When David Grau Sr., founder of FP Transitions, wrote Succession Planning for Financial Advisors: Building an Enduring Business in 2014, the No. 1 exit strategy among independent advisors was attrition, where a practice simply winds down to the point where the advisor can’t sell it.
But succession planning in this industry has come a long way since then, Grau says. Mergers and acquisitions activity among independent wealth management firms continues to break records year after year.
Yet, Grau argues that this is still very much an industry of “book builders” rather than “business builders.” FP Transitions data shows that aging advisors that fail to enact a succession strategy show a noticeable drop in firm growth rates, due to attrition, aging clients and lack of internal talent supporting business development or client care.
Now, Grau is watching his own succession plan play out. In a recent interview with WealthManagement.com, he reflects on the evolution of succession planning in this industry over the last eight years and where it’s headed in the future.
The following has been edited for length and clarity.
WealthManagement.com: Can you take us back to when you wrote the book on succession planning—what was the state of succession planning at that time?
David Grau Sr.: When I first wrote the book, succession planning was alive and well for other professional services—doctors, dentists, lawyers, CPAs, but it really did not exist for the masses in the independent financial services world. A handful of mega firms did it, but those were, I think, more anomalies. For the average practitioner with a firm value or practice valued in the two to four or 5 million range, it was a force of one. And we would call those one generational practices, and that's exactly what they were. So that's what we found and that's where we started.
WM: Some people see you as the grandfather of succession planning. What do you think people mean by that?
DG: FP Transitions was first on the drawing board in 1998. We opened our doors in January 2000, and our business plan was to be eHarmony for financial advisors. We were literally going to be a matchmaking site and help bring buyers and sellers together. The fact that they might be from two different generations, super, but that wasn't the mission. The mission was to help people who wanted to retire find folks who wanted to build and grow and marry them up. So the idea was that succession planning meant selling it. Sell what you've built. We found out a couple of things, though, that were obstacles early on, and it wasn't succession planning.
The first thing we had to conquer was value and valuation. You can't get people to buy and sell something if they don't believe that it has intrinsic value separate and apart from the work that a person does, and that those assets and relationships are transferable. And to our great surprise, 2000 through about 2010, the biggest issue we had was convincing independent financial advisors that they owned something beyond just their work. They used to fight us and say, "There's no value. It's just me. It's a bag of air. These clients have been trained to trust just me. They'll never work with anyone else." But I almost smile and laugh when I say that now. We had to get past the valuation issue.
I literally brought in a great team. Our current CEO, Brad, was brought in, and we had to crack the code on valuation. We had to make it clear. We had to make it readily transparent, even simple to a way, because if you're trying to convince a sole proprietorship who's got way too much on their plate that this intangible services practice is the single most valuable professional services model in America.
What we did is we created a valuation tool. It was not online. That wasn't the way to do it back in 2006 or 2007. We literally produced a 65-page written report. We put it inside of a hardbound leather cover. We gave them the data. We made it understandable. And starting almost in year one, a thousand advisors a year made use of that valuation.
They found that their book and their practice was the single most valuable asset they owned. And once we put it in writing and showed them the math, the next question was, "Okay, I can accept that. I have a very valuable book. Now what do I do with it?" At that point, all avenues became open, from selling it to building a succession plan and helping people invest in it.
WM: I've heard you say the No. 1 succession plan in this industry is attrition. Is that still the case or has that changed?
DG: It’s still the case, but we're making progress. This is still very much an industry of book builders and much less so business builders. We're making a dent in that. But I mean, we're still way into the first generation of this process. This is going to take a couple generations to get this figured out and to get it accepted from one generation to the next.
If you're independent and you get to a certain age and you want to call it quits, what do you do with your client relationships, your AUM, all that recurring revenue, and of course your responsibility to the clients for the lifetime of their wealth? So what's the answer? Nine out of 10 advisors, and this has been a consistent number for 24 years now that I've been doing this, said, "Well, yes, but I don't want to sell, at least not in the near future. I like what I do. My clients depend on me. I do feel a responsibility. I don't have any next generation talent behind me that's ownership or entrepreneurial worthy, but I like what I do. I think I'll just keep doing it."
WM: That’s surprising because you hear about how there’s this flood of sellers coming out on the marketplace.
DG: On average, over the course of the last 12 months, the buyer to seller ratio is about 50 to 1. There are more sellers today than there were five years ago, 10 years ago, 15 years ago, 20 years ago. But I don't think I'd call it a flood. I think a flood would be a good thing because it is an older and aging industry still. And if you're not going to build something that outlives you then sell it to someone who will.
WM: Has the number of advisors who have formal succession plans changed over the years? Since the book came out, has that gotten better?
DG: We do a thousand valuations every year. We do hundreds of succession plans in an industry with hundreds of thousands of independent advisors, probably 75% of whom are book builders. We're making a little bit of a dent. There really aren't a lot of other companies that specialize in succession planning, and one reason is we've got a staff of 60 people to do this. A succession plan takes an appraiser. It takes a cash flow analyst. It takes a compensation specialist. It takes a couple of lawyers. It takes a tax specialist. You got to bring all those different skillsets focused on one problem for two different generations that understands what FINRA or an RIA under the SEC means.
WM: How have structures of succession plans changed?
DG: One, we had to convince what we call G1, the founder, that they had value and that this would work. Once that box got checked, then we had to go talk to the next generation and say, "No, you would be wiser to invest in this existing business, even as just a 10% equity shareholder initially. Build on top of that existing foundation and borrow the money on the way up. Bootstrap it." So we had to convince one generation, then we had to convince the next.
