Search for scale and specialist expertise point to increased dealmaking among asset managers

Fundraising challenges, higher financing costs, market volatility and an ever-tighter regulatory environment are upping the pressure for M&A among asset managers. Those drivers, however, apply differently depending on which segment of the market you’re looking at.

For many large, listed managers there is an imperative to build scale. Here, a general stagnation in asset performance is squeezing returns, with merger synergies one way to offset the associated fall in fee income. According to a recent PwC survey of 500 asset managers and institutional investors, 73% are considering an acquisition or merger over the next 12 months primarily as a defensive play.

Asset managers in the private markets are similarly looking to increase their assets under management (AuM) and protect fees, which are under increasing scrutiny from both regulators and investors. Among this group, however, we are seeing more focused M&A. Over the past decade, private capital has been gravitating towards a smaller number of multi-strategy mega firms, and in response many managers are looking to move into this bracket by building out their asset focus via acquisitions of boutiques that specialise in high-performing or niche classes such as private credit, infrastructure and secondaries.

Private managers behind some of year’s biggest deals

There were some significant acquisitions in this space during 2023, with CVC taking a majority stake in DIF Capital Partners, Bridgepoint acquiring Energy Capital Partners (two deals we explore in more detail here), and Man Group pushing into private credit via its purchase of a controlling interest in Varagon Capital. In addition, some of the better-known PE firms that focus on financial services (such as Reverence Capital and Apollo) have also acquired asset management platforms in recent years.

Looking ahead to 2024 we expect further deal-making across all segments of the market. We are not alone in this prediction; Partners Group CEO David Layton recently told the Financial Times that the current landscape of roughly 11,000 private asset managers could shrink to “as few as 100 platforms” over the coming decade. Ardian president Dominique Senequier is not predicting such an extreme period of change, but still thinks a 50% reduction in the number of players isn’t out of the question. Brookfield CEO Bruce Flatt, however, goes further, suggesting the industry could eventually coalesce around just 10 global giants.

There are some interesting nuances to asset manager deals that buyers should consider – from ways to protect fragile sources of value to the importance of preparing an existing platform for the deal. Here are some of the most important.

1. The value in asset manager acquisitions depends in large part on AuM, which can be vulnerable during an acquisition. Investors in open-ended funds can redeem their capital at short notice, and if a deal has the potential to shift the fund’s risk/return profile they may choose to take their money elsewhere. LPs in closed-ended funds do not have the same ability but may have change-of-control clauses that limit or block the general partner’s ability to make capital calls following a sale. Buyers in private market acquisitions will often look to protect against capital flight by building retention of AuM (or the fees generated from AuM) into deal terms as a condition precedent or price adjustment mechanism where the fall is assessed at closing. (Alternatively, where the assessment is carried out post-close, the protection may come in the form of an earn-out or deferred consideration). In U.S. private fund transactions, a change of control of a registered investment advisor is a deemed assignment of the advisor’s investment advisory agreements, meaning that some sort of client consents are required. Again, this typically leads to conditions precedent relating to obtaining fund and/or client consents, as well as price adjustments and earn-outs. For deals involving U.S. public funds, a change of control of the investment advisor would result in the termination of the investment advisory agreement with the public fund entity; a new agreement would require the purchaser to seek the approval of both the fund board and the public fund shareholders through an SEC proxy process. 

2. If the acquiring fund is a financial buyer and its limited partners (LPs) include institutional investors such as pension funds, regulatory restrictions - particularly in Europe - could impose limits on the target firm’s investment approach if it falls outside their risk parameters.

3. Retaining key investment managers is important in all deals and can be critical in some. The best individuals are essential to both investment performance and distribution, and in an acquisition may be a flight risk as rival firms look to seize on any doubts over the deal.

4. In some fund structures, LPs may have “key man” clauses that prevent further capital calls if particular managers leave.

5. Top managers will typically benefit from the performance of the investments they manage via carried interest, share awards or bonuses, which may include revenue- or profit-sharing arrangements. These structures encourage retention but may be impacted by an M&A transaction. For buyers and sellers, it’s crucial to understand the contractual and incentivisation arrangements for key managers so that they can assess flight risk and the need for additional retention or other bonuses, which may impact valuation.

6. In all deals it’s important to diligence the employment terms of these individuals, particularly any termination and post-termination provisions such as gardening leave and restrictive covenants. The UK government has proposed banning the use of non-competes that last longer than three months beyond the end of an individual’s employment (a similar debate is taking place in the U.S., where states including New York have either banned or limited the lawfulness of non-competes). In response, we are seeing some firms looking to negotiate longer notice periods and/or make greater use of gardening leave provisions to boost the longevity of their teams (you can read more here). If the changes go through, buyers and sellers may want to consider updating employment contracts to protect their businesses using such alternatives.

7. As a more general point, in the war for talent it’s possible to use guaranteed bonuses in the first year of employment to entice managers to move to a new platform and offset incentives they might leave on the table with their existing employer. As a defence, firms looking to keep key individuals may offer retention or other bonuses to incentivise continued employment post-completion. However, in the UK and Europe, firms subject to any of the FCA remuneration codes (and equivalent European rules) should be careful to navigate the regulatory rules on these payments.

8. Sellers will typically try to put the risk of key managers leaving onto the buyer, who in turn may press for a condition precedent linked to retention rates and/or the agreement of new contracts (while a formal condition precedent is relatively rare, it’s more common that the buyer simply will not sign until they are satisfied they have reached agreement with management). As a result, buyers will often have to enter into parallel negotiations: with the seller for the business, and with key managers to agree new employment terms and remuneration deals.

9. The asset manager’s client contracts will require careful diligence, not least in light of recent SEC rule changes designed to ensure more robust disclosure in relation to fee structures and the use of side letters, among other things. Another important issue to assess here is whether a negative consent process could be used to seek any necessary investor consents.

10. The scope and terms of current licences and permissions will similarly need reviewed as they may not transfer in a sale (or indeed a carve-out pre-sale reorganisation). Likewise, the buyer may need to extend its existing licences to match the transferring business or retain the target as a standalone entity within the group. Any regulatory DD will need to be forward-looking and consider the potential consequences of recent thematic reviews or market studies, as well as enforcement activity against peers.