For financial advisors, planning is in their DNA. Retirement planning, financial planning, estate planning, tax planning—are all part of the job description. But when it comes to planning for their own future, many advisors are lagging, according to a new study commissioned by NFP Advisor Services Group and produced by Aite Group. But advisors can get more money for their practices by planning further in advance of their succession and focusing their efforts on client retention, the study showed.
People often expect a high rate of client retention when purchasing a book of business—in the range of 90 percent or more, said Alois Pirker, research director at Aite. According to the study, “The Efficient Frontier of Succession: Maximizing Practice Value,” 28 percent of advisors had acquired a practice in the process of building their own book of business. Of those advisors, one in three (35 percent) had a client retention rate of less than 50 percent (see chart). Another 22 percent of those advisors lost more than a quarter of their acquired book of business.
Buyers will often assume a high rate of client retention initially; then a year or two down the line, they’ll get to a checkpoint and adjust the valuation accordingly, Pirker said.
“If retention is not there, it really can destroy a lot of value for the seller,” said Pirker.
James Poer, president of NFP Advisor Services Group, attributes the low retention to the failure to properly prepare for succession. For example, you’ll often see low retention numbers from sole practioners who need to walk away from their practice due to a health issue, premature death, or some other issue. They don’t get the value out of their practice because they’re doing it under duress. Client retention is lower because there’s no transition of the advisor relationship, as opposed to taking one or two years to get clients used to the new advisor/owner.
“You’re taking over relationships that are close ties with another person, so you need to be able to take those over,” Pirker said. “The more that’s a warm hand-over, the better.”
Start Early
In addition, the more lead time you give before transitioning, the better, because the transition will be less of a disruption to clients, Pirker said.
“If that’s started early enough, it’s not even perceived as an internal succession anymore,” Pirker said. “The person has been a few years at the firm already before they actually take over that client relationship, and therefore, the client might know them already.”
According to the study, 17 percent of practices expect to transition to a successor by 2014, while 40 percent expect to transition within the next 10 years. But of those transitioning in the next two years, 42 percent lack a succession plan. Of those FAs transitioning in 10 years, two-thirds of them have no concrete plans for succession.
Part of the study also involved talking to mergers and acquisitions consultants, who felt FAs need to start thinking about a succession plan 10 years prior in order to maximize the value of their business.
When you have more time, you can look at your business from a strategic perspective, and work on any problem areas, Pirker said. For example, if you have a client base with high average age, this can be an issue, and put a damper on valuation.
If you have a lot of older clients taking disbursements, the valuation won’t be as high as a book of business growing towards building wealth, Poer said.
But a longer time horizon gives you the time to go after younger clients, go after the kids of your clients, and get a more balanced client base going, Pirker said.
Also, if you’re five to 10 years away, you can really focus on growth, Pirker added. When the valuation is done, buyers will often look to the growth pattern of the last three years or so, to determine what growth could be going forward. For example, you should take out any expenses that aren’t business related, because when all else is factored in and there’s no profit left, that’s not good for the valuation.
You’re in a good spot if you have revenues and income after you’ve paid all the principals and advisors, Poer said.
Practice What You Preach
So why don’t most financial planners plan for their own succession?
“They are planners so you would that that comes natural to them, but actually it doesn’t seem to be,” Pirker said. “It’s like when you get to the hospital, and you see the doctors lined up outside smoking.”
It’s so much easier to plan when you’re looking at someone else’s assets, but when it’s your own assets, it’s tougher to take a step back, look at the big picture and make the right adjustments, Pirker said.
Perhaps advisors get so busy with their client base, which is what generates revenue for them, that succession planning takes a second seat, Pirker said.
Poer believes it’s just human nature. Advisors don’t think they have to worry about it until they wake up, they’re 63 years old, their clients are 80 years old, and they’ve diminished the most important asset they’ve worked years to build.
According to Poer, the organizations in this business with the highest valuations are those that have leveraged technology, outsourced responsibilities that are not their core competencies, and focused on growing their revenue and servicing their clients.