Bridging the Succession-Planning Gap

Financial advisors work countless hours helping clients plan their financial futures. But, unfortunately, too many advisors need help planning their financial futures. Today, only about 18 percent of independent advisors have a well-defined business succession plan that is ready to implement, according to a recent survey.

Financial advisors work countless hours helping clients plan their financial futures. But, unfortunately, too many advisors need help planning their financial futures. Today, only about 18 percent of independent advisors have a well-defined business succession plan that is ready to implement, according to a recent survey.

For many advisors, their practice and the equity locked inside are the keys to their retirement plans. But too many advisors lack a strategy to maximize the value of their business and eventually liquidate their equity to fund a comfortable retirement.

The average age of an independent advisor is 51, and, as more advisors near retirement, they have to consider how they will smoothly transfer their businesses to competent successors who will continue to provide high-quality service to clients.

While creating a strategic transition plan is not easy, there are best practices to follow and pitfalls to avoid. There are four pillars to a transition plan:

· Setting a timetable for liquidation/retirement.
· Reviewing the available options for selling or transferring the business.
· Maximizing the value of the business and working to make it more “transferable.”
· Accurately valuing the business when the time is right.

Setting a Timetable
Just as an advisor meets with a client to map a retirement plan, an advisor setting a business-transfer timetable must anticipate how long he or she wants to continue working, and at what pace. Some advisors want to transfer a business quickly and stop working. Others want to create a longer-term plan with a nod toward working part-time. There is no one-size-fits-all strategy. Each advisor needs a plan and timetable that meets his or her individual goals.

Weighing the Options
There are generally four options for exiting a practice.

· Merger or acquisition
· Sale to a junior partner or partners
· Sale to a roll-up firm
· Simply fading away

Some assume that a family member will take over, but, actually, that happens rarely. Less than 9 percent of transitions involve family members. So what about the other 91 percent?

Fine-Tuning the Business
Maximizing the value of a practice and making the business more transferable is like remodeling and staging a home before putting it on the market.

For the advisor, this means making business operations as efficient as possible, so that he or she can focus on what is most important to the practice and a potential buyer: client relationships. Over the years, I’ve worked with hundreds of advisors on practice management to streamline their businesses. This entails, in part:

· Documenting processes and systems to make them easier to replicate, understand, scale up or down, and eventually, transfer
· Working to improve employee productivity
· Evaluating the options for outsourcing certain tasks to save on operational costs and free staff from low-value work

Maximizing the value of a practice often requires reviewing and improving an advisor’s marketing efforts to attract and retain clients, as well as build the practice’s all-important brand and value proposition. This type of goodwill is very attractive to many buyers. Creating client-referral programs is another vital tool for spurring growth.

Valuing the Business
There are generally two ways to value a practice: a discounted cash flow method and a market-based method. Using a discounted cash flow approach allows an advisor to accurately measure the quality of the practice, because it takes into account the risk rate, growth rate, and cash flows of the business. The expected after-tax cash flows of the business are projected forward and then discounted back to a present value based on the relative risk level of the practice. This method enables advisors to differentiate between high-quality firms with established systems, defined processes, strong growth rates and predictable cash flow versus. firms that are not as well developed.
Alternatively, these two market-based approaches, while less accurate, are a good way for an advisor to gain a basic idea of the business’s value:

  1. Multiple of Revenue: This is the rule-of-thumb method. The most important valuation factor is the way an advisor charges clients. Fee-only practices are consistently worth 2.3 times their 12-month revenue (fees and trails). Commission-based practices are worth 1.1 times revenue. Practices that use a combination of the two can employ a simple valuation formula: Multiply the percentage from recurring fees (trails, 12b-1 fees, assets under management) by 2.3, the percentage of non-recurring income (commissions) by 1.1, and add the two amounts. For example, the multiple for a fee-based practice with 75% of revenues from fees and 25% from commissions would be 1.75 ([2.3 x .75] + [1.1 x .25].
  2. Multiple of Profit: The average multiple is between 4 times and 8 times profit. So if profit is $100,000, the practice would be valued between $400,000 and $800,000. This range is generally dictated by the quality of the revenues generated by a practice. A larger portion of recurring revenues indicates higher-quality of revenues, so the higher end of the range used. A 100% commission-based practice would be valued at approximately 4 times profits, a 100% fee-based practice would be valued at 8 times profits.

As noted above, there are four common paths transitioning an advisory practice. Now let’s consider in more detail two of them.

The Junior Partner Option
An advisor eyeing retirement in five years or more generally has time to recruit and groom a junior partner or partners to take over the practice. If an appropriate candidate does not currently work in the business, an advisor can launch an internship program to attract the best and brightest minds to the job.

When potential junior partners have been identified, it is important to set in place specific requirements and goals that can be measured to help the principal ultimately make the right choice. Following this five-year onboarding process, the junior partner or partners can begin to buy into the practice (and buy out the advisor).

By working with an expert in this area, an advisor can identify the best financing options to kickstart the buy-in, and design a program of staged purchases that can enable the advisor to completely or partially liquidate the equity in the business.

The M&A Option
When considering a merger or acquisition, many advisors look to the bottom line: how much is the practice worth and how will a buyer finance the deal? There are many financing options to choose from, and an advisor needs to work with an independent expert to sort them and find the best fit. But there are other factors that are equally important.

Given that most buyers will require the advisor to continue working for some time after the deal is struck, it is vital that the principals identify the qualities desired in a buyer, and then look carefully to identify a good match. Among the questions to ask are:

· What types of firms and clients does the buyer work with?
· What types of assets do they manage?
· What is their investment philosophy and internal culture?
· What types of broker-dealer systems/platforms do they use?

An advisor should also consider what issues might be dealbreakers, such as will their staff be transitioned or will the buyer enable them to stay involved in the practice.

Deal structures
Generally, deals are consummated in three ways: 1) cash payment (Including down payments and earnest-money deposits); 2) earn out; and 3) promissory note.

Although no two deals are exactly alike, there are common structures employed in most acquisitions and sales. Smaller practices that sell to a third-party or external buyer for less than $1 million usually involve two components: 1) a cash down payment; and 2) an earn-out arrangement or a promissory note for the balance. In third-party transactions higher than $1 million, all three payment components are often utilized: 1) a cash down payment; 2) an earn-out arrangement immediately following closing; and 3) a promissory note

Final thoughts
The bad news is that as financial advisors age, a tremendous need exists in our industry for business succession and continuity planning. But the good news is that it is never too early—or too late—for an advisor to begin planning around these topics. As this country slowly digs itself out of a deep recession, financial advisors are playing a critical role in helping individual investors regain their footing and rebuild their retirement dreams. But advisors themselves can’t neglect their own retirement issues. In fact, advisors owe it to their clients to secure their own futures now so that they can focus intently on helping their clients do the same.

Author's Bio
Matt Matrisian is the director of practice management for Genworth Financial Wealth Management (NYSE: GNW). He is responsible for helping advisors develop sustainable growth strategies and maximize the value of their practices. He can be reached at [email protected]

Hide comments


  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.