So, you have a succession plan, and you’ve put it in writing and done the computations. It is going to change. Make that part of the plan. That’s part of the fun. That is what owning a business is all about, and that is why independent advisors are such a special group of people.

Returning to the Harbor

The first launch of our Lifestyle Succession Plan occurred relatively recently, only about six years ago. Since Tranche 1 in the planning process takes, on average, about five to seven years to complete, we now have our first group of “shipbuilders” coming back in and preparing for Tranche 2. The tales of their journey are fascinating and provide an excellent opportunity to learn from other advisors (G-1, G-2, and G-3) firsthand. This is part of the continuing evolution of the planning process.

About one-third of the businesses reported that the plans had gone more or less as expected and with good results—results that certainly justified the immediate start of Tranche 2. The common struggles seemed to center on finding the right people to support the plan and the business interests. Another third of the businesses reported that while the plan did its job and worked as expected, it took too long and/or they started too late and they needed to accelerate the process substantially. Fairly, about half of those that wanted to accelerate the process were driven not by G-1’s preferences, but by the preferences of the succession teams. G-2 and G-3 level owners confidently sought out bank loans or reset the plans to buy out G-1 at a much faster pace—in two or three tranches, not four or five. We found this aspect to be interesting, and somewhat ironic, given G-1’s almost universal trepidation over whether G-2/G-3 prospects have what it takes to be an owner. The moral of this story is: Don’t wait too long to build your ship and staff it with owners, or you may end up walking the plank.

The last third of the shipbuilders decided that it was not for them and resigned themselves to selling the business or merging when the time came. The common reasons seemed to center on a lack of time and resources to build an enduring business, sometimes starting way too late, or sometimes simply not having the acumen or the energy to do it. As we said many pages ago, set up plan A, the internal ownership strategy, and give it a try. If it doesn’t work, there’s always plan B, with an average of 50 interested buyers or merger partners ready to step forward at a moment’s notice.

This was the first group of business builders that we were able to study and learn from, and, frankly, practice on, so the results are promising even as the systems and procedures continue to evolve rapidly. Taking into account the changes that were made to each group’s organizational, entity, and compensation structures, a .666 batting average would get us into the Baseball Hall of Fame, but we really think that the one-third failure rate can and will be improved on by starting earlier, better preparing the industry-wide support systems (coaches, broker-dealers, custodians, insurance companies, regulatory structures), the valuation approach, and the diagnostic tools, and attracting a larger pool of qualified G-2 and G-3 candidates who understand how to select businesses with a future. All these things will come, and many are already in progress.

This is the first generation of independent owners that have had to navigate these seas—the first generation that is retiring with the most valuable of all professional service models in their wake. In the opening chapter, we lamented the fact that only about 5 percent of advisors have ever had a formal valuation to determine their equity value, which implies that 95 percent still value only their cash flow. Maybe the better perspective is that the independent financial services industry has moved out of the shadow of the wirehouse/captive model and in just a generation or two has come to appreciate the differences, the opportunities, and the benefits of being an independent advisor. The next step is to build enduring businesses—5 percent down or in process, 95 percent to go.

Empowering the Next Generation

One of the most enjoyable parts of the succession planning process for us is talking to G-2 and G-3 advisors and their spouses about what is typically a first-time ownership opportunity. During these conversations, the usual questions come up: Where does the money come from? What happens if this doesn’t work out? Does the profit-based note or our ability to pay it off affect our credit scores? What are the tax implications? But our favorite question is this: How will things be different after we become owners? That’s a great question.

Our answer is something like this: On the day after you become an owner, you will likely come in to work at the same time. You’ll park in the same space. You’ll hang your coat on the same hook, or hanger. You’ll sit at the same desk and answer the same phone and do the same things you did the day before you became an owner, and you’ll earn the same amount of money. What comes next—what changes and what improves—is up to you and your fellow owner(s).

Over the course of the first year, more things probably remain the same than change. That surprises a lot of first time owners. Restructuring ownership-level compensation has little impact in year one, as the planning process tends to start slowly. Profit-distribution checks will issue once a quarter, but it will take a year or two of growth for that cash flow stream to make an impact. None of that changes the fact that, from the clients’ perspective, the business is growing stronger and younger. What’s missing is experience. Buying stock and signing a promissory note to pay for it is not enough to transform an employee into an owner, at least beyond the legal sense. It takes something more.

G-1 will have to relinquish some roles and loosen the reins a bit as the former and accomplished dictator (a term we use respectfully); this is no longer a one-person show. One way to do that is to provide G-2 and, in time, G-3, with the appropriate titles, roles, and duties that come with being an owner (COO, CFO, CIO, senior vice president, vice president, etc.), once capabilities have been proven and the titles have been earned. Dare we mention the workload and the worries that are built into this part of the process? But they are part of the process. Share the wealth, share the workload.

As G-1 gradually cuts back on work hours per his or her planned workweek trajectory, G-2 and G-3 level advisors will have to learn to pick up the load, in addition to gradually assuming responsibility for the production as well. Each business will find its own path and pace on these goals and responsibilities. It will take some exploration and experimentation; that’s part of the process.

