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Practice Management > Succession Planning

What’s in a Plan?

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“In our view, transitioning control and management of [advisory] firms from founding owners to a new generation will prove to be the single most challenging issue for advisory firms over the coming decade. ”

So say Dan Inveen and Eliza De Pardo in their “FA Insight 2011 Study of Advisory Firms: People and Pay.” The study includes the usual analysis of the current business climate for independent advisory firms (it looks like the 2008 recession is finally behind us) and how the top firms in each of four size categories got that way—but what’s truly new about this study is its thorough analysis of the industry’s preparedness to deal with the looming retirement of all those baby boom advisors. The short answer is it’s not.

As we move deep into the fourth quarter, FA Insight reveals that few firms have taken serious steps to either realize the value that these business founders have created or to ensure an orderly transition of their firms and the continued care of their clients. With an estimated $3.5 trillion or so in AUM expected to change hands in the next 10 to 15 years, FA Insight’s findings suggest that the future of the independent industry is literally up for grabs.

The study found that the disparity in income per owner for the top 25% Standout firms versus the other 75% of firms increases dramatically as firms get larger. With Operators (firms with under $500,000 in annual revenues), income is virtually the same for both groups at around $135,000, but for Cultivators (revenues of $500,000 to $1.5 million), the Standout firms posted 30.7% higher owner’s income; Accelerators ($1.5 million to $3 million) had 25.7% higher income; and the top 25% of Innovators (more than $3 million in revenues) posted an average of 106.3% higher income.

FA Insight explains the differences this way: “This is a result of Standouts tending to employ fewer non-professionals per professional compared to other firms.” This minimization of non-professional staff is also seen in higher “people” costs as a percentage of total expenses for Standouts in every category, as well as substantially more clients and revenue per full-time employee.

But as I mentioned, it’s the FA Insight data on transitioning the ownership of firms (or lack thereof) that’s most telling for the industry’s future. Fully 51% of primary owners (that is, owners with more than 5% equity in their firms) are within 12 years of retirement. Yet, the number of firms that are preparing for this transition is shocking, especially considering we’re talking about financial planners here. Of the firms studied, a meager 18% are currently implementing a succession plan, while another paltry 16% have an “adequate plan,” but aren’t implementing it at this time.

Of the remaining 66% (that’s two out of three firms, folks), 28% have a plan, but lack financing, a successor or are inadequate for other reasons; and 38% are either “preparing” a plan or have no plan at all. Perhaps most surprising (which I think you’ll agree has to be pretty darn surprising) is that the Standouts (top 25%) in the larger firm categories have the lowest percentages of adequate succession plans. (See chart, below.) Yes, you read that right: The larger firms tend to be the least prepared to transition their firms.

What could possibly account for the most successful advisory firms paying so little attention to their ownership succession? Here’s what Inveen and De Pardo offer by way of explanation: “These results could suggest that the current success of many Standouts may be coming at the expense of proper planning for the future.” This would appear to make a good amount of sense, except in light of other data in the study. It seems that in all four size categories, the number of primary owners as a percentage of all full-time employees is higher for Standout firms than for the other 75%. While the ratio of owners drops dramatically as firms get larger, this is what we would expect, considering that their support staffs—both professional and non-professional—are proportionately larger.

Perhaps a more consistent explanation of the lack of “adequate” succession plans among the most successful firms would be that these firms consider sharing ownership with younger advisors to be, by itself, a sufficient plan. This conclusion is further supported by data showing that between 25% and 26% of the three smaller firm levels have career paths for all employee positions, while just 14% of the larger Innovators do—again, suggesting that the potential of ownership may be viewed as a panacea for all employee desires for advancement.

In addition to the data on succession planning itself, FA Insight offers a view of the mechanisms of ownership with far-reaching implications. Of the firms that are adequately prepared for succession, 45% offer long-term financing to purchase shares, and 82% sell shares immediately to new owners. Yet, only 29% of the new owners avail themselves of that firm financing; while 33% chose to pay cash up front, 17% buy in with an existing book of business, and 20% are granted ownership without payment under incentive plans or other arrangements.

Of those employees who choose to buy in for cash, 31% use personal cash reserves, and 24% either didn’t require funding or used other financing sources. This strikes me as an extraordinarily high percentage of “younger” advisors paying cash for equity considering today’s market value of even smaller advisory firms. David Grau at FP Transitions tells me that smaller firms are currently selling for around three times gross revenues, paid over three to four years, which would put the cash value at around two and a half times revenues. So, for a firm with $500,000 in revenue, we’re still talking about $1.25 million in value, which would make a 10% stake worth in the neighborhood of $125,000—a pretty good chunk of change to have lying around.

My suspicion is that this data suggests many firms are selling ownership to in-house advisors well below market value, a practice that has broad implications for the industry. Certainly, if, as FA Insight and others suggest, the biggest issue facing the independent advisory world in the coming years is the succession of existing firms, the converse is equally troubling. How can today’s junior advisors afford to buy out their firm owners? While selling at substantial discount is laudable for the current generation of owners, it’s not really a viable solution. For one thing, it’s not fair to the founders who created these valuable firms or to their heirs who may have to live on their financial legacy. What’s more, it creates a huge financial incentive for the junior advisors to sell to a roll-up firm at full market value—the very thing that the owner/advisors had hoped to avoid.

Although transition programs that enable younger advisors to buy out their owners are becoming commonplace, they usually require up to 10 years or longer to implement, which ironically seems to be more planning than the majority of today’s advisors are willing to do. Perhaps a more useful solution will be for custodians and independent BDs to offer truly workable funding for their affiliated advisory firms to buy the transitioning practices of their competitors. As I mentioned, we’re looking at an estimated $3 trillion to $4 trillion in client AUM up for sale. A firm that enables their advisors to grab the lion’s share of those assets undoubtedly will emerge as the industry leader of the future.


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