Passing the Torch

How to start thinking about a succession plan for your practice.
Reported by Judy Ward
Art by Claire Merchlinsky

Art by Claire Merchlinsky

While retirement plan advisers are gifted at planning for participants’ futures, they do a notoriously poor job of planning for their own—a situation that Jeremy Holly, senior vice president at LPL Financial in San Diego, finds supremely ironic. Many wait until they are close to retirement age before thinking about a succession plan for their practice, he says.

Why the inertia? “On the positive front, when financial advisers start their own firm, it’s because they love the profession. Years later, they still love it, and many don’t want to leave the profession,” says John Furey, principal and founder at consultant Advisor Growth Strategies in Phoenix. Many also have built up a comfortably profitable business that they hesitate to leave, he says. “The third element is the whole notion of ceding control. It becomes like a founder’s syndrome: ‘No one can do it better than me, and therefore I can’t sell my business.’ So the vast majority of advisers defer, defer, defer, because there is no trigger event, nothing pushing them to do it,” he says.

Meanwhile, clients and employees start feeling doubts. “Your clients are wondering, ‘You’re getting older. What happens if something happens to you?’ Over time, clients’ confidence in your firm is undermined,” Furey says. “Your practice might grow less in the last years of your career” as some clients and key employees leave amid the uncertainty. That ultimately makes the retiring adviser’s firm less valuable.

“Not addressing your succession plan creates risk, in terms of your clients’ and your employees’ confidence in your firm’s future. The longer you wait, the higher the risk gets,” Furey says. “For some financial advisers, that might be absolutely OK. They may think, ‘I want to help my clients as long as I possibly can, and I’m willing to take that risk.’ Where advisers make a mistake is if they assume that if they wait as long as possible to sell, there will be a willing buyer. By the time those advisers leave, there may not be much value to their practice.”

Defining Succession
When David Grau Sr. talks to advisers about succession planning, he uses the term very specifically. “In this industry, many people use the term ‘succession planning’ generically to mean ‘sell.’ And then when advisers think ‘sell,’ their first reaction is, ‘I don’t want to sell my business now,’” says Grau Sr., president and founder of FP Transitions LLC, a succession-management and valuation consultancy in Lake Oswego, Oregon. “What we mean is to build something internally—a business that is durable and sustainable.”

An internal succession plan does not happen all at once but incrementally, over a decade or more, Grau Sr. says. An adviser mentors a successor and builds a multi-tiered staff that he likens to a law firm’s practice of having senior partners, junior partners, associates and paralegals. “You attract young folks to your enterprise and allow them to buy into the equity structure, little by little, over the years,” he says.

Advisers interested in putting an internal succession plan in place need to think about four cornerstones, to begin, Grau Sr. suggests. The business itself should be structured not as a sole proprietorship but as a business entity that facilitates a transition of ownership over time—e.g., a limited liability company (LLC) or an S corporation. Second, he says, think about the organizational structure needed to create a durable business and to gradually transfer leadership. “The goal is to build a single business, not multiple books,” he says.

Third, the compensation structure needs to balance rewarding advisers for their strong short-term performance with keeping a long-term focus. “Compensation, nine times out of 10 in our industry, is oriented entirely toward production and growth. What happens is that, after a while, your producers grow into super-producers who can make $300,000 to $500,000 a year—and eventually they walk across the street and start their own business,” Grau Sr. says. “Instead, hire them with a base salary and a bonus structure. Then, after three, four or five years, if these employees have earned it, allow them to start buying into the firm’s equity.”

Fourth, to create a long-term sustainable business, he says, an advisory firm needs the right operational practices for profitability. “It has to be a scalable business,” he says. “If you structure it correctly, an advisory firm can get a 30% annual return or more. For a younger employee earning equity in the business over time, that’s the investment of a lifetime. Where else can you earn 30% a year or more on your investment and get a paycheck and a mentor?”

Internal succession also has its challenges. It requires diverse skills and takes years to strategically integrate an employee/successor into a leadership role with clients and employees, says David Grau Jr., founder and CEO of Succession Resource Group Inc., a succession-planning consultancy in Tualatin, Oregon. “Most businesses hire reactively; they get busy and hire staff to take work off their plate,” he says.

“Begin with the end in mind, and you will hire proactively for the firm you want to build and have much better succession options,” he says. If advisers focus on new hires who excel at business development, those people may have great sales ability but lack the operational skills needed to run an advisory firm.

