The Business Handoff

It shouldn't take a tragedy to learn about the importance of business succession plans, but that's what drove the point home to Mike Curry. Curry, of the Los Angeles-based AFP Group, a member of Royal Alliance, worked with a 77-year-old advisor who died of stomach cancer only three months after being diagnosed. Perhaps because the man was fit and active in a way that belied his age, he had not made

It shouldn't take a tragedy to learn about the importance of business succession plans, but that's what drove the point home to Mike Curry.

Curry, of the Los Angeles-based AFP Group, a member of Royal Alliance, worked with a 77-year-old advisor who died of stomach cancer only three months after being diagnosed. Perhaps because the man was fit and active in a way that belied his age, he had not made any plans for transferring his book of business to other reps.

The consequences were twofold. First, it denied the rep's widow the stream of income that would have resulted from his selling his business. Second, it left Curry and his colleagues scrambling in a vain attempt to service the biggest clients of the dead rep. The clients ultimately went elsewhere.

“We were a day late and a dollar short — that's why it's so critical” to have a succession plan, says Curry.

An estimated 30 percent of financial professionals are expected to retire in the next five years. That mini-exodus should brings the issue of succession planning to the fore.

It needn't go down as badly as it did in this case. Many of the major wirehouses and regional firms, including Salomon Smith Barney and Wachovia, are prepared to help departing reps sell their businesses in-house to other parties. Yet, relatively few are availing themselves of the service.

“An advisory business is often the most valuable asset of many advisors — more valuable even than their homes or cars,” says Chip Roame, president of Tiburon Advisors, a Tiburon, Calif.-based consultancy. Yet fewer than 30 percent have a succession plan. And not all firms have formal plans. Merrill Lynch, for example, does not.

I, Joe Advisor, of Sound Mind…

By far the most common type of succession arrangement is through agreements with colleagues. Though this might seem the most expeditious way to go, that's not always the case.

Rarely does an in-house transfer “turn out to be the best fit in terms of skills, qualifications, cash down and the long-term benefits to the client,” says David Grau, president of FP Transitions in Portland, Ore., which does consulting and valuation work on succession plans. “It's either a personality fit, or two people who know each other.”

Both Roame and Grau say that advisors can sometimes get more out of their business if they sell it outright to a stranger. But many people feel this doesn't provide enough transition for clients.

Ona Wexler, 60, who retired from the AFP Group run by Curry, says her biggest concern was finding someone of a similar business philosophy who would agree to make the transition slowly.

Initially, she was looking for someone about her age, because much of her clientele comprised of similar-aged people. However, she quickly realized it would be better to have an advisor who could serve her clients for the next couple of decades. So she partnered with a colleague, Craig Steinhauer, 37, who bought Wexler's book of business, gradually taking full control over four years.

The two entered into an agreement in 1998. For the next few years, they conducted joint meetings with Wexler's clients, giving Steinhauer time to get clients comfortable with him. The result: a 90 to 95 percent retention rate. “It's enhanced my practice dramatically,” he says.

Wexler said the transition worked for her as well. “Almost from the beginning, I was very happy with it,” she says.

Working Out the Kinks

There are several important issues to iron out before undertaking an in-house handoff so it is not structured as if the buyer is doing the seller a favor.

Since sharing the risk is an important part of any succession plan, Grau suggests a down payment of around 35 percent from the buyer, with the rest structured through a promissory note or earn-out. If the buyer is into a deal with 40 percent, that's probably $100,000 in up-front, non-refundable motivation, Grau says.

It's also important to spell out how much work each party will be doing and how long the transition period will last. He generally suggests a 90- to 120-day period of transition, after which the new advisor owns the business outright.

In order to build a good succession plan, the buyer and seller each has important prep work to do. The seller needs to know exactly how to value his practice. For instance, a wirehouse broker, because of the large percentage of the gross that's taken out by the firm, is going to have to value the business as significantly lower than an independent.

Then there's the question of how a person wants to receive payments. Some firms keep the rep's CRD number active for two years and direct commissions there. But be careful: That process is called parking, and it's something the NASD doesn't allow. A more prudent course of action would be to use a promissory note that bases subsequent yearly payments on a percentage of the commissions or fees the working broker generates from the shared business.

Meanwhile the buyer must make sure the clients are matched up properly. In addition to his transfer of business from Wexler, Steinhauer purchased a business from a rep who was relocating, but it hasn't worked as well because the clients don't match his style. This was around the market's peak, many were invested aggressively in technology, and Steinhauer says he should have done further review of the portfolios before taking on the practice.

“Between December of 2000 when I wrote the check and April 2001, those tech stocks went down about 40 percent,” says Steinhauer. Then “a letter is out saying the old advisor is gone and I was now in. It didn't paint a pretty picture.”

Another concern: the new rep should be prepared for a decline in revenue in the first year, as more assistants or junior brokers are hired to handle the additional new clients. “You have to meet and get to know all the clients,” says Tom Dillon, 54, of Dillon Financial Services/Raymond James Financial in St. Louis, who purchased a business from a retiring Raymond James broker a couple of years ago. “It's labor-intensive during the first year.”

In the end, the results can be rewarding for both sides. Curry, who was unable to buy the practice of his deceased colleague, has bought other businesses and plans to be the seller someday also. “It's something that we in the business don't think about enough,” he says. “One day, but I'm not there yet, I'll want a junior partner — and then I'll move on and do other things.”

What's it To You?

A quick method for calculating the value of your book

To estimate the value of your book, David Grau, president of FP Transitions, says:

First, take all your recurring income for the last 12 months. Then subtract what your b/d takes out and multiply it by a factor of 2.1.

Next, take your commission business — again, minus the b/d override — and multiply it by 1.1. Add the two together, and you have your figure.

So a person with a book of $900,000, of which $600,000 is recurring, with a 90 percent payout, would value their book this way: $600,000 × 0.90 = $540,000 × 2.1 = $1,130,400. Then, $300,000 × 0.90 = $270,000 × 1.1 = $297,000.

Lastly, add $1,130,400 + $297,000 = a rough value of $1,427,400 for your book.
DAG

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