It is no exaggeration to say that the UK wealth management sector has, over the past five years, been transformed by private equity.
Attracted by a fragmented market and the prospect of rolling returns from sticky clients, private equity has piled into wealth, snapping up advisory firms with the potential to scale.
For some in wealth, the net effect of this cash influx has been positive: increased investment; better terms; greater profile and growing market share.
For others, private equity investment — or the prospect of it — is perceived as negative for both the buyer and the target firm.
As someone who works to connect investors with wealth management, I believe that, when done properly, the benefits to both can be enormous.
But achieving a successful investment in the wealth sector requires more than a decent audit and a spot of due diligence. Other factors — some tangible, some less so — are crucial.
Dangers of debt
The Financial Conduct Authority put its finger on the most significant hurdle to success in its recent review of consolidation across the UK financial advice and wealth management sector.
In its review, the regulator recognised the benefits of scale to wealth management firms and was clear that under-resourced growth strategies are dangerous.
Just as private equity firms considering investment in this sector need to adhere to both the letter and spirit of the FCA’s regulatory guidance on debt management, so too must target firms demonstrate realistic, well-resourced growth plans and avoid over-reliance on borrowed money to fund expansion.
The good news, as far as the regulatory burden is concerned, is that the FCA did not introduce any new rules alongside its recent review.
It instead signalled that it would apply existing frameworks (such as duty FG20/1 on adequate financial resources; duty FG24/5 on change-in-control; and the consumer duty on good customer outcomes) more robustly in future.
This shifting regulatory context means that private equity is more likely to look at wealth targets that show prudent financial management, sound governance and readiness for closer regulatory scrutiny. As far as investors are concerned, these qualities indicate a partner capable of sustainable growth.
On the flip side of the coin, wealth management firms considering private equity investment should view regulatory compliance as a strategic asset. Firms that engage early with the FCA, invest in compliance infrastructure and treat the consumer duty as part of the customer journey will find the investment process far smoother.
Importance of integration
In its recent review the FCA also highlighted the crucial importance of integration.
Successful deals were characterised by consolidators with strong governance, combined group-wide management information, and dedicated integration teams, the regulator found. Weaker firms executed minimal due diligence and left legacy systems in place.
The practical challenges of achieving successful post-purchase integration should not be underestimated. Aligning data, back-office systems and governance frameworks across businesses with different operating cultures requires early planning and clear accountability.
While responsibility for achieving this lies with the buyer, private equity will be attracted to wealth firms that it can easily fit into its existing systems.
Again: the process of integration should not be understood as an unnecessary hassle, the benefits can be enormous. Done well, integration delivers unified platforms, modern data systems and clearer oversight — improvements some smaller firms may not have the means to build alone.
Automation and digital tools are increasingly being used by consolidators to achieve efficiencies at scale, freeing financial advisers to focus on clients rather than administration.
Culture before cash
A common problem with wealth buyouts is that advisers and senior management who suspect malign motives on the part of their new owners simply leave, taking valuable knowledge (and potentially client relationships) with them.
I think it is worth remembering that wealth management is, at its core, a relationship-based business.
Just as firms with deep and long-standing adviser/client relationships will be the most attractive to buyers, so private equity should take care to ensure the transition to a new model of ownership is as smooth as possible.
One well-established means of retaining key staff is the ‘earnout’ clause by which a purchase price is contingent on financial performance over time. This can be effective, but cultural alignment can be more powerful.
To conduct a successful investment in wealth, private equity should take care to ensure buyer and seller share the same broad ambitions and values. It is also important for staff to recognise the long-term benefits private equity investment can bring.
There is also a need to maintain robust delineation between fiduciary advice and commercial ownership, with strong controls around technology integration, operational resilience and data protection.
New old money
FT Adviser has previously reported on how, five years on from private equity’s initial burst of interest in the UK wealth sector, investors — and the investments they make — are growing in size.
The target firms for this second wave of private equity attention are likely to be those that cater for the needs of the generation now taking control of family wealth.
This younger client group want a different kind of service: digital, clear, and built around their values. Wealth firms that rely on legacy systems and relationships will not connect with this new audience.
The most successful of these investments will, I predict, involve buyers and sellers with matched corporate cultures, a strong grasp of the regulatory challenges, and detailed integration plans.
Andrew Wingfield is a partner at Proskauer