Where to Start

Succession planning is not a singular event; succession is purposefully designed to unfold over the course of a career, and to be a continuing process beyond that point. Succession planning is as much a process as building a business is. Remember the definition from Chapter 1: A succession plan is a professional, written plan designed to build on top of an existing practice or business and to seamlessly and gradually transition ownership and leadership internally to the next generation of advisors. So, with all these pages behind you, where exactly do you start? Here is the definitive road map.

Start by gathering some basic but important information that will help you make informed decisions. These steps will also help your support team (CPA, attorney, succession specialists) assist you in making smart decisions based on your specific fact pattern and goals:

1. Print out the past three years’ profit-and-loss statements (P&Ls) and balance sheets.
2. Have your practice/business formally valued.
3. Benchmark key operational data.

The last two of these steps will take about 45 to 60 days to complete, so get started as soon as possible. Remember this simple rule: quality in, quality out—you cannot obtain an accurate and useful valuation result by resorting to an online survey form. Do the job right. Completing the valuation questionnaire is going to take some work and focus, but accurately determining equity value and understanding the value drivers are very important steps in transforming your one-generational practice into an enduring business. Your valuation results will help to assemble the numbers picture comprised of cash flow plus equity value; a succession plan, and a business, utilizes both numbers.

Understand that the valuation process is every bit as important as the valuation result. Many independent owners tell us that they learned as much about their practice or their business from completing the valuation intake form as they have done in reading about their valuation result and accompanying value drivers. FP Transitions also uses this reliable valuation data (including your P&Ls) to create your specific benchmarking results, which will compare your operational numbers to your peer group and to businesses and firms twice your size, for planning purposes.

Next, decide what it is that you want your business to do for you in the future. Don’t be afraid to dream a little—it helps your support team to know what you’re thinking—and then we’ll figure out together what’s possible. Many advisors are surprised at what is possible with a solid plan, but they don’t know what to ask for. If you find yourself struggling with this step, revisit Chapter 2 and look at some of the common goals that other advisors consider important. If you’re not sure what is possible, talk to your succession specialist, but don’t limit yourself to what you know or what you think is possible. Gather more facts if this step isn’t clear or you aren’t confident and bring your support team in closer to help you.

4. Define the goals for your business and your succession plan.
5. Establish a time frame for the succession planning process.

This is the all-important point where you actually decide to start the process and when you’d like to implement the first step, usually the creation of a business partner—an investor in your business. Don’t worry so much about your age or how much time you think you have left; worry instead about the value of what you’ve built and the clients who depend on you for making these planning decisions. We’ve designed succession plans for advisors well into their 70s, and, though the options and time frames might be a little more limited, there are still many great decisions and steps that they can take.

6. Design and develop your succession plan.

Every succession plan starts with general concepts, many of which have been explored in this book. These concepts are then reduced to a set of specific goals, shaped by specific numbers like revenue, expenses, growth rates, profitability, and, of course, years. These numbers are built into a pro forma spreadsheet that may look out into the future for 20 years or more—maybe not your retirement horizon, but certainly G-2’s/G-3’s investment horizon. Every plan is subdivided into a series of tranches that allow for periodic assessment and adjustment—actually a series of plans. Your plans are then vetted with your stakeholders (spouses, accountants, lawyers, business coaches, next-generation advisors, etc.), adjusted based on their input, and written out for consideration and possible action.

Note that implementation is not included in this step. Designing and developing a plan and implementing and documenting that plan are two separate steps, and they may be several years apart; treat them as such. First, just design and develop a plan that makes sense to you. It is okay if you end up deciding later that the plan will take too much time or energy, or that selling or merging would be easier and a better course of action. You’ll be making a fully informed decision about what is best for you, your staff, and your clients. If you do decide to proceed and implement your plan, this is where the fun starts.

7. Build a foundation for success, and succession.
   • Set up or adjust your entity structure.
   • Adjust your organizational structure.
   • Assess and adjust your compensation structure.
   • Find the right advisors to support your plan.

