates and reduce the excessive costs of borrowing:

1. Cash and equity combination: Rather than relying solely on debt financing, successful M&A deals often involve a combination of cash and equity. This approach allows the acquiring RIA to utilize its existing financial resources while also leveraging the potential growth and synergies of the target firm. By using equity as part of the consideration, the acquiring RIA can reduce the immediate cash outlay and limit the impact of high interest rates.

2. Earn-outs and performance-based incentives: This approach involves setting certain financial or operational targets for the acquired firm. The consideration paid to the sellers is then linked to the achievement of these targets over a specific period. By incorporating performance-based elements, we align the interests of both parties and potentially reduce the need for large upfront cash payments.

3. Strategic partnerships and minority investments: Rather than pursuing a complete acquisition, successful RIAs may consider strategic partnerships or minority investments as alternatives. This approach allows for collaboration and sharing of resources, while minimizing the need for significant borrowing. By forming a strategic partnership or making a minority investment, the acquiring RIA can gain exposure to the target firm's expertise and client base, without incurring the full costs and risks associated with an outright acquisition.

4. Leveraging existing client assets: If the acquiring RIA has a substantial base of client assets under management (AUM), we may explore utilizing these assets to finance the M&A deal. For example, the acquiring RIA could offer the target firm's clients the option to transition their accounts to the acquiring RIA's platform. This increased AUM can provide additional revenue streams, enhance the firm's financial position, and potentially reduce the need for external borrowing.

5. Alternative financing options: Many RIAs today seek out private equity investments, venture capital, or strategic investors who are interested in the industry. These sources of capital may offer more favorable terms and conditions compared to traditional lenders, providing the acquiring RIA with more flexibility and potentially mitigating the impact of high interest rates.

These are just some of the ways we customize deals for our clients. So, whether you are merging, acquiring or otherwise partnering to grow your RIA, you shouldn’t be hindered by the current interest rate environment.

It’s always a good time to understand the right options to grow your RIA. If your firm is considering an acquisition or simply wants to discuss whether an inorganic growth strategy is right for you right now, we’re happy to start the conversation.

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This article was written by David Selig, founder and CEO of Advice Dynamics Partners. David has over twenty years of experience in M&A, management consulting and financial services. He serves as a champion and advocate for Advice Dynamics’ clients, as he shepherds them through their complex transactions.