From the Corner Office is the leading blog for emerging independent financial advisors (AUM of $20-200MM) designed to address the common strategic and managerial issues associated with building a profitable practice. The blog is authored by the team at Pinnacle Advisory Group, an independent financial advisory firm serving more than 700 families with assets of over $1 billion and a four-time winner of the coveted Moss Adams Best Managed Practice award. The blog is typically published on the 15th and last day of the month.
Much has been written lately about the aging of individuals who own RIA firms and the lack of succession planning that has been done by this group. At 58, I am the poster child for this group of owners and my partners and I at Pinnacle Advisory Group are working on this very issue. Now sensitive to the problem, we are not only realizing how important the solution is for the future success of the firm, but also how difficult it can be not just for large firms like our own, but even more so for smaller firms with fewer options. Today I wanted to share with you what we are learning and offer a practical new continuity planning solution.
Our Path to an Effective Succession Plan
I am fortunate to have two trusted senior partners that will purchase my interest if I die or become disabled. We are still working through the final details of our living succession plan although one option is included with the current buy-sell agreement. We began adding minority partners over 10 years ago and we are now up to 3. While the amount of equity we have sold is very small thus far, our plan is to accelerate the sale of equity to key people in the firm starting within the next six months.
Most of the case work and analysis suggests that internal buyouts like ours work most effectively for buyers and sellers, but let's face it, as long as our firms grow profitably and as long as we enjoy being engaged, there is usually a significant financial advantage to maintaining a majority equity position.
It is not surprising then, that advisors tend to procrastinate on succession planning until there is motivation to spend the time and energy on the problem: i.e., when a partner is contemplating retirement; or employees clamor for ownership; or when partners recognize that broader ownership will enhance employee commitment and engagement in the firm. There is, of course, the one in a hundred shot that a strategic buyer will offer an outrageous sum for your firm and ask you to immediately ride off into the sunset, but “don't hold your breath”.
Regardless of the reason for focusing on the problem, the most important first step is for the senior partners to have a candid conversation about personal goals and timetables. It is surprising that the owners I talk to do not have a clue what the personal goals of their partners are. Business goals are easy to share. Successful firms have done that since they first dreamed of owning their own business. It follows suit, then, that contingency planning for death or disability is a relatively easier conversation. Somehow, personal goals are just too personal to discuss which makes a lifetime succession planning conversation near impossible to have. Set aside the time for a couple of beers with your partners (like you used to) and be bold enough to open up with one another. Once you get the conversation flowing, it will be easier to move on to your succession discussion. For those of you who are already way past this – congratulations! - you are definitely in the minority.
Once you are ready to address succession, you still face two important issues: talent and money. Do your employees have what it takes to manage and grow the firm? And if they do, do they have the money to buy you out? In regards to the former, if you begin your succession planning early, you can gradually provide increased responsibilities to evaluate whether your employees have the skills needed to manage critical business areas. Even then, there is still no certainty these people will work well together and make the right call on critical decisions. This can be an even greater challenge when founding partners have different opinions on how effective the prospective owners are in accomplishing assigned objectives. It is critical that objective, quantifiable goals be assigned whenever possible to reduce dependency on subjective or "gut feel" evaluations.
Money can be a more challenging issue as employees may not have amassed the funds needed to make a deposit let alone buy you out. We recommend an installment sale opportunity with at least a 20% down payment when possible. We include the down payment because we believe it is important that your employees have skin in the game -- so if they need to tap Mom and Dad so be it. For the same reason, we also want to structure the note such that distribution does not fully cover the payment. Under most circumstances, you will need several employees to participate in the buyout and this may still only cover a partial buy-in. It is entirely possible that you will need to find an outside partner to close the gap.
Smaller Firms Face a Greater Challenge
Smaller firms with only one owner face an even greater challenge in establishing a contingency and succession plan – and these firms far outnumber large multi-partner firms like our own. Why? First, without partners, there is no natural buyer in the event of death, disability or retirement. Second, unless the firm is blessed with multiple suitors at just the right time, it cannot negotiate from strength. That is especially the case in the event of death or disability because there is no one familiar with the business remaining to negotiate a sale and manage a transition. Instead, a surviving spouse or family member is thrown into unfamiliar territory negotiating the sale of a business they know nothing about; and clients are left facing the same uncertain decision they faced years ago when they chose you as their financial advisor. Will the new owner do a satisfactory job? Do I need to find someone else? How do I know who is right?
A Practical New Continuity Planning Solution
Our own practical experience with continuity planning and the innumerable conversations we have had with advisors about their businesses in the context of Pinnacle Advisor Solutions, told us that a better continuity planning solution was needed in the community. We decided to tackle the problem. We developed a unique new solution designed to establish (a) a “realizable” enterprise value for the firm upon death or disability and (b) a seamless continuity plan for clients while (c) allowing the advisor maximum flexibility and control until that event by making the transaction structure revocable at any time. Simple, fair, flexible … and perhaps the only option outside of insurance for your family to receive an additional payment at death.
Here’s how it works …
- Pinnacle will provide you with a firm profile sheet that asks you to detail services provided, demographics of clients served (obviously we would not ask for any specific client information), compliance history and financial information.
- Once we evaluate your financials and understand you practice we will offer you a price for your practice. It will be a 100% installment sale with a retention formula that will be prorated based on clients who stay on over a period of years.
- Once an agreement is in place, you will provide a simple financial update each year to continue in the plan. You or your representative can discontinue the arrangement any time prior to you death.
You have been encouraged to think about succession planning by many experts in our field. I am encouraging you to take the first step and really think about an action plan with a timetable. If you are a sole practitioner, I suggest you further explore the Pinnacle succession option. As an aside, we will talk with you about a lifetime buyout if you are considering your options.