In most cases, we’re able to work with the entity you’ve already set up, adjusting it for ease of use (remember, we need to make it investor-friendly from a first-time owner’s perspective) and for durability. If you’re starting out as a sole proprietor, that’s fine, too. You’ll find that an entity structure, especially a flow-through entity from a tax standpoint, will add clarity to the organizational and compensation restructuring that will help transform your practice into a business.

Aside from the mechanical aspects, finding the right people is really the hard part, but you don’t need to have G-2 and G-3 talent on board at the start. This is part of a plan that will be gradually implemented. More often than not, one or more current staff members step up to fill at least one of the ownership spots. Are they ready? Are you ready? Let’s find out and start to work on it—Tranche 1 is called the incubator for good reason. In the event you start the process and then decide it’s not for you, you’re never obligated to sell more ownership.

8. Manage equity to create a bottom line.

This part isn’t as hard as you might think. We find that using a series of interactive pro forma spreadsheets is a great, ongoing tool to help all owners (G-1, G-2, and G-3) find a balance between top-line compensation and bottom-line profits. As we continue to point out, the right tools for the right job are essential for advisors who want to build valuable and enduring business models. Creating a bottom line, the physical process of issuing quarterly profit distribution checks, doesn’t happen overnight. It is best accomplished as part of a long-range plan, one that you’ll literally grow into.

9. Create a continuity plan.

Plan on two distinct levels: First, plan as though everyone involved will live long, healthy, happy, and prosperous lives as business partners. Then separately plan for what happens if that doesn’t work out. Sometimes life intervenes. Many times, if you plan well enough and work hard enough and surround yourself with good people, things have a way of turning out just fine. Either way, a continuity plan, which needs to take the form of a written continuity agreement, will help you and your team prepare for whatever comes your way.

Understand that, for a one-person, one-generational practice owner, valuation and continuity planning are steps one and two, in that order, from start to finish. In the world of a business owner, however, your best continuity solution will derive from your succession plan.

10. Tell your clients what you’ve done for them.

And celebrate the fact that you’ve taken the steps to put your business in a position that few other advisors are currently in. Use the fact that you’re building a multigenerational business, not a practice built to die, to attract the best of the next-generation talent to benefit from this unique and lucrative structure.

Assembling Your Support Team

You’re going to need some help in setting up your plan and supporting it over the coming years. The good news is you are not alone.

In our experience, the most valuable member of your team, once your plan makes it past the concept level, is going to be your CPA, or accountant. That’s because properly managing cash flow is a daily business event, and accountants are good at this; it is what they know and do. We work comfortably with several hundred CPAs and accountants every year to assist independent advisors who are designing and implementing their plans. Nothing in the processes discussed to this point will be unfamiliar to an experienced tax professional.

Having a good lawyer on your side is a part of the process, too. You do not necessarily need an attorney with knowledge of securities laws or even Financial Industry Regulatory Authority (FINRA) rules and regulations, but someone on your team needs to be familiar with these aspects. For the most part, find an experienced attorney who practices business law and knows a thing or two about mergers and acquisitions (M&A) work. Don’t forget the important role that your attorney will perform in this process, which is to be a zealous advocate for you, and only you. Your attorney’s job is to help you steer clear of risk, or at least to help you understand where the land mines are buried.

Attorneys also tend to be specialists in the documentation process—the paperwork. But draw a distinction here: Most attorneys and CPAs are not skilled in the planning phase; it is just not what they have been trained to do. To that end, don’t confuse 60 pages of professionally drafted contract forms and a $20,000 legal bill with a good succession plan (a buy-sell agreement, or an operating agreement, are not succession plans by any stretch of the imagination!). If you implement the best phantom stock plan on earth and remain the only owner, your practice will die at the end of your career. You’ll be one of the statistics instead of one of the business owners.

