What PE Sponsors Need to Know About Navigating Financial Services M&A

Private equity has long viewed financial services as fertile ground for value creation, and dealflow is accelerating, with M&A activity hitting a three-year high in 2024, according to PitchBook data. Here’s why.

The financial services sector encompasses, among other businesses, asset managers, insurance carriers and brokers, fintech companies, banks and specialty finance companies. While the industry offers attractive yields, stable cashflows and scalable platforms, deals require specialized knowledge and a tailored approach. Below are key considerations for sponsors.

1. Regulatory Considerations
M&A transactions in financial services are distinctively shaped by regulatory frameworks that impose approval requirements, disclosure obligations and ongoing supervision at the federal and state levels. Sponsors must understand what regulatory filings, licenses and consents are required, and negotiate appropriate covenants around approval efforts and responsibility for delays or denials.

• Insurance: Acquisitions of insurance carriers generally require approval in the insurer’s state of domicile through a Form A filing. A transaction triggers this process if a buyer acquires 10 percent or more of voting securities (or otherwise exhibits control). Regulators review detailed disclosures on ownership, financing, governance and strategic intent, and approval may subject the buyer to the Insurance Holding Company Act. That Act imposes ongoing obligations, including enterprise-level reporting, prior approval for distributions and affiliate transactions (via Form D), and restrictions on transfers of control. Regulators may also impose holding periods and assess Risk-Based Capital (RBC) levels to ensure solvency. A low RBC ratio can trigger dividend limits, required capital infusions or regulatory intervention, all of which impact value extraction and exit strategy. By contrast, insurance brokers and managing general agents (MGAs) face lighter regulation, though buyers must confirm licenses are current in all jurisdictions and secure required notices or approvals.
  
• Asset Management: These deals hinge on client consents rather than regulatory approvals. Under the Advisers Act, a change of control (presumed at 25 percent or more of voting securities) automatically terminates advisory agreements unless affirmative or negative consent is obtained. Transactions often include a closing condition requiring consent from a set percentage of the target’s AUM (e.g., 85-95 percent of AUM) or run-rate revenue. Buyers must also update the target’s Form ADV, and SEC post-closing reviews are common.
  
• Fintech and Specialty Finance: These businesses often rely on state lending, servicing or money transmitter licenses and in some cases, chartered bank partnerships. A change of control can trigger regulatory notice or approval requirements from state banking departments, the CFPB, or other relevant regulatory bodies.
  
• Banking: Acquisitions of U.S. banks raise unique regulatory hurdles and are rarely pursued by private equity sponsors without careful structuring. While control is presumed at 25 percent of voting securities (or 33 percent of non-voting), the Federal Reserve can find control at lower levels based on governance rights or influence over management. Control generally requires Federal Reserve approval and subjects the buyer to the Bank Holding Company Act (BHCA), which imposes capital and liquidity requirements, consolidated supervision, restrictions on non-banking activities and the “source of strength” doctrine, potentially exposing sponsors to unlimited liability. To avoid BHCA status, sponsors typically favor structured minority stakes, cede certain governance rights and agree to limits on influence, allowing economic exposure without triggering control.

2. Due Diligence Considerations
In addition to standard financial, legal and operational diligence, deals in financial services demand closer focus on licensing, compliance, capitalization and regulatory or reputational risks. The core areas that warrant particular attention include:

• Regulatory Compliance: In the financial services sector, regulatory compliance is a value driver so a strong compliance program can serve as a selling point and a weak one can trigger valuation discounts or cause a deal to die. Buyers must assess whether the target is properly licensed and determine what filings or approvals are required to complete the transaction. In addition, buyers should review the target’s regulatory history, such as past exams, consent orders or supervisory letters from agencies like the SEC, FINRA or state insurance departments, as well as any prior disclosures.

• Financial Diligence: Unlike most industries that rely on GAAP and Ebitda, financial services businesses use statutory or regulatory accounting frameworks. Insurance companies report under Statutory Accounting Principles (SAP), requiring diligence on reserves, reinsurance, dividend capacity and reconciliations to GAAP. Asset managers require review of carry economics, GP/LP splits, clawbacks, revenue sharing and deferred comp, while specialty finance focuses on loan performance, reserves and underwriting discipline. Understanding these alternate systems is essential to accurate valuation and risk assessment.

• Third-Party and Client Consents: As is the case in other industries, change of control provisions are common across financial services contracts. Early identification and mapping of required consents can significantly de-risk the closing process.

• Cybersecurity and Data Privacy: Given the volume of personally identifiable information collected and stored by financial services businesses, buyers should assess which cybersecurity regulations the target is subject to and whether they have experienced any data breaches, lapses in compliance or enforcement actions.

• Intellectual Property: Fintech companies, given their high reliance on consumer data, often require more intensive technical diligence, including code scans and IP chain-of-title analyses.

3. Economic Considerations
Unlike typical Ebitda-based deals with working capital adjustments, financial services transactions frequently rely on alternative valuation methods and creative earnouts to bridge gaps and manage uncertainty. Below are key considerations for sponsors when structuring terms.

A. Valuation
How purchase price is determined in financial services deals depends largely on the subsector of financial services that the target operates in and on what underlying metrics most directly reflect enterprise value.

• Asset Management: Based on AUM, run-rate revenue, management fees or Ebitda.
• Insurance: Based on statutory book value for carriers and revenue or Ebitda for distributors.
• Specialty Finance/Banking: Based on price to book value of the loan portfolio or other balance sheet assets.
• Fintech: Early-stage companies often use revenue or platform engagement metrics, while more mature companies use Ebitda.

B. Earnouts
Earnouts are common in financial services M&A to bridge valuation gaps and align incentives. They often tie to sector-specific metrics such as AUM, management fee revenue, NAV or loan performance, and in fintech, to revenue growth or user milestones. Earnouts address valuation, client retention, key person and asset performance risks while giving sellers upside for meeting post-closing expectations.

C. Purchase Price Adjustments
In most industries, purchase price adjustments focus on working capital, debt or cash, but in financial services they must be tailored to business-specific value drivers and regulatory risks.

• Asset Management: Based on AUM or management fee run-rate, often with thresholds set at 85–95 percent of the levels at signing and paired with closing conditions related to client consents to adjust for client attrition risk.
• Insurance: Adjustments based on statutory vs. GAAP book value or RBC ratios to ensure post-closing capital adequacy.
• Specialty Finance: Adjustments typically rely on book value with adjustments reflecting changes in NAV, loan loss reserves or servicing-related liabilities, which are key indicators of the health of the underlying loan portfolio.
• Fintech: Adjustments tend to follow more conventional approaches such as working capital adjustments.

4. Key Person Considerations

In many financial services businesses, the people are the product, making key person risk central to both diligence and post-closing strategy. Buyers must assess compensation, covenants and licensing during diligence, and then deploy tools to retain and incentivize key individuals like restrictive covenants, earnouts, and equity and incentive compensation.

Financial services M&A offers private equity sponsors a compelling mix of recurring revenue, scalability and long-term growth potential, but realizing that potential requires navigating a complex regulatory, structural and operational landscape. For sponsors willing to engage with that complexity, the financial services sector has become one of the most durable and dynamic areas of private equity investment.