Untangling Ownership: Succession Strategies for Firm Partners

To prepare a valuable succession plan that will take their firm into the future, advisors have to begin at the beginning and build a business instead of a practice, according to Charles Farrell and Fred Taylor of Northstar Investment Advisors. Regardless of an advisor’s exit strategy, it won’t work if he can’t detach himself from the firm.

“In order to build any kind of enterprise value, to be worthy of receiving some sort of buyout when you retire, you have to build a business not a practice,” Farrell, CEO for Northstar, told Investment Advisor. “Saying you have a practice that’s unique to you, the clients are tied to you, the philosophy’s tied to you; there’s really no way for anyone to buy you out because there’s no way to tell how many of those clients will stay, what sort of revenue you’ll generate, not a year or two out, but really 10 years out.”

One of the hurdles to building a business with enterprise value is getting past individuals’ personalities. “Everyone who’s started these firms, they’re Type A,” Farrell said. “They don’t like to listen to other people. They don’t play well in groups. It’s very hard to find partners where you have Type A personalities—because you have to have them to build your business—but when they get in the office, they can check that Type A personality at the door and figure out how you can each work to blend your talents into a business that is scalable and can be run eventually without you.”

He added, “If you’re the sole owner and the firm’s named after you, that’s going to be tough.”

Taylor, president and co-founder of Northstar, agreed.

“That’s why we didn’t name our firm after the partners 18 years ago,” he said. “Prior to Charlie joining Northstar in 2007, we all had four different practices. Then when Charlie came in, he had this idea of this model portfolio. All new business was under the new model, which is way more efficient because now everybody is managing money the same way. It’s not like, ‘I work with Charlie’ or ‘I work with Fred.’ It’s, ‘I work with Northstar.’ It’s a better model. We’ve doubled our business since Charlie’s been working with us.”

Another obstacle advisors encounter when trying to establish a business instead of a practice is finding strong partners they can trust.

“In the end, it’s your partnership and relationships that are the most important,” Farrell said. “It’s hard to find people in finance that you can trust and work really well with. I personally feel very fortunate that I have Bob and Fred as partners because you can’t get to the point of building a business if you can’t 100% trust your partners.”

Lack of trust is what causes advisors to “pull in and build a practice instead of a business because they think they’re going to get hosed at some point,” Farrell continued. “If you don’t have that trust there’s no way you can turn over the client base to the business. Every person thinks about, ‘If I had to leave, what would I take?’ That’s what guys think about in our industry, and you have to be able to get over that and say, ‘No, I’m fully, 100% committed to building a business with my partners.’”

Farrell and Taylor described their own buyout structure, which has evolved over the years.

“The first person who retired, there really was no buyout for it,” Farrell began. “There was no theory or formula; the clients that were there were turned back over to the firm.” The next partner to retire was offered a buyout based on the clients that person brought to the firm. The buyout for the following retirement was based on firm profitability as well as the clients that had been brought in.

“Now there’s no connection to clients,” Farrell said. “It’s based on what we think the enterprise value of the business is and is designed so that there’s no windfall if you leave—there’s an incentive to stay. If you were to retire, there’s a fair payout to you that’s based on the value of the business, but there’s also potential for adjustments if the business profitability changes. You have to be sure that when you’ve left, you’ve left it in really good shape or you can’t get your buyout.”

Taylor added that when advisors are still invested in the firm, it’s better for all the partners.

“You still have skin in the game to make sure your clients stay with Northstar,” he said of their buyout structure. “We manage 95% of assets, so if one of us leaves, it really hurts the other partners. There has to be a way we can go out and hire someone else to replace one of the partners and maybe hire two more people. You can’t just write whoever retires a massive check and be done with it. A lot of firms have done that and lived to regret it.”