The role that we play at FP Transitions is that of a succession specialist (we prefer the term equity manager). We consult and coach advisors, and their broker-dealers and custodians, on the process of managing equity and the succession planning process. We bring to the table the specialized skill set of building enduring and transferable businesses in a highly regulated industry. Our backgrounds include law, taxes, securities rules and regulations, cash flow modeling, value and valuation, mergers and acquisitions, succession and continuity planning, benchmarking, and analysis—and only for this industry.

Perhaps one of the most important and unique things we offer is nonadvocacy support. We are not a law firm and therefore do not represent the founder or any member of the succession team. We serve as the field marshal for the equity management/planning process and endeavor to create a formal structure and a long-range plan that will serve all constituents well for the length of their careers. We don’t believe in “fighting to the finish,” and we don’t believe that there can be winners and losers in this process. Everyone has to work together, for a long time, and get the job done. We’ve been doing it this way for the past 16 years, and it has served our clients well; in hindsight, it is hard to imagine doing this work successfully any other way.

Enjoy the Planning Process

No two succession plans are ever the same. To that end, no single succession plan unfolds year after year without a few adjustments and tweaks. That’s the nature of a plan. But that is all the more reason to plan, plan, and plan some more.

Over the course of your career, you’ll hear a number of stories. One independent advisor will relate that she sold her practice for a multiple of 3.0 times gross revenue or gross dealer concession (GDC) and will offer to tell you how she did it. Another independent advisor will tell you how he granted some ownership to an ungrateful and, as it turned out, incompetent advisor who now is a full-blown competitor and that you should never do that or have a partner. Another will insist that the best practice model is the single-owner model, one over which you have total control of your income, regardless of what you do with it after you’re done working—buy life insurance if you’re worried about how things might end. There are always lots of stories, lots of experiences, and we suggest that you respectfully listen to each and every one.

And then go home and plan and decide for yourself what you will do, not what will happen to you. You’re an independent advisor. You control your own future. To do that, you’re going to need good information, a good plan, and the patience to execute it.

We made the point earlier that succession plans are kind of like a set of blueprints for your dream home. You’ll need to narrow down, on your own for the most part, where and when the home will be built. But what will the home look like? What will it cost? How well will it reflect your tastes and the things you’ll want to enjoy once it’s built? Can you see yourself there when you’re 70? How strong and durable does it need to be to withstand the elements for the next 50 years? The answers are different for everyone, and many of us learn by building, or buying and improving, more than one home. We learn from experience what we like and would like more of, and what we don’t like.

Unfortunately, many advisors don’t have a lot of time or patience when it comes to planning for themselves and their own businesses. That statement early in an advisor’s career is intended to be an observation of the life of a busy entrepreneur; later in an advisor’s career, that same statement starts to sound more like an excuse, because planning and strategizing are hard work. That, of course, is why many of your clients hire you to help them! It is so much easier to utilize the short decision chain in most practice models and hear a story, turn the boat around, and “head thataway.” Don’t do that.

At some point, being too busy to stop and plan ahead is a luxury you can no longer afford. Have your practice or business formally valued. Write the equity value number down on your personal financial or wealth statement. Look at it in the context of the value of your home, your savings, your investments, and your retirement funds. Is it the largest asset you own? Is it one of the top three? Give it the proper level of priority for its place in your life. And don’t forget: Unlike your other valuable assets, your work provides two levels of value: cash flow plus equity (both of which you control).

Once you’ve taken these steps and you know where things stand, set the dollar signs off to the side for a few minutes, because there are more important things—things to plan for. A succession plan starts with you and your dreams and goals. It’s about what you want to build and what you need your business to do for you one day when you no longer jump out of bed at 6:00 a.m. in the morning and head into work with boundless energy and enthusiasm. It’s going to happen, so plan for it—starting by about age 50. Embrace the changes with a realistic plan and adjust it to fit your life, not vice versa. Just don’t build anymore without a clear plan for where you’re going and how you are going to get there.

