The Importance of Succession Planning

Succession planning—the notion of passing ownership of your business to a successor—is said to be critically important for the vitality of an advisory business, yet far from all advisers have a succession plan in place. Estimates of advisers who have a succession plan range from less than 30% to 60%, which means anywhere from 40% to more than 70% of advisers do not have a plan. If having a succession plan is unanimously accepted as being a vital business move, why don’t all advisers follow through?

“Most entrepreneurs see it as an event, rather than as a process. In reality, the day you start your business, you should start to see the end,” says Paul Lally, Founder of Gladstone Associates, a company specializing in transaction advisory services for the financial services industry. “[Succession planning] gives [business owners] guiding principles; a good one can be thought of as an operating plan— ‘who am I hiring, how do I increase value, do I have all the necessary systems in place?’ are all part of it.”

Benefits of Planning Ahead 

Succession planning is not just about you and your plans for retirement. Experts say the main beneficiary of succession planning ultimately will be your clients.

“You have a moral, ethical, and fiduciary obligation to your clients,” says Michael Paley, Senior Vice President, Focus Financial Partners. Your firm and your clients’ assets have to be protected no matter what happens to you, he emphasizes.

A succession plan will boost your clients’ confidence in you, says Brian Heapps, Executive Vice President, Sales and Business Development, John Hancock Financial Network (JHFN), which offers succession planning as part of its Build4Success practice management platform. Clients can be assured that if anything happens to you in an emergency, or when you are ready to retire, their assets will be safe. Additionally, Heapps says that the stronger your relationship with your clients, the more easily they will be transferable to your successor, since their trust and loyalty are squarely planted with your firm.

Other beneficiaries of succession planning are your employees. Dave DeVoe, Managing Director of Strategic Business Development for Schwab Advisor Services, says that being mindful of your employees is beneficial on multiple levels: it can give them a clear career path and improve employee retention (if they have a potential goal of inheriting the company); they will be better contributors to the organization (if they see it as being viable and healthy in the long run); and a junior associate may be a candidate for a future partnership, with you by their side to coach them and develop their skills. Having a succession plan in mind when hiring new talent also will help guide your decisions, says DeVoe.

“Your business will change hands and it is inevitable,” adds Lally. “The question is how much control you want over that. By having no plan, you have the least amount of control but, if you have a plan, you can control it,” he says.

When looked at holistically, a succession plan can be the nucleus for many things, says DeVoe. Your clients will have more trust in your services, your employees will feel more deeply connected to the business, and the company’s overall value will be increased.

How To Do It

“It is not an exit plan, it’s a perpetuation plan,” Lally says of a proper succession plan. There are three generally accepted methods for succession planning: an internal succession, hiring someone specifically for the purpose of having them become a successor, or engaging in a sale to another firm.

 Heapps says that no matter which route you take, the first step is to determine the value of your business. This is a procedure in itself, and is a critical first step before going any further (see “Is it Possible to Put a Price Tag on Relationships?” ). Another suggested first step is to examine your objectives, recommends Paley. “What do you want to achieve? Are you trying to exit the business? Or expand the organization’s capacity for growth?” he asks.

The Schwab 2011 RIA Benchmarking Study found most business owners would prefer to have an internal successor, either an employee or an heir, says DeVoe. “That’s a powerful indicator of what they put into their business; it shows confidence in their teams.”

The most common challenge with internal succession is the fact that “entrepreneurial DNA cannot be taught or trained,” says Lally. Someone may know how to work well with clients and have strong managerial skills, but owning a business, in any industry, takes a certain level of risk tolerance, he explains. One solution Lally offers is to find a few successors or junior partners that, when combined, have the necessary characteristics to carry on the business.

Heapps says that smaller practices that are up for sale are high in demand, often with multiple offers on one firm (he has seen as many as 50 offers at once). He doesn’t think this demand will decline soon, no matter how many firms come up for sale, because businesses are always looking for established client bases. Heapps says it’s common for these transactions to begin simply by word of mouth—get the word out that you’re looking to sell your business and see what comes to you.

However, if you’d like to be more selective about whom to sell your business to, DeVoe suggests starting locally and creating profiles of other firms in your area. “Do you want to work with a similar size firm, or a larger one?” he asks. “What are your clients’ needs?” Develop a profile of who would be a good match for you and your clients and go from there.

Another option is to use external help in finding a “larger home” for your firm, says Paley. He says that joining an adviser network can provide more than a succession plan; it allows you to focus on growing your business and serving your clients. Then, whether you’re ready to expand or exit the industry, you’re already part of a network that can help you achieve either goal.

