From the December 2006 issue of Investment Advisor • Subscribe!

December 1, 2006

Do It Now; Do It Right

The best time to start planning for the transfer of your business is now

As 2006 comes to a close and you reflect on the year's successes, it's important to look ahead by asking yourself a question that too many advisors ignore: How do you plan to exit the business? If you're not sure, it's time to consider your options--sell externally or internally--and create a business transition plan that spells out the future of your firm.

There's no question that building a business transition plan is one of the most crucial steps you'll take in your entire career. After all, your business is probably your most valuable asset. How you treat it will therefore largely determine how well you're able to provide for yourself and your family during retirement. It also will affect the professional legacy you leave behind to your clients, employees and community. When you consider that the average advisor is 54 years old and 30% are over age 60, it's clear that these concerns are of paramount importance for many of you.

But even if you're decades away from retiring, a business transition plan is a key step in developing your firm. By thinking now about how you define the 'maximum value' for a transition, you'll ensure that you optimize your options and position your firm to capitalize on the opportunity. In short, a business transition plan can serve as the guide for nearly every professional decision you make for the rest of your career--and make you more successful in the process.

Moreover, whether you're 35 or 55, there are two big reasons to start planning for the transfer of your business now: time and money. Business succession may generate excellent returns for both the buyer and seller, but it requires careful long-term planning, and the plans themselves often take years to fully implement. Getting a late start could severely limit this option. By contrast, the valuation of an external sale can be optimized by focusing on the key success drivers and metrics today, so that the company is best positioned for sale when the decision is made to exit. "Business transition is a lengthy process that evolves over time, so it's imperative that you start long before you want to step down," says Tim Kochis, the veteran advisor and CEO of Kochis Fitz in San Francisco. "Having a well-developed plan early on gives you flexibility and gives your employees and clients confidence that they'll be taken care of in the future."

The first step in the planning process is to evaluate which makes more sense for your firm: an external or internal sale. The answer to this question will depend on your goals and situation. If you want to exit quickly and maximize the near-term economics of the transaction, then an external sale could be your best option. By contrast, if you value having more control over the business through this transition and flexibility on when and how you exit the business, then an internal succession is probably the leading option. In either case, the earlier you start developing and implementing your transition plan, the more value you will extract from the transaction.

Internal succession: Four steps to success

Advisor Mike Sargent, who sold his practice--Boulder, Colorado-based Sargent, Bickham, Lagudis--in 1999, opted to sell to a key employee who had been with the firm for 10 years. "He showed loyalty to me, and I wanted to show it to him by making him the buyer of choice," says Sargent. "Also, the clients trusted him, which I knew would help the transition go smoothly. Outside deals can be long and drawn out, and the unfamiliar faces can increase your risk of losing employees and clients along the way."

Regardless of your potential buyer, it's vital to be careful and methodical in your succession planning to maximize the results that you desire. Rushing it will only result in a lower valuation, an inappropriate successor, or both. In the long run, poor succession planning could mean the death of the business you've worked so hard to create. Make no mistake: Planning and implementing the transfer of your business takes time. But the effort you invest now will pay off down the road.

To get started on solid ground, consider the following four-stage process for the creation and implementation of a succession plan.

Stage 1: Identify Your Strategic Goals

Start by deciding what you want to accomplish by transferring ownership. The initial thought most advisors have here is "I want to sell at a premium and get a big payday." That's certainly a key consideration--but it's best to take a step back and think strategically about other issues that will have an impact on your plan. Chances are, you'll find you have more varied and complex goals than you first realized. For example:

Business objectives. These might include issues such as whether you want the legacy of your firm to remain intact in terms of client service techniques and other processes. While some advisors want to ensure that their business practices stay in place after they're gone, others are mainly concerned about maximizing their valuation and are happy to let a new owner set the tone of the organization.

Professional objectives. Your planning efforts are an opportunity to think about career goals you haven't yet tackled, and start shifting your focus toward them. Ask yourself what you really enjoy doing. What's less appealing to you? Are there other goals you want to accomplish with the rest of your career? Take a thorough inventory and then structure your plan accordingly. For example, owner-advisors who have been responsible for day-to-day duties may choose to shift to a business development role after they migrate ownership to a junior partner.

