With the graying of the profession and the complexity of today's financial services world, many advisors find themselves overwhelmed and stuck when it comes to creating a viable succession or exit plan. Too many have postponed what should be a long-term process; sadly, these advisors may feel successful now but will be disappointed with the final outcome.
Over the past decade, many firms have applied business discipline to create practices that meet or exceed their personal financial objectives during their working years. That's a great development for those individuals and the profession. Yet the regrettable reality is that most advisors still fail to plan effectively for a sustainable business that doesn't require their ongoing personal involvement; a business that would be attractive to a future owner.
Having worked with hundreds of advisors and business executives over the years, I believe the most critical transition is not from advisor to business owner but from business owner to long-term strategic business thinker. By this I mean having the ability to look at the business objectively, ask and answer the right questions and formulate a strategic plan — whether it's for business development, operations, marketing or attracting next-generation advisors as a step in the owner's path to retirement.
By “strategic plan,” I refer to a plan that is based upon a long-term outlook — 10 years or longer.
For a long time now, industry experts have been trying to help advisors change their understanding of their firms — to move them away from running a practice and toward running a business. The distinction may seem specious to some people, especially those whose firms have prospered without much tending. Moving toward a strategic business mindset becomes crucial, however, when you start to think about your internal succession or exit-sale strategy.
Are You an Accidental Entrepreneur?
One big problem my strategic consulting team and I have been observing for some time now is that many advisors are actually accidental entrepreneurs. These advisors never really intended to build a transferable business, but somewhere along the way they bought into the idea that they could cash in their chips when they got too old or tired to muster the same energy for the business that they’d had in the past.
Misinformation in the marketplace about practice valuations and the apparently growing number of active buyers led many to believe that even the smallest solo practitioner has built actual transferable equity, and that he or she will enjoy a liquidity event when it's time to retire. While a practice can provide the founding principal with an excellent income and lifestyle, an outside buyer is unlikely to see that income and lifestyle as something worth paying for — something that is literally valuable.
Those prospective buyers can probably build their own practice, exactly the way they want it, for less cash than buying an existing practice and inheriting all the legacy systems and people that come baked in with a package price.
Improvising as a Way of Life
As the founding generation of the financial planning industry moves toward retirement, its members are inventing a process for succession or exit planning, just as they invented their practice model. And once again, much of this process is improvised. There hasn't been much thoughtful methodology put in place for professional financial services firms to employ uniformly, whether for standard evaluation metrics, professional development or, importantly, just creating an attractive future for the next generation of advisors and firm owners.
M&A consultants abound but standards do not, and too much of their time is spent looking in the rearview mirror. Enterprise value — the financial value of a sustainable business — is a function of the future, not of history. While today's firm founders may have done an amazing job of cutting their service model out of whole cloth, many, if not the majority, have focused on growing their firms primarily to meet their lifestyle needs. As a result, they may have trouble attracting buyers or internal successors.
Entrepreneurial Risk and Reward
Even those who have been highly disciplined about building a business often didn't think about developing a new generation of leaders, or about creating career paths that would help the next generation step into leadership or governance roles. They may have taught the next generation how to create a financial plan, use financial planning software and work with clients, but failed to help them see how to embrace the risks of entrepreneurship. They thus fail to understand that business risk, just like investment risk, has the potential to pay off.
To find younger advisors is itself a challenge. The number of colleges teaching financial planning is mushrooming, but the graduates from their programs are still too few to meet the need, and they don't want to walk out of school and start cold-calling like their forebears did. Some forward-thinking firms are succeeding at recruiting these new grads by building teams that enable them to use the technical skills they went to school to obtain. The new grads want to develop and grow on a personal and professional level.
If you’re looking to develop a successor internally, you’ll likely need 10 years to groom that person. That’s assuming you already have a candidate in mind — that time frame doesn’t include the time it will take to find that person. Of course, you can find and hire someone who’s able to run the business, but will they have all the business-owner skills needed, and can they take the risk of being an entrepreneur as a buyer?
If the answer to those questions is yes, then it is likely the capable candidate will not be willing to meet the selling advisor’s price for the opportunity.
If you’re looking to be paid well as you retire from the business, you have to share “your life's work” and passion with others and build a culture that prompts the next generation to say, “I want to be part of this.”