To G-1, we have this message: Give G-2 and, eventually, G-3 level owners the room to learn, and to grow, and to fail. No, they won’t do everything like you’ve done it and they won’t do things as well as you’ve done them, but they will find a way, if you give them your support and guidance and patience. Remember, this is not a competition; the goal is to build an enduring and valuable business with a collaborative team of professionals, and in doing so, they are as new at this as you are. Enjoy the process; don’t fight it.

Growth Is a Sign That Your Plan Is Working

We track growth rates with data gathered from each of the thousands of comprehensive valuations we perform. From this data we know that financial professionals in a one-owner practice (the typical model in this industry) have the highest sustained revenue growth rates when the owner is between ages 45 and 55 at an average compound rate of 13 percent per year. One-owner practices whose owners are between ages 56 and 65 have an average compound growth rate of less than half that rate, about 6 percent, but trending downward, and owners over the age of 65 have negative revenue growth rates of just under –3 percent—these practices are in attrition mode.

The net number of new clients provides an advanced warning system of what is about to happen for each age group of owners. For financial professionals between ages 56 and 65, the net new client rate levels off at around age 58 to 60 and then tracks negative, even though in a good to strong economy the top-line revenue numbers will still track positively and may even look strong, or at least stable. For the group of owners over age 65 in a one-owner practice, both data sets are typically negative.

The leading cause of these declining growth trends is obvious: As advisors get older and achieve many of their personal financial goals, they simply don’t invest the same amount of time and energy and money into the business as they once did. The practice is on cruise control, but it is slowly losing speed and momentum. The effort to stay on top of modern technology and each new software release begins to wane. Owners take Friday afternoons off and then the entire day. Three and four-day weekends no longer require an official holiday. As entrepreneurs and independent owners, this is a well-deserved benefit and reward. But as the client age demographics for the remaining client base begin to climb and with too few younger, new clients to balance things out, the practice begins to decline, bleeding off the equity value as the cash continues to diminish gradually.

Succession plans have the ability to reverse these trends and even stop them in their tracks. In the businesses where there are two or more generations of owners (a minimum of 10 to 15 years between each generation is sufficient), and especially those in which an internal ownership track has been established, we’re seeing an interesting result. The average age of the ownership team determines which growth rate level the practice or business falls into. For example, a 63-year-old founder who owns 80 percent of an advisory practice set up as an S corporation and a 38-year-old junior partner who owns 20 percent have an average age of just over 50 and tend to have an average compound growth rate in the 10 percent to 15 percent range. As the succession plan is gradually implemented, the client demographics level out over time, the cash flow increases, and the value climbs even as the founder gradually reduces his or her hours worked. G-1 and G-2 advisors often refer to this as the “rejuvenation effect.”

While the early data are quite promising, this isn’t quite a plug-and-play system. These results require a good plan, built with good, reliable information, and professional equity management. But when equity is managed well and the next generation has access to this opportunity, the results can be amazing.

What to Do When Your Plans Change

Assume that this is a possibility, even a likelihood, and build an exit ramp into your plan and your documentation.

The whole purpose of a succession plan is to help your business outlive you, so count on this being a long process. As you’ve learned in previous chapters, while some plans on paper may go out 20 or more years, they are implemented tranche by tranche, with planned opportunities for reassessment and course changes or adjustments. At a minimum, plan for annual valuations to monitor value, annual benchmarks using that valuation data to track operational numbers, and plan adjustments every five years or so. Depending on the size of the business, the number of owners, and the goals, some businesses and firms prefer more frequent maintenance so that the course corrections are more subtle.

While there are many reasons why your plans could change, let’s address the more common ones. First is a health issue or a similar concern that causes you (G-1) to want to significantly accelerate your end of the plan. Second is a dissatisfaction with the performance of the business in the hands of your successor team; perhaps they are just not taking on their responsibilities or you’re still the largest producer of revenue by a wide margin and you don’t see that changing. Third, you decide that what you really want is a lump-sum payout, a large one at that, and you’d like to be done with the whole thing and allow your team to take over and go their own way.

In reverse order, if you want to cash out, see the previous section on bank financing. Bank financing is possible, even likely, if you’ve set up your plan correctly. You can be substantially cashed out at today’s tax rates, and your succession team gets 10 years to pay for the business out of its cash flow and future growth. It can be a win-win, if everyone is ready. The tale of ownership in Chapter 8 also provides an interesting example along these lines.

If the succession team isn’t stepping up to your satisfaction and you’re unable to resolve that problem with your business partners, then sell the business to the best-qualified third party and be done with it, when the time is right—but don’t wait too long. Once you go into attrition mode, value falls fast. To retain the needed level of authority to sell or merge the business, you’ll need to have your plan documents prepared with this possibility in mind. Among the tools you’ll need are drag-along rights and probably tag-along rights, which are part of the paperwork, at least in the early stages of most succession plans. This is also why you need annual valuations to track the equity number and to make decisions proactively and on a fully informed basis.