Personal objectives. Start with the basics: When and how do you want to exit? The issue of how you want to shape your non-work life in retirement will be especially familiar to you, as you've probably guided clients through this discussion for years. When plotting your own retirement, however, keep in mind that your situation may be unique. If you're like many advisors, your roles as an advisor and business owner have largely defined you over the years. How will you feel about your identity when you're no longer an owner and the main go-to person at your firm, and how will that influence your retirement lifestyle?

Your goal in this step is to create an overall strategic context that will guide the rest of your planning efforts. Once you understand exactly where you want to go, you can craft a succession plan with the terms and conditions that will take you there. "A big part of succession planning is understanding your various goals, and the goals of any other owners, so there are no surprises," says Scott Roulston, CEO of Fairport Asset Management in Cleveland. His firm conducts regular meetings at which the partners discuss where they each want to be in five years. That information is then factored into the firm's overall succession planning outlook.

Stage 2: Identify Your Successor

Your next job is to determine who from within your firm should take the reins. This decision may seem obvious--there could be one employee or partner who has expressed interest or who is especially competent. But here again, it's best to take a step back and think strategically. Ask yourself: What are the skills, resources and capabilities that my successor must possess based on what I want to see happen to my business after I'm gone?

There are three main areas of expertise that successful advisors typically have:

Management capabilities. Any potential candidate should be able to take on the responsibilities of effectively running and growing your organization, managing people and making business decisions that enhance your firm's value.

Client relationship expertise. The ways in which advisors build, manage, and maintain relationships with their clients is typically the most important factor in their success. Look for someone with client expertise and business development acumen.

Investment management abilities. In firms that manage investments in-house, a successor obviously needs to be an expert at money management. At firms that outsource investments, an owner must be proficient at communicating the firm's investment philosophy and approach to clients.

Once you've determined the most important qualities that you require in a successor, evaluate your staff to see how they stack up. Don't expect any one person--even your best employee or junior partner--to fully possess all of the capabilities. Chances are, your top candidate or candidates will have many of the necessary qualities along with some gaps that need to be closed. This can be done through coaching and mentoring, or by building a team with unique skills that complement each other.

For example, Colorado advisor Sargent built a team that included his key employee (who focused on investments), another with strong financial and estate planning skills, and a third who was adept at administration and technology. After that team eventually took over the firm, they brought in a new partner with marketing capabilities. "The team had the skills and chemistry that told me they were highly capable of running the firm I had built," says Sargent.

Stage 3: Detail the Deal

Plotting out the specific details of the transition is vital in order for the actual migration of ownership to flow smoothly. When making decisions about the terms and conditions of your succession plan, consider the following key areas:

Roles and responsibilities. Transferring various responsibilities can present challenges for many owners. Often there's a period of one year or longer during which the new and old owners are both present in the office. This can create confusion among staff members about who to go to with questions and issues.

It's therefore best to create a plan and timeline detailing when various duties will be handed off to the new owner. How that handoff works will depend on the objectives set by your firm. In some cases, investment-related duties will be the first to shift; in others, client relationship responsibilities will transition first while in still others, management roles such as employee reviews initiate the process.

You'll want to take these steps at a moderate pace to ensure you don't overload the future owner with too many responsibilities at once--yet another reason why it pays to begin your succession planning efforts as early as possible. In advisor Sargent's case, he began early on by having his key employee prepare client reports and sit in on client meetings. That role expanded until the employee was adept at handling such meetings on his own. Sargent then built off that base by incorporating management duties over time.

Ownership transfer. The timeline you develop for transferring ownership will relate directly back to the goals you identified in stage one. If you hope to hit the golf course as quickly as possible, a rapid migration is appropriate. If, however, you plan to stay on in a limited capacity, you may want a slower transfer over several years. In general, larger firms transfer ownership at a more measured, methodical pace. Smaller firms, by contrast, tend to hand over ownership more quickly as a way to avoid confusion. At Roulston's firm, for example, there's a clearly designed timetable for ownership changes which includes a yearly re-evaluation that sets the price for anyone announcing their retirement over the following 12 months.

