We are pleased to announce that Ropes & Gray LLP has formed a dedicated asset management M&A team, co-chaired by Ariel Deckelbaum, Scott Abramowitz and Greg Davis, which includes more than 180 attorneys from various practice areas, including our asset management, M&A, tax and employee benefits practice groups. We look forward to meeting with our clients and friends to discuss how our knowledge and experience in this area may be helpful to you. To mark the launch of this new team, we would like to share some observations on the current state of the market.
To begin, we note that it is hard to talk about asset management deal activity these days without turning to the topic of asset management M&A. Transactions involving the asset managers themselves—whether between one manager and another in a consolidation or growth play or with third parties seeking exposure to GP economics or to assist with generational transitions—have been steadily on the rise for several years. Managers who have traditionally earned healthy fees for deploying third-party capital into operating companies are increasingly considering transactions for the house account. In an M&A environment that has been increasingly challenged of late, these are some of the largest and most high-profile transactions to be announced. Asset management M&A transactions have taken a variety of forms but largely consist of control transactions, minority stakes, lift-outs, lift-ins and joint ventures.
Below, we take a broad look at market trends and key terms.
- The Numbers. To begin, here is a snapshot of some recent market
data.
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- Drivers. The old adage that "bigger is
better" has taken hold in the asset management industry. Not
only have managers raised increasingly larger funds, but they have
also sought to grow their firms by acquiring additional AUM in the
same or parallel strategies. Similarly, as managers have sought to
institutionalize their firms and ensure their staying power, they
have tried to build more diversified platforms, adding new and
often complementary products that can deliver a broader
fee-generating platform and better withstand macroeconomic shifts.
Asset management M&A transactions have therefore sought to add
AUM, new managers and new platforms, as well as geographic
diversity.
- Access to Alternatives. Registered fund sponsors have sought to diversify their retail product offerings by adding on alternatives platforms, while traditional LPs and dedicated funds seek minority stakes and participation in the GP economics of private equity, real estate, and hedge and credit firm managers. As wirehouses and feeder platforms seek to provide retail investors with access to privately offered funds and investments that have historically been available only to institutional investors and ultra-high-net-worth individuals, M&A is a tool being used to accelerate such expansion.
- Market Participants. No one is immune. Recent
transactions have seen participation from a wide variety of
participants. Of course, it all starts with willing
managers—but given the attractive valuations that have been
available, the potential liquidity opportunity for founders in
parallel with permanent capital to fund growth and participation by
future generations, there has been no lack of managers who see a
once-in-a-lifetime chance to address succession or grow their
platform. At the same time, the number of potential investors has
been steadily increasing. Much of this trend started with investors
seeking stakes to benefit from GP economics by means of equity
investments, revenue-sharing arrangements or structured financings.
Insurance managers and pension funds were also early participants
because they wanted preferred access to investment opportunities
and, in some cases, saw their initial investment as a stepping
stone to a control stake through which they could actively manage
their assets "in house." More recently, the demand by
retail investors for access to alternatives has led registered fund
sponsors to invest in or develop such platforms.
- Key Terms – Economics. With the number
of potential investors and pools of capital growing faster than the
number of mature managers, it is no surprise that valuations have
increased markedly. Even in the current economic environment, which
has challenged the valuation of many companies, managers are still
able to attract double-digit multiples for their management fees.
However, unlike minority stakes, which are largely acquired for
cash, most control transactions have been funded by a combination
of cash and stock, with the stock component often constituting a
majority of the consideration. In addition, many transactions
include some form of earnout that is tied to future performance or
growth.
- Key Terms – Management. The ability to
retain management is the sine qua non of almost every
asset management M&A transaction. Management is typically
incentivized through a combination of carrots and sticks that
include ring-fenced compensation pools and bonus opportunities,
vesting and forfeiture of non-cash consideration in the event of
early termination (with exceptions for death, disability, good
reason and termination without cause) and a suite of restrictive
covenants. The typical commitment period is five years, but it can
range from three to seven years.
- Key Terms – Governance. Many asset
management combinations are similar to joint ventures in that two
or more teams come together to build on their respective strengths
while needing to protect their individual assets, at least for some
initial period (especially in order to retain the team for the
initial commitment period as well as the ability to realize any
deferred consideration such as an earnout). Outlining the scope of
each party's responsibilities is critical to setting
expectations and aligning on the path to success. The topics that
arise most often in addressing governance include defining
oversight over day-to-day operations, investment decisions, hiring
and firing decisions, as well as authority over strategic decisions
such as budget, future M&A, the incurrence of debt, liability
management, GP economics, and decisions to launch or terminate
funds or strategies. Arrangements as to these matters may also lead
to discussions about board or committee representation.
- Key Terms – Legal. Like any M&A
transaction, it is important for the parties involved to address
contingencies and allocate both execution risk and exposure to
historical liabilities. Given that asset management transactions
are valued based on AUM and the ability to generate recurring fee
revenue, it is common to provide for conditions that address
minimum AUM and client consents. These are often observed in
control transactions in which there may be an adjustment to the
purchase price relative to a specified client consent threshold as
well as a related condition. Other common adjustments to purchase
price often address working capital, indebtedness (including
severance, bonus and similar liabilities) and transaction expenses.
Transaction agreements also include extensive representations and
warranties, though, like in other facets of the M&A
marketplace, indemnification is often limited through the use of a
representation and warranty insurance policy.
- Key Terms – Tax. When equity consideration is used, it is important to structure the transaction to achieve tax deferral for the equityholders of the target. As with any M&A transaction in which retaining and incentivizing management is paramount, there is often tension between the buyer's desire to make management's receipt of consideration contingent on future employment, on the one hand, and sell-side management's desire to obtain capital gains treatment, on the other. In many cases, this tension can be managed by imposing employment restrictions on stock consideration rather than cash consideration or by using an earnout based on performance metrics rather than employment.
Finally, we note that, unlike in prior cycles, it appears that this subset of the M&A marketplace is here to stay. M&A among managers is now recognized and deployed as a tool to address long term strategies and is part of the regular discourse on planning for the future. We are pleased to share our observations and experience in the hope that they may be helpful to you.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.