From the January 2008 issue of Boomer Market Advisor • Subscribe!

Exit planning strategies

When David Bugen and his partners decided to establish a plan for an eventual ownership transfer of Regent Atlantic, their priority was to ensure their clients would be taken care of. By entering a loan arrangement with Fiduciary Network, Bugen's Chatham, N.J.-based advisory firm enabled the current generation of employees to fund commitments over a 25-year period.

"Typical advisory relationships with clients last thirty years or more, and fees keep appreciating with the market," explains Mark Hurley, president of Dallas-based Fiduciary Network, a subsidiary of Emigrant Savings Bank. "The enormous present value of the business is more than any subsequent generation can afford to pay."

So his firm lends money for that generation to buy as much equity as possible, while he purchases the rest in non-voting stock. He seeks only wealth management firms that generate at least a million dollars before distributions, and requires a planning phase of at least six years.
Divesting a financial advisory business is a complex process that requires both time and care. Consider it the ultimate opportunity to take control of your own business life. Whether you are contemplating an external sale to a third party, or creating a path to ownership for your own employees, you should start at least five years before the transition -- ideally, even ten or twenty years in advance.

The average age of planners is currently 55, with the average seller age 57. As the industry average gets older each year, there is no ready replenishment of younger advisors and principals, and most firms report an acute talent shortage. In that context, exit planning becomes more critical than ever, in what has become a sellers' market. The ratio of buyers to sellers has rocketed in the past two years, rising from 40:1 to 100:1. If capital markets pull back, more advisors will be ready to withdraw, says David Grau Jr. of Business Transitions in Portland, Ore. "But at 100:1, we are still far from equilibrium."

The planning process should begin long before the exit plan. The first step is to calculate the value and equity of the business itself. An evaluation provides multiple benefits. With it, it becomes easier to make acquisitions, as well as to attract and retain high caliber employees.

It is difficult to quantify invisible assets, which consists primarily of intangible relationships, and it is insufficient to rely on multiples for simple gross revenues. Advisors can use a CPA appraisal, which runs about $10,000, or a market evaluation for about $1,000. The latter gathers about 100 data points, and benchmarks them to industry statistics.

"Using that, we can determine to about 10 percent the price for which they could sell on the market, like real estate," Grau says. (Hurley points out that his deal actually creates some liquidity in a firm's stock, because he himself has incurred an obligation to buy it at a specific price.)

The issue as to whether an internal or external sale is preferable will then arise. Both offer pros and cons. Many advisors gravitate toward the internal route, which they see as the best solution to achieve their objectives: they love their work, want to retire gradually and hope to retain key employees. Another internal option is to sell to a child or another family member.

Others opt for a third party purchaser, striving to put the best possible successor in place. They seek a slightly younger business owner than themselves with a book of business, who brings added energy and efficiencies to the table. If you are looking to a third party, you should make every effort to increase the value of the enterprise. Examine your revenue sources, consider switching to a fee model, and fine tune your metrics according to the 80/20 rule, dividing up your A, B and C clients. Hurley, who is determined to help Regent Atlantic grow wherever possible, contributes his own teams of professionals to aid on compliance issues and for co-writing white papers with them.

"Consider partial book sales," Grau suggests. You could sell your least lucrative clients, which are extra baggage for you, to someone else. The new purchaser may rank them as A clients in a win/win scenario. As your retirement date draws closer, you may want to start selling the B clients as well. On the other hand, if you are setting up an internal sale, you are more likely to keep your infrastructure intact. In that case, you might want to let your own employees work with the C clients.

Your business transition will affect many parties.

"It is not a victimless act," says Mark Tibergian of Pershing Advisor Solutions in Jersey City, N.J. As you lay the groundwork for both continuity and succession, you must take into account yourself, your clients, your employees and your own family members.

From your own perspective, you need to address both financial and emotional aspects. When factoring the sale into your personal retirement plan, Tibergian recommends a highly conservative approach: keep it minimal. You want to be able to walk away from any deal, and negotiate from a position of strength. In today's sellers' market, advisory practices are commanding large premiums. But what happens in a weaker market? Buyers take out a substantial mortgage on the purchase of a practice, but will they be able to sustain it in another environment, with enough cash flow? Analogous to the housing market, think of those who borrowed heavily to acquire homes on the theory that housing prices would continue to rise.

The emotional front requires serious foresight as well. Ending the active involvement in an advisory business can be a blow to self esteem, and self definition in the community. Aside from your reputation, you will need to fill your life with meaningful activity.

"Lots of advisors would like to go on managing from the grave, if they could. And you can only play so much golf," says Tibergian. Your eventual "third life" may include learning, new skills, part-time work or volunteering.

What will happen to your clients when you retire? As they watch their advisor get older, clients are already speculating as to what will become of their accounts. They want to know that somebody with the same levels of technical expertise, communication and empathy will be there for them. In fact, the co-dependency you have created may become a moral quandary. It could be traumatic for a client to reestablish a new, trusting relationship.

The best firms involve teams in rendering advice for a seamless continuation. In an ensemble practice, the transition should go smoothly. In the meantime, find a continuity partner who could take over, in case you cannot. That person may or may not be your long term planning partner, but keep your clients informed.

When Regent Atlantic finalized its succession arrangements in February 2007, it sent out a letter to all the clients.

"So far it has had little impact on them, but they were relived to know we had a continuation plan in place," Bugen reports.

Next, consider your employees. Create a culture for training and developing their skills, which may differ greatly from your own. Founders are typically entrepreneurs, who live by the courage of their convictions, while staff are often less risk-oriented. If you are molding employees to become future owners, make sure they fully understand the role of ownership.

Tibergian suggests you identify three prospective candidates for every current owner, taking into account that one may disappear, and one alone may not be able to buy the practice.

"Like a diversified portfolio, you increase your odds of success by building diverse skill sets, such as advisor, manager or rainmaker."

Lastly, consider how your retirement may involve your own family. Do you have family members who might like to take over? How would it be financed? Would it create disharmony among siblings? Would you be able to take a back seat, or interact at arm's length if they were running the practice?

It is up to each advisor to decide whether the priority is to maximize value or to optimize the transition on other levels.

"There are ways to earn a lot of money, but you could end up selling your soul to the devil," Tibergian warns.

By the time you step down, the deal itself will probably be somewhat anticlimactic -- that is, if you have properly prepared. You will have built value in the business, and will know what do with the rest of your life.

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