Doing the Math

This is the part that separates concept from reality, a succession idea from a formal succession plan. Does it work for all participants mathematically, after taxes? Is there sufficient cash flow? What sustainable growth rate is needed to achieve success? How long will it take to realize your value, or for G-2 and G-3 to pay off their purchase obligations? What happens to the plan when dollars are moved up to the compensation line and away from the bottom line?

At the conclusion of the planning process, those questions are turned into black-and-white answers. And well-informed decisions and plan adjustments are based on those answers and hard numbers. You become the owner of your plan.

Every succession plan should be subjected to a rigorous, comprehensive financial analysis that illustrates the long-term impact of the plan by incorporating compensation strategies and ownership changes with pro forma estimates of business growth and profitability, among other things. The analysis is tailored to each business by virtue of its valuation results (including the information gathered during the valuation process, which is why starting with a formal valuation is so critical). This is not something that can be accurately accomplished by filling in the blanks, online, in a survey approach. Doing the job right takes accurate information and analysis and planning time and experience.

Our pro forma analysis, for example, includes a series of interactive fields to help you and your succession team explore possibilities and what-if scenarios. We also provide separate viewpoints from each individual owner’s position, year by year, share by share, over 5, 10, 15, or 20 years, all tied to an enormous database that provides benchmarks for similarly sized businesses. We include in the math models, if applicable, minority discounts, interest rates, payment terms, profit-based note payments, fixed note payments, and grants of stock (or ownership interests) if warranted. This is a lot to consider, but you and your team do need to consider every aspect before you start.

The point of doing the math is to lend credence to the planning concepts. Sometimes the math proves what you might have suspected—that it won’t work and that you’ll have to consider something else. It might be because the growth rates are too low, the overhead has crept up to too high a level over the years, or the revenue-sharing arrangements have pushed the payroll so far out of bounds that creating a bottom line is nearly impossible. But that doesn’t happen too often, at least not to the point where it can’t be fixed if everyone wants to make the plan work.

If you haven’t done the math and tested the theories, you don’t have a plan. It’s as simple as that.

Establishing a Fair Price

It is important that you set a fair price for what you’ve built, but don’t turn it into a contest of wills. There is a right way and a wrong way to determine the value of your business. Understand that, in the context of supporting a succession plan, the valuation process and valuation results aren’t really aimed at you anymore; as the founder, you’re more of an interested bystander, so to speak! In the course of a succession plan, the valuation process and the valuation results are aimed at the next generation of advisors. They’re the ones you have to impress and to teach the concept of equity, and that’s why you have to learn to do it right.

The next generation of advisors, in order to embrace the unique opportunity afforded by advisors who offer an equity stake through a formal succession plan, will require a reliable method not just to determine the value of the business they are investing in, but to track the value of their investment accurately over time. The proper tool is a formal third-party valuation. This process takes some time and work, and it isn’t free. As a result, some advisors prefer to just guess using a multiple of revenue, so let’s address the problem using some specific numbers to frame the argument against this haphazard and unprofessional approach.

Over the past five years, the multiple paid by buyers to sellers for every dollar of recurring revenue in an independent financial services practice (fees and trails) ranged from a low of 1.47 to a high of 2.98. The multiple paid by third-party buyers for every dollar of nonrecurring revenue ranged from a low of 0.21 to a high of 1.68. That means that for the average fee-based practice or business in this industry, the range of multiples is from 0.21 to 2.98. If an authoritative source told you that the average value of a home in your area, per square foot, ranged from $21 to $298, would you feel comfortable settling for the average at $235 per square foot? You might, but even if you were, would your buyer (or group of buyers) agree to that same number without definitive proof, something more than a guess? Would you trust them as your successors if they did?

Odds are that they would prefer a much lower guess, and that’s what they’ll offer. In fact, your guess will invite theirs. If you don’t respect the formalities of equity value derived through an authoritative process, why should your buyers?