Then the biggest structural change as a result of generations one and two talking to each other was, "Where does the money come from?" As recently as six or seven years ago, seller financing had to carry the day. The seller would literally have to sell his or her own stock, go back to work the next day, be the primary breadwinner and leader in the firm, and then carry the paper and wait to get paid for 10 years.
They didn't like it. So the direct answer to your question is the advent of bank financing. Live Oak Bank, Skyview. SBA loans, conventional loans, having banks step into the picture who would loan to a 30-something year old G2 who is still paying student loans. They got very little home equity. They got a family. They got cars. They've got debt to pay. They can get a loan, because the banks came to realize, 15 years after we started making the case, that, "Hey, wait a minute. This really is the most valuable professional service model in America, if not the world." And the banks got on board. It took a long time, but when they came on board, then the succession plans moved faster. G1 could take out a big check selling 20% of their ownership, still be the CEO, still be the majority owner, and start to de-risk their position.
WM: What are some of the biggest mistakes advisors are making right now with succession planning?
DG: I'm going to pin the responsibility on G1 because G1 has been at this for 20 to 30 years, and it starts with them. First, got to start sooner. People don't realize that succession planning at a minimum takes 10 years to run and do its job. And the second issue is, take the process seriously and start to hire people. Don't go out and look for entrepreneurs. Look for a successor team. How long does it take to put together a team within 10 years will be your COO, CFO, CIO, and all equity owners who are willing to invest in the business? At least five to seven years to get that team assembled, and that's assuming you do it right on the first trial.
WM: How are current market conditions impacting advisors’ succession plans? Valuations? M&A activity? Are you concerned at all about some of the more aggressive players coming into the M&A space, paying lofty multiples, and holding a lot of debt on their books?
DG: I’m not seeing M&A activity slow down at all. In fact, as the interest rates have climbed, it seems almost as if the buyers have gotten more aggressive. Second, the buyers have gotten bigger and stronger. They know what they're doing. They don't acquire profusely. They acquire smartly. By and large, those are great options for many advisors. Just not for all advisors, and probably not for most advisors. But it's nice to have a choice. I don't think it's a bad thing at all. I think it's a good thing. I'm glad they're out there and I'm glad it is as a voracious and strong of a market as ever.
But by the way, when interest rates climb and recessions loom, the buying advisors worry about where their assets under management are coming from too. How best to go get $200 million of assets in a hurry? Buy them. So buyers have still been very strong and very aggressive, and from what we've seen, very well financed. I can't remember the last time I saw a buyer default on an acquisition. This is a good current strong group of buyers almost across the board.
WM: What does the future of advisor transitions look like?
DG: I think in one more generation, probably another 20 years, I think we're going to see succession planning become the norm. I think it'll be part of the culture. I think when G2 and G3 come to work, maybe as soon as they come out of a Texas Tech or San Diego State with a financial planning degree, they're going to sit down and interview for a job and they're going to ask the owner, "Will I have an opportunity to buy equity and be part of your succession plan?" When that happens, I think we'll have turned the corner. Not quite there yet, but I think the next generation starts to drive that issue. They will.
WM: What has it been like for you personally, professionally, to step back from the firm and watch your own succession plan play out? What is your succession plan?
DG: I’m not officially retired. I do not work in business operations anymore. For that, I am grateful. With the help of many, many others, we created our own internal succession planning. We practiced what we preached, but we also hired people who were specialists in marketing, specialists in sales, specialists in analytics and valuation and compensation and HR, all things that when you bring in specialists, they're better at it than the founder. And so my job was to be helpful and be humble, to be responsible about perpetuating a business, helping where I could and get in out of the way when necessary.
So I get up every morning. I'm an early riser now. I am client facing. That is the role that I like to play. I talk to advisors four or five times a day. I get to do the parts of the business I love. I'm going to stay involved for at least a couple more years.
WM: Do you plan on writing another book?
DG: I always have a couple chapters in the back of my mind. That'll depend on our company, our clients. I'm certainly willing and able to do it if it's wanted and needed.
WM: As a former securities regulator, do you have any thoughts on how transition rules should be changed or any reforms that you think need to happen?
DG: The securities rules, including the Securities and Exchange Act 33 and 34, almost all of the rules are built to address advisors as one. In other words, whether you are a W2 employee at a wirehouse or a 1099 independent advisor at Charles Schwab or LPL Financial, they treat you as one and the same. It is a mistake not to address and regulate this industry separately. The independent folks have a completely different set of responsibilities than someone who goes in as a W2 employee.
If a W2 employee can't come back tomorrow, they have a heart attack, they get hit by a car, they just decide they want to go do something else, everybody just kind of scoots over and the clients are taken care of by the next person sitting to the left, or to the right. If you're an independent advisor and you're a force of one, there is nobody sitting to the left or right. That's your responsibility. And I think the rules and regs need to say that. They need to say, "Listen, continuity planning, sure. I mean, let's be aware of death and disability, the floods and the hurricanes. But what about the proactive responsibility of creating a business designed around the length of the client's wealth cycle?" Most of these folks are going to spend 20 to 30 years building up their nest eggs from 40 to 70. And then I hope they spend the next 15, 20, 25 years, demographically speaking, dispersing it. Sharing it, being philanthropists, bringing their kids into the picture. How you do that, if you're an advisor with a 25 year career? If you send them off to somebody else, at the most important time of their life...
I think the industry itself needs to take greater responsibility and to move from book building to sustainable business building. I'd like to see much more happen in that respect. We've made a dent in it at FP Transitions. Sometimes it doesn't seem like we have enough support from the broker/dealers out there. The custodians, I think, get it. On the insurance side, the independent insurance agents are just getting started. I mean, literally they are in their infancy.