“When you need somebody to come in and potentially carry on your legacy, you start looking for another layer of qualifications,” Grau Jr. says. “If you are considering two hires to help your business grow, one who is great at selling and the other who is good with selling but stronger operationally, the choice isn’t as clear if you are thinking long term.” And once an adviser hires the next generation of talent, he still has years of training to do while also running the business, he adds.

An adviser serious about internal succession should start the process at about age 50, Grau Sr. recommends. “A succession plan, at an absolute minimum, takes five to 10 years, and 15 to 20 years is more likely. Starting at 50 lets you gradually throttle back, as the next generation in your business steps up,” he says. “But that can take 20 years to get it finished, and it requires an adviser to know how to build a sustainable business. That’s not for everybody.”

Acquisitions and Mergers
For some advisers, particularly with smaller practices, an external succession makes more sense. “A lot of folks don’t have an internal succession plan, so their succession is a one-time transfer of ownership,” Holly says. “The adviser sells his or her practice and then typically exits the business within about six months.”

About 80% of advisers selling their practice transition to an external acquirer, usually another adviser at the same broker/dealer (B/D), Grau Jr. says. “More often than not, it’s somebody who is just like the retiring adviser but 20 years younger,” he observes.

Selling to a large vs. a small acquirer each has pros and cons, Furey says. “There is less risk in getting acquired by a larger firm, because the larger firm is more experienced in doing acquisitions and it is better financed,” he says. “But a larger buyer might have a pre-set way of doing acquisitions, and if it has worked well in the past, the buyer is not really going to deviate from that established plan.”

If a retiring adviser finds a peer adviser interested in buying, the peer may offer more flexibility in the timing of the retiring adviser’s departure, as well as in how he turns over his clients and employees, Grau Jr. says. However, the peer may offer a less profitable deal than a larger acquirer.

For an external sale, the biggest drivers for valuation are cash-flow quality and transition risk, Holly says. “Cash-flow quality refers to the repeatability of a practice’s revenue streams and [to] running an efficient, profitable business,” he says. “Transition risk refers to the likelihood that a selling adviser’s clients will transfer to an acquiring adviser.” Transition-risk factors include whether the selling adviser plans to exit the business immediately, whether his billings are concentrated with a small number of large clients, whether client tenures with his firm are long, short or mixed, etc.

Compared with internal succession, getting acquired by a well-established buyer can mean a more lucrative deal for the retiring adviser, in Grau Jr.’s experience. “With the external deals, will you get paid more and faster? Yes, is the short answer,” he says.

However, an external sale can pose more trade-off dilemmas than an internal succession. “The biggest challenge is prioritizing purchase price vs. ‘fit,’” Holly says. In this case, “fit” refers to factors such as compatible beliefs about how to serve clients, similar work processes, and personalities that mesh well, he says. “Most advisers enter into this process saying, ‘I want to maximize my practice’s valuation.’ But then they change their mind to prioritizing fit. They say, ‘I’m going to take the lower offer, because this adviser is a better fit for my business and my clients.’”

To help ensure both a good fit with the acquirer and more growth potential in their business, more advisers nearing retirement these days are opting to do a multi-year merger rather than a one-time acquisition, says Greg Opitz, executive business coach at Peak Advisor Alliance, an adviser coaching and consulting company in Omaha, Nebraska. “I call it ‘strategic succession,’” he says. “Think about a 60-year-old adviser who finds a 45-year-old adviser with a bigger firm, who wants to keep growing.”

“Let’s say these two advisers fit culturally. If they merge, instantly the merged firm becomes larger, it has more resources, and it has more scale and better margins,” Opitz says. “They can have one website and one story to tell clients but keep the financials separate in the beginning.”

Then the two advisory firms see how it goes. “If they are together for a year or two and then they have a falling out, they can unravel things. So if they are ‘dating’ and it doesn’t work, they aren’t ‘married,’” Opitz says. “If it works well, three or four years down the road, the adviser in his or her 60s can say, ‘I want to monetize this now.’ They do a valuation of the selling adviser’s business, and the acquiring adviser buys the selling adviser out over a period of time. When the seller wants to sell, the buyer buys.”

Key Takeaways

  • Failure to have a succession plan in place can erode client and employee confidence in the practice.
  • One option is to develop an internal succession plan that will come together after several years of strategic hiring, mentoring and equity stake incentives.
  • Another pathway is to sell to another practice, either immediately or over a period of time.

 

Tags
Partnerships, Practice management, Training,
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