Judging by the amount of coverage succession planning has been getting in the trade press in the past couple of years, it is one of the most pressing problems facing the independent advisory industry today. It's certainly an issue for tens of thousands of baby-boom age owner-advisors who are quickly approaching retirement age—and for the younger advisors in their firms who are hoping to take control and bring those firms into the 21st century.
Yet, as evidenced by the relatively few successful successions we hear about these days, the transition of firm ownership to the next generation of advisors is quite a bit more difficult than one might think. Equally surprising, the barriers to a smooth succession actually boil down to just two: finding a qualified successor (or successors) and financing the buyout of the current owners.
But, as management consultant Angie Herbers has recently documented (see “Death of the Rainmaker,” July 2014, and “The Fatal Succession Planning Mistake,” November 2013), owner-advisors often have difficultly planning their succession far enough in advance (go figure)—and getting their heads around the fact that the skills required to take an established firm to the next level are vastly different from those that were necessary to launch one. Perhaps most surprising of all: Industry custodians and broker-dealers have been largely ineffectual at helping their affiliated advisory firms to overcome either challenge.
In most industries, widespread challenges usually spell opportunity for those clever enough to find workable solutions, and the independent advisory business is no exception. There's no shortage of consultants peddling their version of “succession programs” (although I’ve come across very few who have any stake in the actual outcomes); larger firms looking to absorb smaller firms; and so-called roll-up firms whose business models typically consist of buying out retiring owner-advisors and replacing them with much less experienced salaried advisors.
So I was encouraged to recently come across a relatively small firm—$250 million in client AUM—whose owner recognized the looming succession challenges facing the current generation of owner-advisors, created innovative solutions to help them with their current lack of financing and next-gen talent and is growing his own firm doing it.
Tom Karsten, a CFP and enrolled agent with an MBA, is president and chief investment officer of Karsten Advisors in Fort Worth, Texas, a second-generation family business, originally founded in 1977 as an accounting firm. In 1997, not long after Karsten graduated from business school and joined the family firm, he initiated adding investment management to its lineup of services through accounting pioneer Herb Vest's broker-dealer, HD Vest. Renamed Karsten Advisors, the firm grew to be the largest HD Vest affiliate, but broke off four years ago to form its own RIA.
“We are now a hybrid firm working primarily with pre-retirees and retirees. Our reps are registered at Triad, and advisory client accounts are with Pershing, Schwab and TD Ameritrade,” said Karsten. “We fully appreciate the fee-only model, but in our retirement work, we inherit a lot of VAs and 529 college plans that need servicing. We believe handling them in-house is in the best interest of our clients, and we’re up-front and transparent about how we get paid for that.”
Karsten described his firm's model as “extreme holistic services: The same services as family offices provide except we work with clients who have from $1 million to $10 million portfolios. In addition to providing financial plans, tax planning, insurance planning and investment management, we do tax returns, gift tax returns, estate tax returns; trust work is one of our largest areas.” To provide these services, Karsten's 16-member staff consists of CFPs, CPAs and EAs.
Thirteen years ago, Karsten merged a smaller Fort Worth CPA firm into his own and stumbled on a unique—and what's turned out be a very successful—business model. The other firm was owned by a solo accountant who wasn't doing so well on his own and was getting up in years. “There are limitations for solo firms: software, reporting, overhead,” explained Karsten. “We found we could run his business more profitably and provide an exit strategy whenever he wanted to retire.”
Even better, Karsten found a much bigger benefit: Many of those new accounting clients were interested in financial planning and investment management services. “The revenues from the tax work meant that our investment management prospects were paying us to market to them,” he remembered. “We get 1.25% annually, based on our full service including financial plans.”
It was a model that Karsten could build a business on. Over the past 13 years, Karsten Advisors has acquired nine more CPA firms. And the valuation math is even better: “In general, CPA firms tend to sell for between 1 to 1.25 times their revenues from accounting services. But RIAs typically sell for 2 to 2.5 times their AUM revenue. Ninety percent of our clients use us for tax work, and we manage all of their assets. That means we get a premium every time we buy a firm and put some of its clients’ assets under management.”
All Karsten's acquisitions are internally financed based on the FP Transitions’ model of 33% cash, 33% promissory note and a 33% earn-out based on client retention. Karsten's retention averages 85%. “Tax work without a doubt creates a stronger bond with clients,” he said. “The tax service occurs every year, and people like the continuity. Also, we’ve refined our process over the years and kept it simple: communication and service. The more you contact new clients and the more services you provide, the more they want to stay.”
The firm's most recent acquisition is a perfect example of this formula. On Jan. 9, Karsten bought the accounting firm of Kurtenbach & Co. in Denver. It's owner, Terri Kurtenbach, wanted to retire. She already offered investment management, but hadn't been very successful marketing it to her clients.
“This is our first acquisition outside of Texas,” said Karsten, “but it's a very good fit for us. With only $15 million in AUM and 250 tax clients, many of whom have oil or real estate money, Terri was only managing investments for 35% of her clients. We think that's a great opportunity for us. The Colorado market, from a cultural and demographic standpoint, is a close fit to the market in Texas. And Denver is only a short flight away.”
To facilitate Kurtenbach's retirement, Karsten has already hired Andrea Folkes, a CPA with 10 years’ experience at an advisory firm in California. Folkes will be responsible for creating and implementing wealth management and investment plans for clients, as well as supervising tax and estate concerns.
This is Karsten's model for helping CPAs who may or may not offer financial planning and asset management find successors and finance their retirement transitions. “All our acquisitions are succession plans,” he said. “The timing of the retirement of the current owners ranges from a few weeks to a few years.”
In short, what Karsten does is match investment advisors with CPAs. He finds a good fit with the retiring owners and then works to make a smooth transition of clients from one advisor to the other. “The more you can keep things the same, the more likely you are to keep the clients and meet their expectations,” he said.
And his process takes less time than you might think. “Having the old advisor sit in client meetings for a year is pretty standard,” he said. “But they don't have to be coming into the office every day during that time. Sometimes, just two or three weeks working with the new advisor is enough.”
In fact, sometimes, the less the selling owner comes into the office, the better. “Retiring advisors almost always think they want better processes and procedures, but then those changes can ruffle their feathers sometimes. When that happens, we just go back to the way it was. In most cases, there's no real hurry to make changes, and we want the former owner to feel comfortable in ‘their’ firm. We’re very careful about matching owner-advisors with their successors—we’ve never had a situation not work out.”
With more baby-boom advisors thinking about retirement every day, the market for providing successors and succession financing is only getting bigger. And as in many other areas of the business, the small advisory firm market is woefully underserved.
This, of course, spells big opportunity for Karsten Advisors. “We’re going to be pretty aggressive in our business going forward,” admitted Karsten. “We are closing on another firm in Fort Worth in two months. One of our senior advisors here wants to move back to the West Coast to be with family, so we are beginning a recruiting campaign to find a few successful advisors in California, where we can add tax services or investment management and provide them with a successor.”