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Yet Another Reason Why Internal Successions Are Best

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A couple of months ago, ThinkAdvisor’s Gil Weinreich posted a story (Advisors: Don’t Sell Your Practice!) about a newly released white paper from CLS Investments in Omaha titled “Reinvent Your Practice: Alternatives to Traditional Succession Planning” (okay, I’m a little behind on my reading).

In it, the third-party money manager—which also offers practice management consulting to its affiliated advisors—suggests that owner-advisors should think twice about “selling” their firms to an outside firm when they reach retirement age. 

CLS does a good job of illustrating the current crisis in advisory firm succession. However, in places, the paper seems a bit confused (such as when it mixes an internal succession with an outright sale to a third party), and more importantly, does a poor job of assessing the other options available to owner-advisors approaching retirement. Perhaps that’s not surprising, given that CLS has an obvious conflict of preferring that its client firms don’t fall into the hands of other firms that don’t use its services. 

First, the bad news. CLS paints a not very happy picture about the current state of advisor retirement based on a poll of 117 of its client advisors. (Surprisingly, CLS offers no information these “advisors”—such as their ages, proximity to retirement, the size of their firms or source of their firm revenues [AUM or commission], which would allow for a clear analysis of their data and of their valuation methodology. CLS did not respond to our inquiries for more information.) 

By way of introduction, CLS cites a Pershing Advisor Solutions/Moss Adams study that shows “only 28.7% of advisors have defined or implemented a succession plan.” It also references a Cerulli Associates survey showing the average age of advisors today is 51 years, with 43.3% of advisors over 55. I think we can all agree that retirement is a looming issue for the advisory industry. 

Then, CLS adds its own data, starting with the scope of the retirement “problem.” Some 46.5% of advisors project they’ll need between $1.5 million and $3 million to retire comfortably, and another 14.3% figure they’ll need more than $3 million. Altogether, that’s 60.9% hoping for at least a $1.5 million nest egg. 

To date, however, only 30.2% of advisors have funded more than half of their retirement goal—which of course, leaves a whopping 68.8% who have yet to get to the glass-half-full mark (and remember, 43.3% are over 55).

Where do these advisors think the rest of their retirement is going to come from? You guessed it: CLS data shows that some 55% of advisors polled expect to fund at least half of their retirement through the sale of their firms. 

By comparing amounts advisors “need” for retirement, with the current state of their savings, CLS concludes: “Thus, over half the industry is banking on the idea that their practices will fetch anywhere from $750,000 to $1 million when they retire.” 

Pretty clear so far, right? Unfortunately, here’s where things start to get a little murky.

Possibly in its zeal to turn advisors away from selling their firms to third-parties, CLS paints a dismal picture of such a transaction, without offering any data to support the numbers or methodology it offers. Basing its valuation on “free cash flow,” which is essentially gross profits, and setting multiples ranging “from 2 to 5 times,” the paper concludes that an “advisory practice that has $400,000 in annual revenues…using an optimistic multiple of 5…would be valued at $400,000.” 

This, of course, is a revenue multiple of one (1). That would be accurate if the firm in question generated only commission revenues. If however, the revenues came from AUM fees, based on industry valuations and our experience, the firm would be worth between $800,000 and $1.2 million, depending on factors like the age and wealth of their clients, their potential for additional assets and the local market prospects of the firm. Even based on CLS’s dismal figures for advisor savings, these valuations will make many retirement plans work. 

CLS goes on to offer a number of alternatives to an outright sale: winding down a practice to work longer, merging into a larger firm and transitioning most of the clients, outsourcing “day to day operations by working with a third party money manager” to leverage the owner and cut expenses (I didn’t say anything), or leveraging firm owners with junior advisors. 

While all of these are workable, and enable owner-advisors to continue to generate an income stream with less work, they usually involve special situations which are hard to find. In our experience, the hands-down, no-contest, best exit strategy for advisors is an internal succession: selling the firm to junior partners.

As we illustrated in our 2013 white paper, Take 2: The New Direction of Succession Planning, the two keys to successfully transitioning an advisory firm internally are time and growth. By extending a succession over 10 to 14 years, motivated junior partners and owners will accelerate annual  firm growth sometimes in double digits: which can pay owners up to 3 times firm revenues (from AUM fees), and allow owner-advisors to keep working as long as they desire.

If you don’t have that kind of time to make a plan work—or viable successors—sell to a third party. Your TAMP can take care of itself.


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