Finally, if a serious health issue strikes you or a loved one, there are a couple of ways to address this in terms of your participation in your own succession plan. First, consider this one of the benefits of owning a business with a strong and collaborative team (remember Chapter 5 on continuity planning?). This is a major benefit of having a succession plan and why we encourage you to plan at multiple levels, including the what-if challenges. If your succession team is strong enough and you’d prefer to wrap it up, accelerate the process. Many plan participants call us in the middle of Tranche 1 and roll the plan over into Tranche 2. The process requires some obvious plan adjustments and a new set of paperwork, but to put that in perspective, it usually takes less than one month to make that course correction.

In short, your plans will change one way or another. A good succession plan assumes this fact and provides for frequent and sometimes severe course corrections. Enjoy the ride.

What to Do When Their Plans Change

This one is a little trickier and harder to plan for. The first thing to consider here is what you always tell your clients about their investments—diversify your risk.

There are several reasons why a succession plan starts by widening the ownership base. The one that is relevant to this discussion is pretty simple: Supporting an enduring business and being part of the succession team as a G-2 or G-3 level owner represents a lifetime commitment, and some younger owners simply won’t stay with it for the duration. There could be partnership disputes, health issues, a spouse’s relocation or career change, a divorce, a change in vocation, or even a recession. Your stellar G-2 advisor could get a more attractive offer from a larger competitor, or decide to start his or her own business. Stuff happens to everybody, but it seems to happen more frequently and with less warning to those in their 20s or 30s.

This is why you should never tie your future plans, and the value of a business it has taken a lifetime to build, to any one key staff member (and that includes family members) to succeed you—though we often make an exception for a next-generation advisor in his or her 40s or 50s. In addition, having more owners (i.e., widening the ownership base) lowers the cost and risk of the investment to G-2 and G-3 advisor/owners, making the process less demanding and onerous for them.

Second, and it bears repeating, do not give your stock away. If you don’t place real value on what you’ve built, neither will your successor or succession team. Have your business formally and authoritatively valued once a year because it is an important and valuable asset, and that is, of course, what you do as a financial professional with any asset you own that is worth six or seven figures and growing. Share those results with your team and sell the stock, in small amounts; people tend to value what they work for and have to earn, and they don’t easily leave valuable, hard-earned assets behind.

Finally, create an ownership position that matters, something that really makes a difference. We don’t mean that your G-2 owners should have their names on parking spaces out front of your building, but we do mean that you need to sell them enough stock that a change in their plans or their lives revolves around this business opportunity and not some other. Plan on each G-2 next-generation prospect owning at least 10 percent in Tranche 1, most through a sale and maybe a little through a granting process if, and only if, they complete the tranche and make that last payment. If G-2 stays through the end of Tranche 1, our thinking and experience indicates that they’re committed for the duration.

Handling the Culture Shift

We worked with a group in Florida several years ago that was owned and run by a husband-and-wife team, both in their early 60s. Rob and Diane had no children in the business, but they did have one key employee, Mark, who was quite capable, though young at age 29. The owners admittedly were starting the succession planning process very late, but after more than 30 years as financial professionals and entrepreneurs they wanted to cut back their work hours substantially and quickly. They were adamant that they did not want to sell and walk away. They felt strongly, after reading and studying and weighing their options, that an internal sale was best for them and their clients.

So they turned to Mark and offered to sell him 49 percent of the business. They would finance the deal, of course, but they wanted Mark to take on the role of president immediately and begin to assume increased responsibility for the operations. Mark agreed, but seized on his opportunity and bargained for the ability to purchase a controlling interest if the business did well over the next 24 months. They set up a series of benchmarks to quantify the hurdles and documented the transaction. Rob and Diane went to half-time status within a year’s time, well below the 30-hour threshold. Mark worked long, hard hours and with the winds of a good economy at his back, easily achieved the financial goals.

As the controlling owner, Mark decided to bring in a friend of his to help him, promising an ownership opportunity when it came time to buy out the rest of Rob and Diane’s ownership. Together they worked hard, and they began to make the business their own. After every extended vacation, Rob and Diane returned to an office that looked and ran very differently than the one they’d built and, while pleased with the financial progress, watching the change was very hard. They felt their culture had been abandoned, and they felt hurt. Rob and Diane no longer wanted to be involved, so they sold their remaining ownership at fair market value and stepped out of the business for good, but not on great terms.

When advisors sell their practices to a third party, one that is larger and better financed, they understand and expect that their culture will be absorbed by the buyer and replaced. That’s part of the deal in most cases. An internal sale is supposed to provide a different result, and it can, if next-generation owners have time to immerse themselves in the business’s culture and can appreciate it. As a G-1 level owner, if you go too fast, often a result of starting too late, culture gets traded in like a used car.

If your culture and the identity of your firm are important to you, take steps to preserve those aspects by teaching them to your handpicked succession team. At the same time, don’t be afraid of improving on the current state. Work with your partners and make the course corrections gradually, as a team, over a period of decades. To do that, you need to surround yourself with people you trust, and you need to start the process earlier in your career. Make teaching and transition and respect for history a part of your culture, and it will carry your business and your team into the next generation.