Lally notes that it’s important to give yourself a primary plan, but it’s also advisable to have a contingency plan in place in case something doesn’t work out. “Having to go with ‘Plan B’ is still better than having no plan at all,” he says.

No matter which venue you decide to pursue for your succession plan (internal or external), the successor will want to know that they are inheriting a business that has potential for growth and includes “repeatable processes,” says Paley. “You want to develop repeatable processes so the new management can pick up where you left off.”

When To Do It

Heapps says that younger advisers should at least have a “continuity agreement” with another adviser—either a business partner or an outside firm. “The idea behind this is they would agree to pay, with an unplanned valuation, sort of like a fire sale, since the clients have not been transferred properly, but they would be able to absorb your practice,” he says. Continuity planning is part of succession planning, in his view; it’s more of a quick first step along the road to developing a stronger succession plan.

Lally also noted that many entrepreneurs are likely to have a will or an estate plan, but these are not the same as having a succession plan. If you suffer a premature death, he says, your spouse should not have to think about your business along with all the other parts of a will. When emotions become involved, rash decisions are more likely to be made, he said.

If you’re older, your options become more limited, says DeVoe. You can’t wake up one day and say “I’m going to retire tomorrow” and think you’ll be able to find a successor or buyer immediately. Not only do these things take time, he says, but they often take more than one time for a plan to work.

DeVoe offered an example currently unfolding with a client of Schwab Advisor Services. An advisory firm with two principals didn’t have internal talent that wanted to adopt the firm, so they decided to look externally to find someone who would be able to take the helm. DeVoe says it took this pair eight months to hire someone; then, after a year, they realized it was not a good match. It took another seven months to find someone else and that person was not the right match either. Now, they are back to the drawing board and, as if that doesn’t sound frustrating enough, DeVoe says one of these principals was ready to retire within the year. This was an unrealistic goal, he says, because the transition process itself takes time—there should be at least a year to work side by side with your chosen successor and make sure they are prepared (as well as the clients and employees) for the hand-off.

Overcoming Obstacles

Clearly, advisers have several options at their disposal to help them form a succession plan. So why don’t all have a succession plan in place?

Lally says part of it may be caused by advisers’ hesitation to ask themselves some personally challenging questions. “For a lot of advisers, they’re facing their own mortality. You have to ask and answer a lot of difficult questions about yourself, your family, and your business that you’ve avoided up to this point. ‘Have I truly grown value in my business or just created a lifestyle for myself?’ ‘If I transfer ownership of my business, do I lose my own identity?’” he says, adding that most succession planning occurs in emergency, when it’s too late to plan objectively. “An overabundance of emotion leads to poor decisions,” he says.

Is it Possible to Put a Price Tag on Relationships?

It is widely accepted that the value in a financial services practice lies first and foremost in the relationships an adviser has with his or her clients, but how can you put a numeric figure or value on a relationship? This is a question that must be dealt with when putting together a succession plan—what is the value of your business? After all, you can’t sell anything unless you know what it is worth. The answer will be different for every company.

There are third-party consultants to help, such as FP Transitions, which has developed a three-tier approach it refers to as the Comprehensive Valuation System. The three tiers include transition risk, cash flow quality, and marketplace demand.

David Grau, Sr., President of FP Transitions, explains that, unlike a manufacturing company or a wholesale supplier, “the value of a financial services practice is not found in its fixed assets, inventory, or intellectual property—the value is vested primarily in the client relationships.” Transition risk refers to the likelihood that clients will keep their assets with the buyer or successor, and be retained in the years immediately following the sale. The deeper the adviser-client relationships, the more likely the clients are to agree to work with their adviser’s successor, therefore increasing the value of the business.

The second tier involves cash flow quality. Grau says this looks at the demographic qualities, concentrations, and wealth index of the client base, as well as the expenses associated with servicing the client base. The last step in determining the value of the practice is to determine the marketplace demand for a practice. This process links the valuation figure to the market for such practices, by applying capitalization rates that are keyed to the type, size, and geographic location of the practice, says Grau.

With a current buyer-to-seller ratio of about 50 to 1 for an open market listing of an independently owned financial services practice, equity value is very real, and it supports powerful and advantageous choices for those who plan well in advance, he says.

Several succession planning consultants say that business valuations should be conducted on an annual basis. Grau says that having an accurate understanding of practice value each year allows the principals to make fully informed business and growth decisions, as well as implement long-term plans. Ideally, he says, a worthwhile valuation system will not only tell you what your value is, but also give you ideas about how to improve it. —Nicole Bliman