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Market conditions make succession planning a priority

Jul 18, 2021

For many wealth management firms, the past several months of economic and financial turmoil have been a wake-up call. Market conditions pushed two inescapable matters of firm management to the forefront:

  • Short-term: Has ownership properly prepared the business for an unforeseen circumstance, such as the death or disability of the owner?
  • Long-term: How and when will the owner make a successful transition of power to a new owner, while realizing value for the firm the current owner has built?

According to numerous studies of the wealth management industry, over 70 percent of the industry considers succession planning an integral component of their firm’s future viability. However, only 30 percent of registered investment advisor firms have an unwritten plan in place and a mere 15 percent have a formal, written succession plan. A staggering 55 percent of firms have no succession plan at all.

Succession planning is the process of deciding when and how the business will be managed or transitioned in the event of the owner’s premature death or permanent disability. It’s important to protect the firm’s value, as well as its clients and employees, from such unforeseen events. A succession plan addresses a time frame and a party to whom the owner will leave or sell the business, and how to fund the transfer of ownership.

Considerations when selling a firm

The single most important issue for selling or transferring a firm is the extent to which clients of the transferring advisor(s) will remain with the successor firm. Without the prospect of continuity, there can be no viable transfer. Although a successful transition includes several variables, some have greater impact than others. (Note: For purposes of this discussion, the transferor will be referred to as the seller, even though the client service may be provided by another party through a merger or formation of a new partnership.)

Time and client comfort. The more frequently an advisor communicates with clients, the easier it is for a transition to take place. If most clients are visited monthly, within just one calendar year the seller and his successor should have ample opportunity to execute a proper transition.

Desire or willingness to continue working. This is a personal choice of the seller, which affects the decision of  when to sell and to whom. If a seller wants to continue working while a successor is put in place, he or she may have to consider successors with self-sustaining firms. The seller might merge with such a successor early on, in order to promote an image of continuity. At the same time, the seller avoids an immediate reduction of income that requires a change of lifestyle.

Upcoming investments. What if a seller is considering a sale or merger but anticipates the need for a significant investment that could affect the timing of the sale? The investment could be a lease renewal, a computer upgrade or a new phone system. Each could be a non-recoverable cost to the seller. Inquire about whether a buyer’s existing resources make such a purchase unnecessary.

Staffing. Can staffing affect the timing of a sale or merger? Absolutely! The loss of a manager or strong performer can accelerate the timetable for a planned sale or merger. On the other hand, such an event could lead the seller to hire an individual who fills the current void and is groomed to become the seller’s successor.

Choosing a successor

The purchaser or successor to a wealth management firm should carefully review the firm being transferred. The review should include scrutiny of the firm’s clients from a business point of view. In effect, the purchaser must perform client acceptance procedures on all clients that might become part of the firm. The seller or transferor of the firm must perform due diligence procedures in order to protect the seller’s interests. This means the seller must take a hard and objective look at the prospective successors and determine whether they can accomplish a successful transition. The seller must thoroughly examine the following:

Types of services provided. Carefully examine the similarities and differences between the respective platforms to identify opportunities to be pursued or disconnections that could hinder the transition process.

Size. The idea is to find a firm that offers the greatest amount of continuity. Clients accustomed to dealing with partners are going to have doubts about a new firm that sends lower level personnel.

Fee structure. A successor's fee structure should be like that of the seller, so serious fee adjustments are avoided. Clients are fee-sensitive, and many will not embrace a change in ownership that comes with higher fees.

Buyer's client retention record. A successor with a strong history of client retention has the best chance to retain the seller's existing clients. Continuity will likely affect the contractual obligation to be paid to the seller. The seller should have the opportunity to examine pertinent client records of any proposed successor.

Financial review. To become comfortable with a successor's ability to meet the financial obligation related to the client transfer, the seller should review all relevant financial information.

Chemistry. When selecting a buyer, the most important consideration for a seller should be chemistry.    

Clients will stay with the successor firm for the long term if they feel good about the successor. If the buyer and seller get along well and it’s apparent, clients are more likely to welcome the new owner.

Structuring the transfer of the firm

What are some of the ways to structure the transition from one firm to another? The answer to this question has great impact on the success of any change of ownership. Here are the likely options:

Merger contract with buyout. The seller and successor merge their firms with a future buyout agreement in place. The detailed terms of the agreement are signed, sealed and delivered up front, providing ample time for a transition that leads to the seller's retirement. This approach allows for a stronger, more comfortable transition of clients. In addition, back-up is already in place in the event of the seller's death or disability.

Sale with a consulting agreement. Selling a firm with a continuing consulting agreement provides the seller many benefits of a buyout without the liability exposure of partnership. While a consulting agreement is intended to facilitate an orderly transition, (i.e., it gives clients an opportunity to get accustomed to the change), announcing it to the seller's client base could have the opposite effect.

Sale/Transition/Gone. This is probably how the owners of most small advisory firms sell their businesses. The successor acquires the equity from the seller and a transition of some sort follows. The key to making this effective is the transition; there is always a need for clients to gain comfort with the new firm.


Paul T. Lally
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