Ownership stakes. If you operate a larger firm with multiple partners, you'll need to consider how to structure a new owner's buy-in in relation to the existing partners. At Kochis Fitz, Kochis (one of nine partners) has developed a well-designed system. When an employee meets the criteria and is offered partnership, he or she has the opportunity to buy a specific stake in the business. Every two years or so, a third-party appraiser provides a formal valuation to confirm or modify the formula valuation. New principals are eligible to buy in at that externally determined price.

Deal Structure. It is important to remember that the deal structure is another tool to help you achieve the partnership goals. You should tailor the structure of payments based on the economic capabilities of the partners, the financial needs of the buyer, and the behavior that you want to incent. Although registered investment advisor transactions typically are seller-financed with an earn-out over five years, stretching the time frame to seven years (with an appropriate interest rate) can help increase the valuation for the seller and reduce the economic impact for the buyer. Bank financing is uncommon, because RIAs have few assets or secondary sources of repayment if a loan is defaulted. SBA loans, an often overlooked solution, are more flexible in their requirements.

Financing is one component used in the deal structure. For instance, at Kochis Fitz ownership stakes are acquired by a new principal over the course of three years--with 60% in the first year, followed by 20% each in years two and three. This staging, plus attractive bank financing negotiated by Kochis Fitz, enables the junior partners to ramp up slowly, and allows the senior partners to benefit from the growing value of the firm. Existing partners who own 15% or more of the firm have the first right to sell, with shares distributed on a pro-rata basis if no one wishes to sell.

At Sargent, Bickham, Lagudis, by contrast, Sargent set terms that enabled him to get paid in multiple ways--including a 20% down payment, a note paid quarterly for seven years at 8.5%, and a percentage of new revenues. Sargent also had set up a deferred-compensation plan for his key employee that was eventually used toward the down payment. "The deferred-comp plan was designed to encourage my employee to stay with the firm, not as a means to buy the company--but it ended up being a big part of the succession plan," says Sargent. The key objective of the deal structure is to align the goals of the parties with the economics of the transaction.

Stage 4: Implement the Plan

Eventually the time will come to put your succession plan into action by transferring ownership. Here again, it's good to have a timeline for key events. Sargent held a number of scheduled meetings with his employees to finalize terms among themselves before jointly drafting a letter of intent that got all the details on paper. Each involved party then retained an attorney to draft specific agreements and execute the deal. Of course, planning carefully and taking the right steps during the first three stages will help ensure that the final implementation goes as smoothly as possible.

Keep in mind, however, that as Kochis warns, the transition may take several months or even years to fully complete--for instance, if your terms call for an extended buy-in period or if you continue to play an active (if more limited) role in the firm. Any extended period of transition can result in moments of confusion or even conflict among principals, staff, and clients. It's thus important to recognize issues when they arise, and work quickly to resolve them.

For example, Sargent's initial plan was to slowly ease out of the firm over a two-year period. Soon, however, he realized there was uncertainty over who the "real" boss was--both from employees and clients--and that by sticking around, he wasn't allowing the new owner to establish himself. As a result, Sargent accelerated his departure and clearly communicated to clients that he was no longer the appropriate primary contact. "I wasn't doing anyone any favors in the long term by continuing to solve the problems that they encountered," says Sargent. "You've got to be willing to move out of the way when it's time."

That said, Sargent admits that it was difficult to fully let go--a common problem when advisors exit their practices. "The emotional challenges of the transition were a surprise to me. Selling your business isn't like selling Intel stock, and advisors who transition should be prepared for the emotional issues that you feel when someone else takes charge of your baby," he says.

Clearly, business succession planning is an undertaking that requires a significant effort on your part. But you cannot afford to ignore it or take a half-hearted approach. The time you invest in your succession planning efforts now will yield tremendous rewards down the road and ensure that the business you've worked so hard to create will continue to benefit you, your family, your employees, and your clients for years to come.

Reprints Discuss this story
This is where the comments go.