Selling your advisory practice — a move stressed in a ceaseless torrent of industry advice — may be hazardous to your wealth.
Broker-dealers, roll-up firms and others who benefit from keeping or acquiring managed assets usually frame the necessity of succession planning in terms of the risk that clients won’t commit to a firm whose principal is aging.
Therefore, the reasoning goes, advisors ought to sell for the good of the clients and to cash out their equity.
A new white paper and advisor survey by CLS Investments, an ETF-based third-party money manager, has a different take altogether on advisor succession planning, arguing that advisors lose out financially through an outright sale of the business.
As a third-party money manager, CLS’ interests are perhaps at odds with roll-up firms, as it stands to lose business, potentially at least, from an acquiring advisor who might have different plans for investing client assets.
But advisors should consider its case for advisors not selling their practices, together with other interesting findings in its survey of 117 of its affiliated advisors.
The CLS survey found that 41% of advisors expected the sale of their practice to fund 25% to 50% of their retirement, with another 14% expecting such a sale to fund 50% to 100% of their retirement.
Thus, a majority (55%) of advisors expect the sale of their business to fund a significant portion of their retirement.
Given that the two largest segments of advisors surveyed expect to need between $750,000 and $1.5 million (27.7% of respondents) or between $1.5 million and $3 million (also 27.7% of respondents) to retire comfortably, do succession sales make economic sense?
Not according to CLS, which says that current industry norms value advisory business at from 2 to 5 times free cash flow, which is typically 20% of annual revenues.
So for $400,000 business — slightly higher than the average veteran advisor, CLS says — free cash flow would be $80,000. Using an optimistic multiple of 5, the advisor should get $400,000, equal to the annual revenue for his business.
While that seems like a decent payout to advisors, the whitepaper cautions that earnout provisions typically spread payments over a number of years (after a typical 40% down payment).
So the advisor would receive a $160,000 lump sum, followed by five years of $48,000 payments under these somewhat optimistic assumptions, which pales in comparison to an advisor’s salary, which is typically 40% of revenue ($160,000 a year in the hypothetical business discussed here). And after the sale is completed in five years, the advisor has no asset left.
Aside from the faulty deal logic, the CLS survey highlights another strong reason to resist traditional succession planning: advisors like what they do.
A bare majority (50.5%) of respondents don’t want to retire till age 71, if ever.
So not only is the sale of their business inadequate to fund their retirement, but it would deprive them of a personal and professional role they’ve invested their careers in.
The report approvingly quotes Michael Kitces saying “financial planning is a classic example of a profession that is not exactly a physically intensive business, and as long as the mind is able and the body allows for meetings with clients, planners can continue to work.”
To that end, the CLS white paper, through case studies of its affiliated advisors, seeks to “reframe” succession planning away from an outright sale of the business and toward keeping advisors happily involved in a growing business.
One such case study concerns Robert Harrell, an RIA now in his 70s, who followed a classic approach to continuity planning by bringing in his son Will, who, now serving as senior vice president, handles many of the firm’s day-to-day responsibilities.
That not only allows his father’s active role in the business, but avoids a rash of potential problems that could occur with an outright sale, such an exit date that coincides with a severe market downturn.
As Harrell, quoted in the report, puts it:
“There are so many variables that you can’t control, such as if the market corrects, and your valuation is dependent on the asset base in your firm; you could leave yourself exposed to not being able to fund your retirement.”
Harrell also cautions against waiting too long to plan succession, thus exposing one to the risk that younger staff with their own ambitions “may grow antsy and want to leave, perhaps taking clients with them.”
Throughout the white paper, CLS emphasizes the role a third-party money manager can play in assisting advisors with succession — one primary example of which is simply handling the management of client assets so that advisors can focus on client acquisition and retention.
That approach is illustrated in the case of its affiliated advisor David Van Rask, who credits “outsourcing the investment management component to CLS and a couple of other managed account platforms” as a key part of his strategy to build up the equity in his financial planning firm.
Like Harrell, but in reverse, Van Rask has sought to capture the value of the firm through family, having worked side by side with his father, who founded the firm, gaining the trust of established clients.
Looking toward the firm’s future, Van Rask has brought on a junior advisor — and far from contemplating a sale of his business, Van Rask is looking to buy, networking with older advisors to explore M&A opportunities.
The CLS white paper suggests numerous other ways for advisors to avoid becoming a “hostage to attrition” that is par for the course of aging advisors presiding over assets dwindling as their own aging clients withdraw money, die, transfer wealth to heirs or because advisors themselves fail to reinvest in their businesses.
These include buy-sell agreements with other advisors, partnering or merging with other firms, building up the capabilities of staff, but especially employing junior advisors.
CLS cites research by FA Insight that firms employing junior advisors report 44% greater income and 15% asset growth compared with firms not hiring them.
That approach is exemplified by Larkspur Financial Advisors, one of whose principals, Rick Arellano, is 81 and still actively involved in the business.
“What if I live to be 100 or more? I really like my lifestyle and don’t particularly want to change it. As long as my mind is still strong, I want to continue working with my clients,” says Arellano, who relies on staff for day-to-day operations, maintains a home office and continues to work on his terms and timetable.
His partner Ron Murphy, though only in his 60s, can similarly enjoy a greater than ordinary degree of flexibility, having developed the capabilities of his staff and invested in technology.
Murphy will bringing on a new advisor from a large wirehouse and will start to cut back, focusing mainly on “A clients.” He credits his ability to do so on the investment his firm has made in staff and infrastructure.
Dave Huber, whose Huber Financial is another case study in the paper, integrated both family and junior advisor approaches to succession, having once made the mistake of selling to an aggregator. When the firm experienced difficulty, he bought back its stock.
By hiring his son and a junior advisor (who, since his 2001 hire, is now president of the firm), the 57-year-old has signaled to clients that their firm is in it for the long haul.
“It is definitely a competitive advantage to be able to show to new clients that you have stability and a strategic plan to continue the firm, particularly as many advisors don’t,” he is quoted as saying.
With those personnel assets in place, Huber now takes long vacations “without having to talk to the office at all.”
The bottom line may be that the best time for an advisor to sell his business is…never.
CLS Investments CEO Todd Clark, in an e-mail exchange with ThinkAdvisor, affirms this possibility.
“Even though the advisor may have passed on, the culture of the firm can live on,” says Clarke. “This culture can continue to provide value to the clients and ensure their financial success for generations to come.”