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Since life has unexpected events that are out of your control, you should have a succession plan when you establish your practice. Everyone has a succession plan, whether they know it or not, but not every plan is a good one.
After my business partners and I sold our financial services business, Terra Financial, to GE Capital in 1998, we established Forum Financial Management in 2002.
More recently, as I passed through my 50s, I knew it was time to give some deep thought to my transition plan. I wasn't interested in selling my business to a third-party consolidator, which is one reason why we decided to create a new system within our organization.
A crash course on succession planning within the financial services industry
Traditional external succession plans have two main downfalls. They usually involve an abrupt cliff-like handoff that can create a chaotic atmosphere of change that often results in the loss of clients. They can also introduce what I call the “fourth constituency.”
All advisory firms have three constituencies. Thinking about it like an upside-down pyramid, the top layer is the firm's clients, the middle is the firm's staff and affiliated advisors, and the bottom is the firm's owners or partners. When you introduce a roll-up firm into the hierarchy, by definition you are obligating yourself to a fourth constituency. This can be hugely problematic. No matter how elegant the acquisition, this fourth constituency will have a say in things, which is bound to introduce a lot of unforeseen impositions that will take a toll on the firm.
Still, advisors might end up selling to a consolidator, considering the appeal of a lump sum up front. But, while there is an obvious appeal to receiving money, it may actually be financially beneficial to partake in a tranche-succession plan. You often get a larger multiple because you participate both in additional client referrals and new business that comes in, as well as market upside. Over time markets go up, and if you've got a 10-year time horizon, odds are you're going to participate in some of that upside.
There is one big mistake advisors make regarding succession: They start planning too late. Succession planning should be included in a business plan from the very beginning, but give yourself at least 10 years to structure, organize, and think through the right approach before your expected retirement.
You have to bring discipline and deep thought into this process of planning. The sooner you start, the better off you'll be.
Avoiding the retirement cliff by retiring in tranches
Because I identified time as a significant factor in the flawed traditional approach to succession, I focused on implementing a tranche-succession system that would allow for a more gradual seven to 10-year transition period instead.
Here's how it works:
The process begins when an advisor identifies a successor advisor and transitions a block of 20-30 clients to them. Acting almost as a trial period, this two to three-year servicing period should help the clients to become comfortable with the successor advisor. There is a direct correlation between the time clients spend working with the successor advisor and the client “stickiness” percentage. The longer the transition, the higher the percentage.
Assuming the advisor, successor advisor, and client are all still on board following the servicing period, a seven-year buyout can then be executed with a time-defined financial interest for the seller in the revenue stream from family members and referrals who may also become clients.
Although most third-party consolidators do require the advisor to stay on for a year or two to help with the transition, advisors in this position can't do things on their own terms. You're doing it under a new brand name, office structure, back office, and sometimes a new platform.
One of the major pros to this method is that because the process is internal, there is much more flexibility to control the narrative. Instead of having to give the classic acquisition spiel, (e.g. in order to serve you better, we've decided to sell to this private equity firm,) an advisor can ease the process along gradually. For example, an advisor could introduce the servicing period to the client by saying something like, "I want to make sure you have two points of contact in the firm," or "I see it as my professional obligation to you to involve another advisor with a longer time horizon in the industry." The buy-out period could be introduced by saying, "I’ve asked [successor advisor] to take a more direct role in the management of your portfolio." A gradual, natural, and comfortable shift will almost always work better than an abrupt one.
How tranche succession benefits all involved parties
For the clients
The longer a client has worked with an advisor, the more comfortable they will be with them. Change can raise red flags for clients, especially when there is a lot of it happening all at once. Luckily, internal succession involves far less explaining and is naturally much more comfortable. Make the change as natural as it can be.
For the successor advisor
For the successor advisor, this tranche succession plan is especially appealing because it eliminates the first three to five years of the “trial by fire” learning period. Approximately 80% of my time during my first five years at Terra Financial was devoted to finding clients. How nice it would have been to instead have focused deeply on the many financial planning subject matter issues residing in a mentor’s client base.
Additionally, it allows the successor advisor a period of mentorship to learn the many nuances of client financial planning matters, and allows for slower, steadier growth into a lead advisor role.
For the selling advisor
For the selling advisor, this gradual plan provides for all parties to agree the transitioned clients are a good fit, and to work with four or five successor advisors over time. This strength-in-numbers approach reduces income stream risk versus selling an entire book to just one advisor. Additionally, the selling advisor is launching not just one, but a group of productive advisors, enabling an increase in the firm’s capacity for future growth, and thereby helping to ensure the buy-out.
If you do this over 15 years, you will slowly rotate out of the business, and enjoy a staggered eight- to 10-year income stream, all the while saving on taxes and enjoying some upside from market appreciation and new assets.
Reaping the rewards
Having gone through this experience firsthand, in addition to the financial rewards, I was especially grateful for the lifelong relationships this experience gave me, as well as the ability to manage my transition on my own terms.
Advisors are drawn to this industry because of a desire to make a difference in people's lives. Your actions and advice shouldn't be dictated by the profit motives of an outside fourth constituency.
Marcus Heinrich CFP® has over 30 years of experience as a financial advisor. He was one of the original principals of The Terra Financial Companies and helped grow the original six-person business into a national, multidisciplinary, financial services organization. He has served as a mentor to hundreds of other financial advisors, and, as one of Forum's founding partners, he has been instrumental in the consistent growth of Forum's national clientele since 2002. If you are an advisor in a firm with limited advancement possibilities, or if you are looking to gradually transition out of your practice, and would like to learn more, please reach out at [email protected] or 630.336.7608. You may also contact Brian Shapiro at [email protected] or 773.454.9414.
Read more articles by Marcus Heinrich
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