Many advisors still have the mistaken notion that the only reasons to value their financial services business is a shareholder or partnership dispute, a marital dissolution, or at the end of a career on the eve of a complete sale of the business. Fortunately, the valuation process in this industry is rapidly advancing past this thinking as equity management gains a solid foothold. We now perform hundreds of valuations for our “shipbuilders” on an annual basis; it is no coincidence that they are building strong, valuable, and enduring businesses and attracting next-generation talent as investors. Equity management has become a part of their culture.

Establishing a fair price is one thing; consistently monitoring that value in a meaningful way to the advisor/owners is quite another. Annual valuations provide a library of valuation results, creating a historical record that is of great interest to key staff members, new partners, or recruits being offered a current or future ownership opportunity in an enduring business. Regardless of the specific valuation methodology used, it is important that the valuation process is consistently applied and cost-effective, and that the expert performing the analysis understands the unique qualities of an independent financial services business. Those qualities, or lack thereof, need to be tied to the marketplace to provide accuracy and reliability.

The Nuts and Bolts of a Plan

There are a lot of details that must be addressed and monitored in order to make a succession plan thrive. For the most part, these are not things that you have to master, but things that you should know about.

It Is All about Growth

Every morning in Africa, a gazelle wakes up. It knows it must run faster than the fastest lion or it will be killed. Every morning a lion wakes up. It knows it must outrun the slowest gazelle or it will starve to death. It doesn’t matter whether you are a lion or a gazelle. When the sun comes up, you’d better start running!

(African proverb)

How do you get the next-generation talent pool to accept and embrace the fact that buying stock or ownership gradually in a growing business (i.e., a business they’re helping to grow) means that each subsequent purchase will be more expensive than the last? The answer is, turn that into good news by connecting those growth rates to both their take-home pay and their ability to buy more stock faster. Here’s how it can work as part of a comprehensive succession plan.

Independent financial services and advisory practices have a decided advantage when it comes to attracting and retaining next-generation talent: strong, sustainable growth fueled by recurring income sources and predictable overhead structures. Last year, FP Transitions’ Research and Analytics department conducted a study on growth rates, titled “Independent Financial Service Growth Rate Study.” Following is an excerpt from this study, along with an illustrative chart (Figure 7.1).

The macroeconomic exposure of financial services practices to positive growth factors is unique when compared against other mature industries in the United States. Consider this: If an advisor simply maintains his or her client base, and we assume an average market portfolio for every client under management, then the assets under management for that advisor will grow at approximately the rate of market growth, before distributions. According to the Federal Reserve, the average annual return on stocks, Treasury bills, and Treasury bonds for the period from 1962 to 2011 was 10.60 percent, 5.22 percent, and 7.24 percent, respectively (including dividend returns and coupons on fixed income securities). For the period 2002–2011, the market returns were 4.93 percent, 5.22 percent, and 7.24 percent for stocks, Treasury bills, and Treasury bonds, respectively.

Our analysis, computed from information we collect directly from our clients, suggests that revenue growth over the 2002–2011 period was 13 percent, with the middle 50 percent of the distribution growing by between 5 percent and 16 percent annually. Our data for this particular study included practices that ranged in size from $1 million in assets under advisory/management up to $2 billion in assets. There was no statistical significance when controlled for the size of the underlying practice, business, or firm, meaning that the largest practices grew at the same rate as the smallest practices, on average.

Clearly this is a positive reflection on the financial services industry as a whole—advisors are not simply limited to the long-term growth of the markets. Independent advisors can add assets and clients to their practices, increase death benefits as part of the planning process, and create a multigenerational asset platform to defray the negative revenue effect of clients and assets that are in the distribution phase of their life cycle.

