Doing It Right

David Grau’s been a friend of mine since 2001, when I worked with him and his newly formed FP Transitions for a few years to brand their expertise in helping independent advisors realize the value in their practices. David recently set aside a few hours to tell me about a new program that he and his team have created which he believes—and now, I do, too—will solve one of the most vexing challenges facing advisors today.

Despite the very substantial revenues that many advisory firms generate, most independent advisors went independent to better serve their clients. In fact, it’s only been within the past decade or so that a broad spectrum of independent advisors have had the potential to earn incomes that rival—or even exceed—what comparably experienced brokers take home. Of course, this relatively new-found advisor earning potential is the direct result of the industry’s transition to managing compounding client assets for ongoing fees during the past two decades. The most valuable aspect of this changing advisory business model has been the apparently unexpected increase in the value of advisory firms: from close to zero in the case of the transactional-based practices of yesteryear to tens of millions of dollars for some of today’s most successful fee-based firms. Yet, due to the newness of this unexpected windfall, few advisors have done any planning for getting this value out of their firms when they retire.

By now, we’re all well aware that with us baby boomers beginning our transitions into some sort of retirement, the independent advisory industry is poised to transfer the management of trillions of dollars of managed client assets—I’ve seen estimates as high as $4 trillion—over the next 10 or so years. That’s a pretty good chunk of change (even by Congressional standards). Consequently, over the past decade we’ve seen this eventuality dawn on the institutions that serve independent advisors, with many of them offering various “solutions” designed to bring the AUMs of “their” advisors within the fold, and possibly capture some of those assets away from their competitors.

Here’s the problem: To the extent that aging baby-boom advisors have done any thinking at all about what they’ll do with their firms at retirement, almost all of them have a vague vision of transitioning the firm to “junior advisors” who are either currently employed by their firms, or whom they intend to hire for that purpose “sometime soon.” Let’s set aside the “who” issue for a moment, and explore the more quantifiable “how much.”

Many independent advisory owners today have found their firms to be worth vastly more than ever expected or planned for—and far more then their “junior” successors can afford to pay. To their everlasting credit, a surprising number of these advisors choose to forgo the market value of their firms, selling their practices at the end of their career to their junior partners at a price they can afford.

In addition to the potential tax ramifications of transferring undervalued assets, these commendable acts of altruism come with another downside. A few years after the acquisition of a firm by the junior partners, a large institution or roll-up firm offers the actual market value for the firm, or even substantially more than that, based on the suitor’s real or imagined projections of increased efficiencies or business synergies, and the junior partners end up reaping the original owner/advisor’s windfall.

The solution, of course, would be for someone to come along with a financing formula for junior partners to buy out senior partners at market valuations, but under terms that young advisors can afford. By some accounts (including his own), Mark Hurley at Fiduciary Network has created just such an acquisition program. However, Hurley is only interested in working with the largest of advisory firms.

To bring a succession solution to the rest of the independent advisory industry, FP Transitions recently launched its Equity Management System (EMS). “As the name implies, our new system enables advisors to manage the equity they are building in their practices,” Grau told me. “Managing equity is not about retiring, at least in the traditional sense. It’s about controlling your end game strategy and protecting what is, for most advisors, their largest and most valuable asset.”