Judging by the amount of coverage succession planning has been getting in the trade press in the past couple of years, it is one of the most pressing problems facing the independent advisory industry today. It’s certainly an issue for tens of thousands of baby-boom age owner-advisors who are quickly approaching retirement age—and for the younger advisors in their firms who are hoping to take control and bring those firms into the 21st century.
Yet, as evidenced by the relatively few successful successions we hear about these days, the transition of firm ownership to the next generation of advisors is quite a bit more difficult than one might think. Equally surprising, the barriers to a smooth succession actually boil down to just two: finding a qualified successor (or successors) and financing the buyout of the current owners.
But, as management consultant Angie Herbers has recently documented (see “Death of the Rainmaker,” July 2014, and “The Fatal Succession Planning Mistake,” November 2013), owner-advisors often have difficultly planning their succession far enough in advance (go figure)—and getting their heads around the fact that the skills required to take an established firm to the next level are vastly different from those that were necessary to launch one. Perhaps most surprising of all: Industry custodians and broker-dealers have been largely ineffectual at helping their affiliated advisory firms to overcome either challenge.
In most industries, widespread challenges usually spell opportunity for those clever enough to find workable solutions, and the independent advisory business is no exception. There’s no shortage of consultants peddling their version of “succession programs” (although I’ve come across very few who have any stake in the actual outcomes); larger firms looking to absorb smaller firms; and so-called roll-up firms whose business models typically consist of buying out retiring owner-advisors and replacing them with much less experienced salaried advisors.
So I was encouraged to recently come across a relatively small firm—$250 million in client AUM—whose owner recognized the looming succession challenges facing the current generation of owner-advisors, created innovative solutions to help them with their current lack of financing and next-gen talent and is growing his own firm doing it.
Tom Karsten, a CFP and enrolled agent with an MBA, is president and chief investment officer of Karsten Advisors in Fort Worth, Texas, a second-generation family business, originally founded in 1977 as an accounting firm. In 1997, not long after Karsten graduated from business school and joined the family firm, he initiated adding investment management to its lineup of services through accounting pioneer Herb Vest’s broker-dealer, HD Vest. Renamed Karsten Advisors, the firm grew to be the largest HD Vest affiliate, but broke off four years ago to form its own RIA.
“We are now a hybrid firm working primarily with pre-retirees and retirees. Our reps are registered at Triad, and advisory client accounts are with Pershing, Schwab and TD Ameritrade,” said Karsten. “We fully appreciate the fee-only model, but in our retirement work, we inherit a lot of VAs and 529 college plans that need servicing. We believe handling them in-house is in the best interest of our clients, and we’re up-front and transparent about how we get paid for that.”
Karsten described his firm’s model as “extreme holistic services: The same services as family offices provide except we work with clients who have from $1 million to $10 million portfolios. In addition to providing financial plans, tax planning, insurance planning and investment management, we do tax returns, gift tax returns, estate tax returns; trust work is one of our largest areas.” To provide these services, Karsten’s 16-member staff consists of CFPs, CPAs and EAs.
Thirteen years ago, Karsten merged a smaller Fort Worth CPA firm into his own and stumbled on a unique—and what’s turned out be a very successful—business model. The other firm was owned by a solo accountant who wasn’t doing so well on his own and was getting up in years. “There are limitations for solo firms: software, reporting, overhead,” explained Karsten. “We found we could run his business more profitably and provide an exit strategy whenever he wanted to retire.”
Even better, Karsten found a much bigger benefit: Many of those new accounting clients were interested in financial planning and investment management services. “The revenues from the tax work meant that our investment management prospects were paying us to market to them,” he remembered. “We get 1.25% annually, based on our full service including financial plans.”
It was a model that Karsten could build a business on. Over the past 13 years, Karsten Advisors has acquired nine more CPA firms. And the valuation math is even better: “In general, CPA firms tend to sell for between 1 to 1.25 times their revenues from accounting services. But RIAs typically sell for 2 to 2.5 times their AUM revenue. Ninety percent of our clients use us for tax work, and we manage all of their assets. That means we get a premium every time we buy a firm and put some of its clients’ assets under management.”