Effective Succession Planning Through Buy-Sell Agreements

Why are buy-sell agreements important for RIAs?

There are at least four reasons buy-sell agreements are important for investment advisers:

1. They ensure that clients will continue to receive the services they need should something happen to the selling advisor. Such agreements help to maintain confidence and trust among clients by assuring them that their investments will continue to be managed by a competent and experienced team. This could also be important to new clients who are looking to sign on with the RIA as new clients.

2. They mitigate confusion among firm owners. Investment advisory firms are not immune to internal conflicts among partners or owners. A well-structured buy-sell agreement can help prevent or resolve such disputes by establishing clear guidelines for transferring ownership interests. By providing a predetermined mechanism for addressing changes in ownership, these agreements promote a more harmonious work environment, allowing the firm to focus more attention on clients' needs.

3. Buy-sell agreements could be perceived beneficially by those looking to invest in RIAs. The existence of such buy-sell agreements helps investors to gain confidence that their investment in the RIA will be protected should something happen to the key persons of the firm.

4. They can help in the recruitment of new employees or advisors as they can generate confidence with respect to the long-term viability of the RIA firm’s business.

What are the key components of a buy-sell agreement?

There are at least five key components of any buy-sell agreement:

1. They define the triggering events that would initiate the process of buying or selling ownership interests. It is essential to clearly define what these triggers are and set parameters to avoid ambiguity and potential conflicts. For instance, it’s vital to determine what constitutes a “disability” that would trigger the need for the sale of an owner’s interest as certain types of short-term disability may not trigger the need to implement the buy-sell agreement. For example, disability events that trigger a buy-sell event could include a principal being unavailable for a significant number of days over any given six-month period.

2. Buy-sell agreements define how the purchase price will be calculated with respect to the sale of an ownership interest upon a triggering event. Practices can be valued utilizing various methods including metrics such as a multiple of revenues or EBITDA (earnings before interest, depreciation, and amortization) or EBOC or using an independent appraisal. For more information as to how to value an RIA firm, click here. The chosen approach should align with the firm's specific circumstances and balance the interests of the buying and selling parties.

3. Buy-sell agreement should clearly spell out not only outline the economic terms, but also what happens with respect to the management of the practice going forward.

4. They define other key terms relating to the purchase, including the date on which the valuation takes place as well as the timing for the payment of the purchase price (e.g., how much of the purchase price is paid upfront at the closing and how much is paid in installments over time).

5. They often define how the purchase price will be financed, if applicable. This issue requires careful consideration to ensure that the purchaser has sufficient financial resources available when a triggering event occurs. Common funding mechanisms include life insurance policies, installment payments, or external financing. The chosen strategy should align with the business's financial capabilities and long-term goals.

What are the most common mistakes RIAs make with adopting and implementing buy-sell agreements?

There are at least three common mistakes RIAs make when it comes to adopting and implementing buy-sell agreements:

1. Failing to clearly think through and define the key terms of buy-sell agreements. Ambiguity can lead to disputes down the road and potential harm to the RIA firm’s business. Therefore, it’s vital for RIAs to consult an attorney who can help think through the key terms that must be clearly defined in any well-crafted buy-sell agreement.

2. Failing to revisit their buy-sell agreements after they’ve been adopted. RIA businesses change over time, and so do the circumstances and needs of the owners. That’s why it’s vital for owners to periodically revisit the buy-sell agreement to ensure that it continues to reflect the terms they want to govern any buy-sell transaction in the future.

3. Some RIAs fail to give sufficient consideration to the need for buyers to obtain financing to affect a buy-sell transaction. Insufficient financial resources to fund the purchase of ownership interests can pose significant challenges when a triggering event occurs. RIAs must carefully plan and implement appropriate funding strategies to ensure they can fulfill their obligations under the buy-sell agreement. Considerations should include life insurance policies, installment payment plans, or external financing arrangements.

What are the best practices advisors for adopting a buy-sell agreement?

There are three key practices advisors can implement to increase the likelihood of adopting a buy-sell agreement that suits their needs:

1. Begin the process early on in your career. Procrastination is understandable given the difficulty of discussing topics involving letting go of the business, whether through retirement, death, or disability. But exploring buy-sell agreements early in one’s career can avoid bad outcomes should there be an unexpected event that causes significant disruption for the RIA business as well as stakeholders including firm employees, clients, and the owner’s loved ones. Unfortunately, I’ve seen circumstances where RIA owners died without having a buy-sell agreement or other succession plan in place, and this can be very disruptive for firm employees and clients.

2. Consult attorneys and accountants who can give advice as to the best terms for the buy-sell agreement given the advisor’s individual circumstances. A corporate attorney can help the advisor understand key terms for putting together the buy-sell agreement. An accountant can help the advisor understand how to structure the transaction in a manner that is the most optimal from a financial perspective for the advisor. A trust and estate attorney can also help the advisor understand the best structure for the arrangement to effectuate the advisor’s estate planning needs.

3. Communicate with all relevant stakeholders in the process to ensure that they can get the best outcome for all involved in preparing the buy-sell agreement. Advisors may be reluctant to discuss topics such as business continuity in the event of the advisor’s death, disability, or retirement, but having those conversations can help to ensure a smooth transition down the road and hopefully make the transaction as sooth as possible when it comes time for the succession to take place.

Conclusion

Buy-sell agreements are not just mere legal documents; they are vital tools for RIAs to ensure a smooth transition of ownership, protect client interests, and maintain firm sustainability. By understanding what buy-sell agreements are, why they are important, the key elements involved, and the common mistakes to avoid, RIAs can secure the long-term success of their businesses. The careful crafting and regular review of buy-sell agreements will help RIAs navigate potential ownership transition events and maintain stability in an ever-changing profession.

Richard Chen is a managing partner with Brightstar Law Group, a law firm that serves investment advisory firms by providing proactive business-minded solutions pertaining to corporate and securities law-related matters. Among other things, our firm provides counsel with respect to securities and compliance matters (including representation in SEC examinations), private fund formation, corporate formation and structuring, business transactions (including M&A and joint ventures), contract drafting and negotiation, employment law matters, operational due diligence, and succession planning. For more information, please visit our website at www.brightstarlawgroup.com or call us at 917-838-7398.

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