If you haven't dealt with the challenges facing the industry today — what I have been referring to throughout this series as “the three C's” (consumer preferences; compliance and regulatory challenges; and competitive threats) — chances are that the beautiful mansion you think you built is really a fixer-upper.
You’ll need to attract the right people now, people who will update the business the way they’d want to buy in to it — which also means you need to share some equity as the transformation unfolds.
If you want to build a transferable business, think about the qualitative factors that are essential to your firm's value: a consistent client service experience, a systematic method for generating new business and a well-defined business model with sustainable margins. These are the qualities that bring multi-generational sustainability to professional services firms.
Skills and Career Paths
Advisory firms will also want consider the career path that CPAs in private practice typically follow — from paraprofessional to professional accountant, from junior to senior, and eventually on to partner. The financial services world tends to take newbies and tell them that their primary job is to find new clients.
Notwithstanding the fact that this recruiting model hasn't been truly effective for decades (in terms of yielding an ROI or producing enough new advisors), it has been commonly accepted as the way one must enter the business.
Most young adults don't have the skills for full-time business development and can't afford the old “eat what you kill” business structure even if they wanted to try it. Many cringe at the old financial services sales structure — that's not what they thought they were signing up for when they took on the CFP program investment.
The good news is that by attracting younger staff members that can be set on a career path leading to the role of advisor, you can accelerate the transformation of your firm into its next iteration and use technology to deal with the emerging complexities of compliance and margin compression. What's more, new graduates of planning programs have experience with the up-and-coming technology that can move your practice forward, making it both more efficient and more appealing to current and future clients.
Of course, training from within requires building a business strong enough to afford staff that may not contribute to the bottom line from the get-go. Translation: An investment in talent is similar to investing in the market — it's a long-term proposition.
Building Transferable Equity
Building enterprise value goes far beyond applying normal business techniques. It's about preparing a business to last beyond the founders — and it typically requires sacrificing some lifestyle income in order to invest in the business. For an internal succession to work, it also requires focusing on a service model and firm structure that's attractive to young people, who will come in and build your business for the future.
By definition, survivor firms need scale to keep up with the competing challenges of growth, compliance and the technology required to provide a forward-thinking service model. Everyone needs to commit to constantly improving capabilities — whether in scope or in convenience and efficiency for the client — to continue to be relevant. If you want to be a survivor firm, you will need to bring in young people who are willing to step-build on your foundation, whether solid or shaky. It's no longer as simple as “I need to find a successor,” and most firms fail to do even that. Complexity, even for the most talented entrepreneurs, is reaching a point where founders will have to accomplish extraordinary things to preserve the value of their businesses and find a buyer.
Wherever you are on the spectrum, consider expanding your approach to building an ensemble-based firm. This is a sure-fire way to build enterprise value. You will need:
A clearly defined strategy
A crisp understanding of what your clients value
A defined path for developing talent
3 Steps to Take Now
If you’re serious about building a succession or exit plan that will be most beneficial for you, your family, your employees and your clients, take these three steps immediately.
1. Stop thinking about selling. If you’re just thinking about dollars and cents, you are unlikely to strike a good deal. Instead, start thinking about what's going to lure the next generation of talent to your firm and who can help you lead the charge — this should be your top priority in 2017. If you can attract new business at a healthy margin, you should be able to bring in talent to create leverage and improve your firm's value over time.
Remember, growth creates opportunity and opportunity attracts talented people.
2. Ask your clients what they value. Use the last 10 minutes of every client meeting to probe for client feelings, preferences, perceptions and value. Form a focus group or client advisory board to explore attitudes and expectations. Ask them how they think you should build the business to better serve them — and their heirs — in the years to come.
Get your clients’ advice on how to attract the best young talent to your firm.
3. Lay out a clearly defined career path and staff development plan. Study how other professional service firms structure their businesses (attorneys, accountants, marketing and PR agencies, and other consulting organizations). Ask your staff what would motivate them to help bring in more business, recruit the right people and drive profitability. Ask a peer group how they have approached these challenges. Hire a professional to help you find and incentivize the right people.
If you focus on these steps, your business could have far more eventual value than it does now. If you choose not to focus on these issues, you would be wise to simply declare the business non-transferable, acknowledge that you won't have a significant earn-out or liquidity event associated with your business and plan accordingly.
--- Read The Valuation Conundrum on ThinkAdvisor.