From the successor’s point of view

Here is what I have experienced:

– vagueness regarding the timing for the founding advisor to retire;

– lack of clarity on how ownership of the business eventually will be transferred;

– changing valuation of the business, depending on the founding advisor’s mood;

– a steadily increasing workload on my part as the other advisor “slows down”;

– arbitrary decisions regarding “who gets paid for what” during the transition period.

Don’t get me wrong: I still want this transition to happen because I believe taking over this practice represents a huge opportunity for me to acquire a great foundation upon which I can build an even bigger business.

I am willing to “pay my dues,” but I am sure the whole experience would be a lot better if my “partner” and I had done a more thorough job of establishing mutual respect and an understanding of each other’s expectations at the beginning.

Coach says: Let me first thank you for writing and exposing a deficiency of the industry – and, I admit, of me in my own attempt to cover the important subject of succession planning. Almost everything that has been written or spoken about at conferences on this topic for the past few years has been from the perspective of the successor, not the person taking over the business.

Clearly, yours is an important view and it is essential that we listen to and respect it. Unhappy successor candidates will lead to failed transitions and damage to the industry, which is in dire need of orderly and successful transitions of practices from one advisor generation to the next.

My view is that both parties have responsibility for making a deal work out to everyone’s satisfaction. The founding advisor must be clear about his or her plan, which means it has to be in writing with sufficient detail to answer the most likely questions. Then, the successor advisor needs to agree that the plan is acceptable to him or her by physically “signing off” on the plan document.

At that point, the successor assumes equal responsibility for the execution of the plan.

If either party wants to change the plan, he or she must seek the approval of the other. When I have suggested this strategy to advisors contemplating the sale of their business over an extended period, several have said: “But, it’s my business. If I want to change the deal, that should be my prerogative.”

My response has always been: “You have asked another person to give up whatever they were doing before to dedicate several years of their life to making your dreams come true. It is unfair and perhaps even unethical for you to change the rules under which they made that choice without consulting them.”

So, what details should be in the written agreement? Although the essential elements of a deal may take lots of words to describe them, in my experience, potential sources of disagreement boil down to three:

– Timing

As I have said in this column before, few advisors abruptly walk out the door on a particular day and say, “Now I am retired.”

There is almost always a transition period that can range from several months to several years. Either way, everyone should know if this is a three-month process or a five-year process. Timing affects more than simply how long the retiring advisor will stay around. It also has an impact on:

– Transfer of management. At what pace does the successor begin to have management responsibilities? What are those responsibilities, and what authority come with them? A gradual transition is preferred to a brusque hand-off.

– Transfer of ownership. At what pace and under what terms will the successor acquire equity in the business? A stated schedule of share purchase and the accompanying conditions lets successors know how long they have to stand by creating more wealth for the founder before beginning to create wealth for themselves.

– Transition period. How long will integrating the successor take? How much time will the departing advisor spend on coaching the successor and introducing him or her to clients?

– Valuation

You would think valuation would be an fairly easy aspect to handle. There is enough professionalism in practice valuation today to come up with a fairly accurate value. Unfortunately, what happens between the time the initial valuation is done and the deal is consummated is what causes problems. Several things can change vendors’ perception of what their business is worth:

– Stories on the Street. Advisors hear that “Joe sold his practice for x dollars.” They then conclude: “My business is so much better; it must be worth 2x dollars.” There is no recognition that one practice might be worth more (or less) than another for any number of reasons.

– A seller’s market. As competition among buyers for advisors’ books of business increases, multiples have climbed. Caution: selling to the highest bidder doesn’t always turn out to be the best deal.

– Growth of business. As a result of the successor’s involvement, business accelerates and the value of the practice increases. How much should successors pay for the higher value they helped to create?

– Compensation

The crux of the matter of compensation is: “Who gets paid, and for what?” Placing value on the individual work of each party is difficult because there are so many factors that contribute to the success of a financial advisory practice. Some areas of potential debate are:

– How much is the effort by a successor to service and retain an existing client worth compared with the efforts of the original advisor to develop a new client?

– If the successor brings a new client to the practice, how much of the revenue should go to the founder for support, overhead costs, etc.?

– How is each party compensated for the time they spend in the management role?

To detail all the provisions of an agreement between a founding advisor and his or her intended successor is beyond the space we have here, so permit me to make a few broad suggestions:

– Put your agreement in writing. Visualize the ideal scenario and the outcome of the transition process, then craft an agreement to reflect that.

– Create a realistic timeline. If it extends beyond one year, establish milestones and review progress regularly.

– Have a professional valuation completed. Either have it redone at least every two years or have a valuation formula in place that can be applied at any time.

– Detail how equity in the business will be acquired – amounts, pricing, payment terms and conditions.

– Describe the transition period: when, how long, who’s involved, what gets done, etc.

– Write job descriptions for both parties and outline how performance will be measured.

– Decide how people will be paid and for what. Separate compensation into “advisor comp” and “owner comp,” and pay according to time, effort and contribution to each.

– Have an “escape clause” in case things don’t work out. Provide scope for mediation and remedies for failure to meet obligations of the agreement.

The transition of a practice from one advisor to another should be a satisfying and rewarding process for all involved. The process should, in fact, be a celebration of the founder’s life’s work and the start of something bigger for the successor. However, enthusiasm and good intentions by themselves will not be sufficient to ensure the positive outcome everyone expects. Mutual respect, thoughtful design, candid dialogue and, of course, trust in each other make the hand-off more likely to turn out that way.

Hopefully, you and the advisor whose business you are seeking to acquire can hit the “do over” button on your agreement before it’s too late to do so.

Good luck!

George Hartman is CEO of Market Logics Inc. in Toronto. Send questions and comments regarding this column to george@marketlogics.ca. George’s practice-management videos can be viewed on www.investmentexecutive.com.

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