Look Toward the Future
Art by Melinda Beck
The COVID-19 pandemic has made it clear that business owners need to prepare for the unexpected and have a continuity plan for their firm. Retirement industry insiders point to plan adviser firms especially, where CEOs are apt to be older, putting them at greater risk of a COVID-related—or other—illness. Adding to the urgency, succession planning has long been a blind spot for most boards.
Financial advisers focused on serving retirement plans and clients who own individual retirement accounts (IRAs) are used to talking about the financial transition that people eventually make from earning a steady income to living off of accumulated assets and investments. For any number of reasons, there is much less attention paid to an adviser’s own long-term financial future, and many of these professionals nearing the traditional retirement age have yet to seriously plan their next step. They realize their business is valuable, but how to extract that value is another question, and so is what happens to clients.
“The pandemic has certainly heightened the sense of urgency in all private businesses on succession planning,” says Alicia Goodrow, a partner at Culhane Meadows in Houston, who focuses on succession planning. “Businesses, including retirement- and wealth-management-planning businesses, owned by healthy, engaged people in their 40s, 50s and 60s, are seeing the very real possibility of debilitating illness or death as a high-risk factor for them and their business. Clients are beginning to ask, quite bluntly, what plans their senior advisers have made.”
Advisers starting a business together do not want to talk about succession planning on day one, she continues, “but there is the human factor. You need to know your partners’ life goals and their spouse’s goals, and those conversations should be ongoing. The conversation should be revisited regularly. If there is an illness or an industry change, it’s easier to have started the planning early on.”
Dimensional Fund Advisors’ 2020 Global Advisor Study notes that the main succession-planning-related challenges that firm owners report are deciding on their successor (49%) and then on a time frame for the transition to take place (28%). Some firms seek their successor externally, in next-generation talent who often join the firm through an acquisition.
“The study results highlight the large number of advisers who are approaching retirement and need to consider their succession options,” says a representative for Dimensional Fund Advisors. “Of the firms that have a documented succession plan, 46% are looking to execute their plan within the next 10 years. When looking specifically at sole practitioners, the study indicated that 43% plan to exit in five years or less.”
While Goodrow has seen some retirement plan advisers making preparations to retire in the next 24 months, “with the market generally trending up and the uncertainties of estate planning and taxes, most planners who were considering retirement in 2021 are waiting a couple of years to take advantage of the activity in the market right now,” Goodrow says. “Many clients are relying more heavily on their planners in these times of uncertainty, so business is good.”
John Anderson, managing director and head of practice management solutions at SEI, in Oaks, Pennsylvania, says, as of yet, he has seen few retirement plan advisers leaving the business. “But what I find most times when people are coming out of a major event, be it a stock market disruption or, now, a pandemic, is they tend to reassess their business,” Anderson says. “In all likelihood, some advisers will say to themselves, ‘Is it time to move on and do something different, or retire?’ Then there may be those who, because of the current inability to conduct in-person meetings or training with sponsors and participants, will reassess their business model. For those who had wanted to capture IRA rollovers from retiring participants, this is now more difficult because it’s no longer in person. Those advisers who have fully embraced technology have done much better, and these are the ones who are likely to remain in the industry.”
Succession Planning as Part of M&A
The increase in mergers and acquisitions (M&As) is somewhat linked to the need for succession planning, as firm owners seek options. Goodrow has represented two advisory organizations that have recently rolled into a bigger group, but, she says, “Succession planning is still a relevant topic because they are keeping a piece of the equity, and as a group they have a responsibility for growth. Even though there’s a different dynamic, with a bigger player at the table, that roll-up is rarely a 100% exit.”
For a retirement plan adviser looking to sell his business, if the practice is large enough, Goodrow suggests that he form a mini “think tank” of outsiders, including his attorney and an investment banker, to help him value his business and develop an exit strategy. This group can help him determine whether he wants a cash deal or whether he would work with an “earnout or seller-financed transition”; the latter, however, can be risky, she warns. The adviser could also consider selling to a pool of employees or merging with another practice, she says.
According to Anderson, advisers looking to exit the business should evaluate their firm fairly. “That will give them a better understanding of its value and what the discount might be,” he says. “Many advisers think their practice is worth more than it really is.”
Goodrow points out that advisory businesses are structured as S corporations or LLCs—companies that have few fixed assets. Thus, it is important that advisers examine their client relationships, as those will be considered when evaluating a transaction. An acquiring firm will also examine what the assets under management (AUM) look like and whether these will hold when the next generation succeeds.
Pricing the portfolio is complicated, Goodrow observes. “People don’t consider how sticky their clients are, or what their organization’s money situation is.”
M&As among retirement plan practices and registered investment advisers (RIAs) continue to be strong, says Amy Philbrook, head of core market sales at Fidelity Workplace Investing in Boston. “There are a lot of motivated buyers and sellers out there, and private equity [PE] continues to play a big role in this space.” Also, because so much client service is now being handled virtually, “those advisers looking to hand their business down to a successor or someone with a local tie find their market has widened,” Philbrook says.
Planning Ahead
Like Goodrow and Anderson, Philbrook says an adviser seeking to exit the industry now should consider retaining a consultant to help value his business and assess the potential market for the sale. For those planning this move a little further down the road, perhaps in three to five years, “they have the time to get up to speed on the market and potential markets and should also evaluate their firm’s value drivers, increase them and do networking,” she says.
If a deal is struck, it is critical for advisers to ensure technology and service models have been established to ensure a smooth transition, before informing clients. “You need to have the infrastructure in place first,” Anderson says. “You also need to communicate the change as a positive. Point out the enhancements that the buyer will bring to the table.”
Philbrook agrees. “Underscore the core values relating to client experience that you have in common with the business, and tell clients what they can expect in terms of continuity and increased value—how the transition will improve their client experience and why they are incredibly fortunate to be handed off to a [new] partner.”