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Building your own business succession plan

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A client base is bound to change, but the basic message advisors preach to clients remains essentially the same, whether the source is a tax specialist, financial planner, insurance agent, estate planner, registered rep or broker: Plan now for the future or risk seeing your retirement goals and legacy unfulfilled.

Tiburon Strategic Advisors has 10 predictions about the future of succession planning in the financial advisor segment:

1. More than 500 fee-only financial advisor succession transactions will occur between now and 2009.

2. At least half those transactions will involve current employees as successors.

3. Current partners will be an option for firms with multiple partners.

4. Local competitors will be the second-most-active group of buyers.

5. Financial buyers – those buying practices for purely financial reasons – will never be successful.

6. Banks will emerge as aggressive buyers.

7. Regional and local CPA firms may acquire their way into the financial advisory market.

8. Acquisitions by buyers with financial and strategic motivations will cause a consolidation that yields more national advisory firms.

9. Free cash flow multiples will reach six times to eight times for the best firms and more buyers will pay with cash and/or public stock.

10. Valuation ranges for similar size firms will widen dramatically.

But when it comes to their own retirement and the future of their practices, many advisors, it seems, are not practicing what they preach. The reality, according to Chip Roame, managing principal of Tiburon Strategic Advisors, is that many advisors are so focused on helping plan the future for their clients that they’ve neglected planning the future of their own businesses.

“Most advisors have planned poorly for the succession of their practices. It’s often a case of the cobbler having no shoes.”

“They’re financial professionals, but just like anybody else, they sometimes need to be nudged into planning for the future,” observes Richard S. Dennen, president and CEO of Oak Street Funding, a firm that provides capital and consulting services to insurance agents for succession transactions and other funding needs.

Findings from a report issued in 2005 by Roame’s northern California consulting firm document just how unprepared many advisors are for the succession of their practices, whether it comes as a result of retirement, a strategically motivated transaction or unforeseen circumstances. The Tiburon report, which analyzes the state of succession planning, firm valuation and the acquisition market within the financial advisor segment, found that only 45 percent of the largest fee-only financial advisors and 29 percent of the largest independent reps have written succession plans.

Why are self-planners in the minority? According to Roame, many advisors have a succession plan in mind but haven’t committed it to paper. Others lack one because they don’t envision ever retiring. Some simply haven’t realized the substantial value of their practices – and how a succession plan eventually can help them tap or preserve that value.

For advisors who find themselves in one of those categories, the risks of moving forward without a formal succession plan are substantial, Roame says. What happens to a practice in the event its principal advisor dies unexpectedly or is incapacitated by illness? What about the advisor who, with retirement looming, realizes he has started the succession planning process too late? Those are moot questions for advisors who have a plan in place. Advisors who don’t are the ones who should be worrying about seeing their practices change hands under transaction terms that are less than favorable.

“It can mean the difference between the seller being stuck taking a promissory note [from the buyer] and getting cash upfront [for a practice],” says Chris Hirschfeld, managing director of Goelzer Investment Banking, an Indianapolis firm specializing in business valuation and succession planning.

The planning imperative
Changing demographics within the advisor set make succession planning a more pressing issue. Tiburon estimates there are 19,500 independent fee-only and fee-based financial advisory practices, roughly six times as many as 20 years ago, along with about 85,000 independent reps, up from about 75,500 as recently as 2002. Meanwhile, 50 percent of independent advisors are over age 50. All this points to more advisory businesses changing hands.

Any advisor who envisions his practice continuing without him needs a succession plan, whether the goal is to pass the practice on to a child, business partner, or employee, to sell it to a competitor, or to find a buyer in the open market. Even advisors who aren’t contemplating retirement need a fallback succession plan in case they die or are disabled. And the right time to begin succession planning? “Immediately,” Hirschfeld says.

At minimum, an advisor should start the succession planning process five to seven years before he anticipates retiring, Hirschfeld and Roame agree. It’s not an easy process, Hirschfeld says, mainly because advisory practices tend not to be asset-rich but rather derive their value from service and relationships. Oftentimes, a transition in leadership gives clients the green light to change advisors, he notes, so many advisors are reluctant to go down that path. But with a plan in place to ensure the transition goes smoothly, clients may be less apt to defect.