In a typical succession plan, the next generation builds on top of an established business and, as a team of owners, they work together to build a stronger and deeper organization. The reward is illustrated both in the improving multiple of gross revenue or earnings and in the total realized equity value by the founder. The final results tend toward a value, expressed as a multiple of gross revenue, of about six times the starting point, not including a reasonable salary for the owner for the duration. In addition, founders benefit from a reduced workload in the second half of the plan and a built-in continuity plan to protect business value as the practice is transformed into a multigenerational business.

The presence of one or more internal successors is intended to support and accelerate growth even as the founding owner gradually retires on the job. This is in stark contrast to the single-owner model where production tends to decline rapidly as the founding owner works less and less as the founder nears retirement. Growth is imperative if you’re building something that can outlive you. You cannot attract next-generation talent to support your model if you aren’t growing. The ship either is under power or it is adrift.

Finally, never lose sight of one simple fact: Growth is the reason next-generation advisors invest their money, time, and careers into the process of building an enduring business, and building on top of your existing practice model. Growth provides the return on investment and the means by which ownership is paid for. Succession planning is all about sustainable, long-term growth, and that is why this is one of the steps you need to understand and build around on the path forward.

Proper Application of Minority Discounts

Minority and marketability discounts are adjustments to the fair market value of stock because the minority interest owner(s) cannot direct or control the business operations and because the minority interest lacks marketability. G-2 and G-3 owners will invariably become minority owners. In fact, it is highly likely that, by Tranche 3, your business may never again have a single, majority shareholder. This is part of the shift from the “strong man” approach where one person does it all to the collaborative environment where no one person can excel unless the business as a whole does well.

Understand that as a business owner, it is entirely your decision whether to offer a minority discount. If you do offer a discount, it is also acceptable to never, ever offer another one regardless of whether your next-generation staff members are purchasing another minority ownership interest. If you’re an S corporation, mind that “one class of stock” rule and be consistent in applying discounts from one shareholder to the next. Most of the succession plans we set up employ only one minority discount, that in Tranche 1, and then never again.

A minority interest is noncontrolling ownership, usually defined as less than 50 percent of a company’s voting shares. A minority discount, at least in the case of an amicable buy-in situation, is a reduction in the price of stock from its fair market value because the minority interest owner(s) cannot direct or control the business operations, and because of lack of marketability and therefore liquidity of the shares.

A minority discount applied to a noncontrolling ownership interest in a small business reflects the notion that a partial ownership interest may be worth less than its pro rata (proportional) share of the total business. For example, ownership of a 25 percent share in the business may be worth less than 25 percent of the entire business’s value. This is so because this 25 percent ownership share may be limited as to control over critical aspects of the business, including:

• Electing the company’s directors and appointing its officers
• Declaring and distributing profits (dividends or profit distributions)
• Entering into contractual relationships with customers and suppliers
• Raising debt or equity capital
• Hiring and dismissing employees or officers
• Selling the business or acquiring other operations

In practical terms, the applicable range of discounts is generally between 10 percent and 40 percent, though it is imperative that every owner and investor confer with his or her CPA/accountant as to what is reasonable and appropriate in each situation. The amount of the minority discount is not set or specifically established by law. It depends on a number of factors and is adjusted for any given situation, rather than being applied as a universal standard. Note that it is appropriate to calculate separate discounts for lack of control and lack of marketability, but the cumulative total should be within the range of 10 percent to 40 percent (see Figure 7.2). A discount, if offered, should be applied fairly and evenly. For example, if a 10 percent interest in the business is being sold to two members of a succession team at or at about the same time, the same valuation method and the same level of discounting (if any) should apply to each sale.

That said, here’s the practical side of this argument. Consider that in most internal sales of independent financial services and advisory businesses, the owner or seller of the stock (G-1) almost always provides very generous financing terms enabling the purchase of the minority shares, perhaps even providing the funding through profit distributions or a salary increase or bonus. Also consider that, in the majority of cases we work with, the minority owners have a direct path to majority ownership upon the founding owner’s death, disability, or retirement, usually through a written continuity or succession plan (i.e., a buy-sell or shareholders’ agreement), which also, again, is usually accompanied by very generous, long-term financing from the founding owner or the business itself. More succinctly, the buyers rarely pay cash or even a significant down payment for the ownership interest they’ve acquired or are about to acquire. The seller has to wait, be patient, and take the risk, usually without a corresponding interest rate to reflect that position.

