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by Eric Leeper, CFA

Eric Leeper, CFA, oversees financial modeling for FP Transitions and is a succession planning consultant. He has helped create more than 300 succession plans for independent businesses.

I talk to a lot
of financial advisers about succession planning. I lecture on strategy, equity management, mergers, acquisitions, and I visit clients in their offices across the nation. Over the last several years, I’ve built and tested financial models for more than 300 individual plans, and I work very closely with founders (G1s) and next-generation advisers (G2s) to craft plans that will work for decades to come. But I don’t meet some financial advisers’ expectations of a succession planning expert.

When I first started presenting on these topics, I was introduced as the “boy wonder of succession planning” in front of an audience of about 200 senior advisers. My encroaching gray hairs seem to win over some of the skeptics (more so lately, but I digress). I roll with it and focus on providing levels of detail appropriate for each unique audience, whether that be technical or anecdotal. I’ve seen plans succeed and accelerate to the finish line and plans come off the rails.

Next-generation advisers reach out to me when they are struggling to motivate their G1s to execute a succession plan—they want a slice of equity and they’re eager to buy it. I sympathize with them because, in many cases, I’ve worked on their unique plan and understand the struggle between personalities. I empathize with them because I see the benefits of business ownership exhibited all around me, in my personal life and professional life.

As I move through my 30s, many friends have jumped headfirst off the corporate ladder and launched their own businesses in various professional or creative fields, and they’re loving their independence. This industry is full of financial advisers boasting about the rewards of owning their own book, business, or firm. If you have an entrepreneurial mindset, there may be no better option for your career.

But this eagerness is often lost, distorted, or ignored as the deal begins to take shape. In many cases, the cultural influences between generations and the personalities involved can create tension in the early stages of the planning process.

In a broad sense, succession planning has a lot in common with traditional M&A deals. The principle distinctions of succession planning are the relationship of the participants (typically one of established mutual respect and appreciation, over a longer period of time) and the desire to strengthen the partnership rather than hasten the parting of ways. Nonetheless, many aspects of the deal resemble typical arms-length transactions, including:

  • Seller hesitation stemming from pride that nobody can run the business or care for the clients as well as they do
  • Urgency from the buyer to get the deal done
  • Differing opinions of value: seller wants a higher value; buyer wants lower
  • Importance of deal structure on realized value
  • Understanding the tax consequences of the exchange
  • Dependence on client satisfaction to measure the success of the deal

Understand the History

The first piece of advice I have for G2s is: try to imagine yourself in G1’s position and see the opportunity from the founder’s perspective. A successful negotiation begins with having the right mindset, and successors must understand the history and foundation of the firm.

A founder who built their business from scratch, weathered markets, politics, and structural changes, and grew it to a seven-figure value won’t likely regard your early career achievements as highly as theirs—they have built a firm of considerable value over the last several decades through experience, leadership, and grit. The value that grew over that time came from G1’s own entrepreneurialism and management—including the decision to recruit you and others like you. And that value is real and attainable on the open market if an internal deal cannot be struck. As a potential buyer, you must make a competitive offer.

Keep Your Position in Perspective

My next recommendation is to keep your position in perspective. Firm owners, senior advisers, and those with less experience have fundamental differences. One of the most tangible differences is compensation—owners are typically compensated much differently than employees, reflecting the risks and rewards of running your own show. Multiple types of compensation are available as a business owner, and the type of compensation may change at the beginning, middle, and terminal phases in an adviser’s career. Along with these different channels are various tax treatments that impact cash flow of G1 and G2 as they are paid out. The technical details of these elements are complex, but not necessarily complicated.

Early in your career, as a non-owner member of a team, you likely earn salary and commissions or bonuses. In this early stage, your risk is minimal, but your reward is generally consistent and reliable (your tax return is also pretty simple). As you become an owner, you establish equity, which lays the foundation for future wealth, and your compensation channels expand to include profit distributions.

With the first tranches of equity, your profit distribution will likely be tied up in satisfying the financing obligations of purchasing a significant stake in a privately held, growing, and valuable firm. But crafting a successful plan should include a financial model that forecasts the team’s ability to grow efficiently. This can be a transformational stage in a next-generation adviser’s career—G2’s risk is still relatively low, while the opportunity is huge; minority ownership opens the door to a future reward built on top of an already valuable business.

With increased ownership comes increased risk as well as opportunity. As the next generation buys out the founding generation, G1 receives equity payments as well as a salary and profits, but the responsibility of leading the business means owners typically get paid last. When G1s transition into retirement, they free themselves from the risk and responsibility of managing the business: their compensation is tied to only equity payments, which are generally received at long-term capital gains tax rates. At this point, the next-generation adviser(s) will have fully assumed all of the risk and responsibility for growing the business and establishing their legacy. And the cycle continues.

Make Progress

It is sometimes frustrating for a next-generation adviser to be in a successor role and feel powerless to affect the opportunity, especially when one of the most avoidable challenges to designing a viable plan is G1 starting too late. However, you can make progress in spite of a stalling G1. Show that you understand the basics of your business and that you connect with the founder’s clients. Respect their legacy and the history of their firm.

A common concern from G1 advisers is that their best G2 candidate is not a motivator—so be a leader—before, during, and after the plan is initiated. Figure out how to provide value and bring in business and, most importantly, back up your results with data—number of new clients, new assets, improved efficiencies, or reduced expenses.

Be Financially Prepared

Finally, understand that there’s no “free lunch.” Business acquisition brings risk and the technical details of the transaction means G2 must be able to meet the financial obligation of the deal.

It is an exciting time for entrepreneurs in our profession. An aging demographic of advisers is bringing tremendous opportunity for young, energetic, and talented advisers to take these businesses to the next level. Getting involved and capitalizing on these opportunities is one of the best things that you can do to improve the client experience and establish businesses that will last for the next several decades. And they have the added benefit of being extremely lucrative, if structured correctly. Approach these opportunities with the respect that they deserve, and you may find that this is the best investment you will ever make.

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