Best practices
Based on an in-depth analysis of real-life succession scenarios involving financial advisory firms, Tiburon specifies seven key steps to successful succession planning:

1. Identify an appropriate advisor to serve as a guide through the process.

2. Develop objectives, expectations and a strategy for completing a sale, plus an understanding of what motivates prospective buyers.

3. Value the firm and understand the value drivers.

4. Negotiate a fallback business continuity scenario.

5. Position the business.

6. Negotiate the transaction.

7. Prepare for the close and make it work after the deal.

Positioning the business so it is both attractive to buyers and ready to thrive after a transfer in ownership is one of the most crucial steps in the process, Goelzer’s Hirschfeld says. “You want to sell your company when the outlook is good.”

That involves such things as establishing a clear corporate governance, ensuring the practice is meeting all its regulatory compliance responsibilities, having a strong employee team in place and supported by a strong technological infrastructure, and having management incentives to retain key players in the practice. “They’re the ones who are most likely to buy out your business,” Hirschfeld says.

Early in the process, Hirschfeld says, it’s vital to perform due diligence on one’s own practice by assessing goals, strengths and weaknesses, market position, and factors that determine the attractiveness of the practice to prospective buyers or successors. Here’s where an objective third party can help. Firms like Hirschfeld’s specialize in succession planning and valuation. Oak Street Funding not only provides insurance agents with capital to build their businesses (such as by borrowing against future commissions), it performs valuations and structures and negotiates succession transactions.

Most succession deals ultimately hinge on the valuation of the practice. Often valuation is performed by an independent third party based on factors such as assets under management and the makeup and track record of the sales force, Hirschfeld says it’s important in valuing a practice to research what companies with similar profiles have been fetching on the market. In a majority of cases, practices are valued according to a discounted cash-flow model, explains Roame, which essentially forecasts a business’ ability to generate cash flow based on such factors as projected client retention (the extent to which the buyer expects to retain the practice’s clients), the cost structure of the practice and the discount rate applied to the noncash portion of the transaction.

Finding a match between buyer and seller is no small task. Buyers can be employees, partners or competitors, or they can be entities motivated by strategic synergies or pure profit. Historically, most buyers fall into the first three categories, according to Tiburon. These days, according to Tiburon’s research, parties looking to buy an advisory practice far outnumber those looking to sell a practice. Within five to 10 years, however, Roame says he expects sellers will outnumber buyers.

Once a match is in place, there’s the matter of negotiating and structuring the transaction. “How you structure the deal can be more important than the price,” Hirschfeld points out. Will it be a pure cash deal? Will a seller-subordinated note be involved? Will the transaction include an earn-out provision? What are the income tax and capital gains tax ramifications for the buyer and seller? How are the interests of buyer and seller protected in case of underperformance, misrepresentation or fraud? If it’s a struggle to answer those questions, he suggests calling upon an objective third party with a firm grasp of the legal and tax considerations associated with succession-type transactions.

While no two deals are structured exactly the same, many tend to involve an upfront cash payment for some portion of the practice’s value, with the balance financed via an earn-out provision. The fairest, most favorable outcomes often come from transactions in which the departing owner stays onboard for a period of time to smooth the transition, Roame notes.

Tiburon found that negotiations tend to unfold according to a 10-step process:

1. Sign a confidentiality agreement.

2. Review financial statements, client base and work products.

3. Examine cultural issues.

4. Negotiate price and terms.

5. Draft a letter of intent.

6. Complete a legal document review, purchase audit and other due diligence.

7. Determine appropriate purchase methodology.

8. Negotiate nonfinancial issues.

9. Discuss reactions to all scenarios.

10. Get a well-written purchase agreement.

Once the transaction closes, then the heavy lifting really begins. For, according to Tiburon, many advisors who have gone through the process report “that the sale and all of its valuations, legal issues, negotiations, etc., was the easy part. It was the integration of the firms after the sale that was most challenging.”


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