For all these reasons, many owners choose not to provide any minority discount or, if they do, it is offered only on purchases in Tranche 1 of the succession planning process to help get the process started. All subsequent purchases of stock, regardless of the minority position of the buyer, are at fair market value as determined by a formal valuation within six months of the date of the transaction.

Documentation

To recap, the succession planning process typically involves two distinct phases. Phase one focuses on design and development of your custom plan. Phase two is about documentation and implementation of your plan—in other words, the paperwork necessary to make your plan a reality. The paperwork and contracts necessary to support succession plans may include the following:

• Multiple stock purchase agreements (one for each advisor/successor)
• Promissory notes (fixed or profit-based format)
• Amortization schedules (in advance for a fixed note, in arrears for a profit-based note)
• Stock grants
• Stock pledges (collateralization)
• Employment agreements
• Corporate resolutions/recapitalization events
• Shareholders’ or buy-sell agreements
• Operating agreements (for corporate tax structures)

In about 20 percent of the plans, the process commences with the selection and setting up of an entity structure. Since this step often builds in a delay of one year in order for G-1 to obtain long-term capital gains tax treatment on the sale of his or her stock in Tranche 1, it is important to consider this aspect as part of the anticipated implementation time frame. For everyone else, the process commences with a recapitalization event to reset the existing structure and prepare it for the duration and plan specifics.

All documentation, once prepared on a plan-specific basis, should be reviewed by local legal counsel for each participant. In most cases, the documents are virtually identical as to each member of the succession team, which helps to create a fair and level playing field and allows the process to proceed at a fairly brisk pace. The tax issues for the plan are typically reviewed during the plan design and development phase and then carried over into the documentation.

Promissory notes in Tranche 1 are generally nonrecourse and tend to be profit-based as opposed to fixed notes. As a result, the buy-sell protocol (i.e., the continuity agreement) restricts the rights of investors who leave the plan for any reason other than death or disability prior to completion of the first tranche, but these items are always negotiable within reason.

Separate documents are executed at each tranche. Most plans are accompanied by formal, annual valuations of the business, part of our basic Equity Management System (EMS) or the enhanced Succession Maintenance Program (SMP). G-2 and G-3 level owners are encouraged to review and approve the valuation inputs and are provided a copy of the valuation results. Stock should be sold and purchased (or, on occasion, granted) at fair market value, so the ability to monitor and determine that value annually is an important aspect to the succession planning process.

Limited liability companies (LLCs) may require an amendment of the operating agreement, depending on the plan, which may need to include a unit structure and other corporate attributes to create some level of rigidity and predictability in the entity structure and operational format—it matters to minority owners. LLCs taxed as partnerships will need to rely on local legal counsel to custom draft the agreement based on the specifics of the actual plan. Other than for this element, local legal counsel tends to review and augment a set document package designed to address the specific plan elements and goals.

Bank Financing—Expanding Your Options

Whether you’re considering selling your business externally to the best-qualified buyer or internally to a team of successors, bank financing solutions can provide powerful tools to reshape or to accelerate your plans (see Figure 7.3).

Bank financing solutions for independent financial professionals looking to buy or sell a financial services practice have been almost nonexistent in years past. That has changed. Today, qualified banks are now lending to next-generation advisor/owners who have a formal succession plan. As a result, lending and funding solutions now can provide a retiring owner with the ability to quickly cash out of the business if that business has the necessary foundations and personnel in place. In other words, founding owners can decide exactly when, over the course of a 10- to 20-year plan, they’d like to step away from the business in favor of a team of internal successors who have proven themselves capable on the job.

Since the year 1999 when FP Transitions first launched and subsequently orchestrated the open market concept for independent practice owners, the rule in almost every transaction has been that of seller financing. Strong, well-positioned buyers (not usually consolidators) came in, paid a substantial down payment (30 percent to 40 percent) out of cash reserves, and then dedicated the acquired cash flow to paying the balance in three to six years with at least one contingency to ensure a motivated seller. The result was a shared-risk/shared-reward transaction, and it worked well, whether the buyer was a third party or an employee, son, or daughter.

Seller financing has certainly proven its value; the shared-risk/shared-reward concept between buyer and seller has routinely delivered 90 percent to 100 percent client transition and retention rates in the years following the sale of the practice—often to a complete stranger from the clients’ perspective. But the benefits have also had a cost; seller financing placed two-thirds of the risk of every transaction on the shoulders of the seller, while immediately transferring full control of the cash flow to the buyer. In addition, sellers have had to play the role of banker and wait years to fully realize the value they’d built over a lifetime. Occasionally, the financing period was interrupted by events beyond anyone’s control—think recession, market fluctuations, regulatory issues, and the like.

The ability to professionally finance an independent financial services transaction, internal or external, provides a powerful new tool when used correctly and as part of a well-constructed plan designed to maximize client retention and tax benefits. Bank financing provides a business founder with the option of either seller-financing the entire transaction over the span of a decade or two (with the attendant benefits in terms of value and cash flow and control or participation) or opting out of the lengthy process at a time of his or her choosing, eliminating the lending risk, and leaving the proven and committed succession team to work with a qualified lender.

Given that more than a few of today’s founding owners are starting the succession planning process five to 10 years late, bank financing has become an important consideration and is typically built into every plan, just in case. One of the reasons succession plans are successful is because they don’t lock in positions or obligations too far into the future. A sound plan must provide its participants with room to adapt because, inevitably, there will be course corrections.

Beware of Benchmarks and Survey Results

Go back to square one: 99 percent of today’s independent financial services and advisory practices will not survive the founder’s retirement or the end of the founder’s individual career. When the advisor leaves, for whatever reason, it’s over. So what do you think will happen if you pattern your business decisions on data and survey results from a group of fellow owners who are heading over the cliff? Do you really want to follow a model and a stream of data from practices built to die? Do you think your results will be any different if you use benchmarks from hundreds of one-generational practice models? Lots and lots of bad data doesn’t start to make it good data. This isn’t about feeling right; this process is about getting it right.

If you’re going to use benchmarks as guideposts on your journey, be sure you’re getting good data; specifically, you need to benchmark against businesses and firms, not practices designed for just one generation. Benchmark your business against other shipbuilders, not the life rafts or the flotillas. There is a lot of data available to you in the independent financial services industry. Before you rely on any of it, ask yourself these simple questions:

• What are your goals for the future? What do you want to build? Is it a valuable and enduring business?
• Who supplied the information you’re thinking of relying on—one-owner practices or multigenerational businesses? Are the data reflective of practices below where you’re at, on par, or businesses twice your size?
• Is the practice data useful in building an enduring and valuable business model?
• Have the owners of these practices or businesses ever accomplished what you are setting out to do?
• If you do exactly what the crowd did that supplied the data, where will you likely end up?

I had the recent opportunity to talk to an independent advisor who wrote a great article on building an enduring business model and setting up an internal ownership track. He championed next-generation talent and their role in helping practice owners build enduring businesses. I was taken aback when, in asking him about his own business structure, I learned that he actually was not an owner of the business, which was rather a siloed model that had clear and strong fracture lines built into the foundation—deliberately built into the one-generational practice. This was an advisor who wanted to be part of a business, but who accepted a revenue-sharing arrangement and the opportunity to build an individual book because “that’s how it’s done in this industry.”

Too much of this industry follows that pattern. It is time to change direction and take control. Build your own team and create your own future.