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The Importance of Succession Planning for Financial Advisors

For Use With Financial Advisors Only. Not For Use With The General Public.2

The Importance of Succession Planning for Financial Advisors

Financial advisors frequently impress upon their clients the importance of careful planning for their goals of tomorrow. Ironically, many have not yet addressed their own critically important question: what  will happen to their business when it comes time for them to retire?

Only a small percentage of advisors have formal succession plans in place — as few as 18 percent, according to a survey of 117 advisors by CLS Investments.1 Another study by FPA Research and Practice Institute puts the number at about 25 percent. “…The percentage with a formal plan increases slightly to 31 percent at age 60 to 64 and 41 percent at age 65-plus,” said the study authors.2

Though the data varies a bit, the picture is clear. The vast majority of advisors, even those nearing retirement age, have not developed plans for the next leadership of their firm, nor for funding their retirement after they step away from the business.

Adding to the urgency of the question is the fact that for many advisors, their most valuable asset is the business that they’ve built and nurtured over the course of their career – their advisory practice is where much of their net worth resides. One reason advisors avoid this vital planning may be that selling a business is an emotionally charged issue. Many advisors enjoy their work and derive such satisfaction from caring for their clients that it’s hard to think about retirement in the traditional sense, or to imagine ever stepping away from their practice.

1 Nick Thornton, Younger Advisors Report High Levels of Job Satisfaction (BenefitsPro, March 24, 2015).

2 The Future of Practice Management, conducted by FPA Research and Practice Institute, October 2013.

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SMALL PERCENTAGE OF ADVISORS HAVE SUCCESSION PLAN

25%

31%

41%

About 25% of advisors have a formal succession plan

The number increases slightly to 31% for ages 60-64

And at age 65+, only 41% of advisors have a succession plan

The Importance of Succession Planning for Financial Advisors 3

Advisors are not well prepared for their own eventual transition out of the business world...46 percent of financial planners surveyed admitted to having no retirement plan.

3 Nick Thornton, Younger Advisors Report High Levels of Job Satisfaction (BenefitsPro, March 24, 2015).

4 Lisa Barron, Demand for Financial Advisors to Grow (BenefitsPro, February 24, 2014).

5 Lisa Barron, Demand for Financial Advisors to Grow (BenefitsPro, February 24, 2014).

Industry is greying

Even so, the question of what the next chapter will hold is fast approaching. The average age of the approximately 316,000 financial advisors in the industry is 51 years. About 43 percent of all advisors are over age 55, and about one-third are between the ages of 55 and 64, according Cerulli Associates of Boston.3

As a profession, financial planning is expected to expand by 27 percent over the next decade, due to baby boomers retiring.4 At the same time, the financial services industry is set to undergo a wave of retirement and transfer of ownership as the founding generation of baby boomer financial advisors approach their own retirement. Over the next decade, 12,000 to 16,000 advisors are expected to retire every year,” according to a recent BenefitsPro article.5

AGING ADVISOR COMMUNITY

The average age of the approximately

316,000 financial advisors in the industry is 51 years.

About 43 percent of all advisors are over age 55, and about one-third are between the ages of 55 and 64.

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How will advisors fund their retirement?

Financial advisors routinely ask clients to visualize how their lives will look five, 10 and 20 years down the road, yet it’s easy to see that many financial advisors are more focused on working and growing their businesses than on making plans for future downshifting. As a group, advisors are not very well prepared for their own eventual transition out of the working world. In a 2013 study by FPA Research and Practice Institute, 46 percent out of the 2,400 financial advisors and employees surveyed admitted to having no retirement plan for themselves. Yet, fully 40 percent say they plan to retire within the next 14 years.6

When asked how much money they need for retirement, 61 percent of respondents to the CLS Investments survey estimated that they need at least $1.5 million, while another 42 percent said they need $2 million. Almost half of respondents said they were less than halfway there. Only 11 percent said they were in a position to retire comfortably.7

6 FPA Research & Practice Institute, The Future of Practice Management (2013).

7 CLS Investments, LLC - CLS Advisor IQ Series, Reinvent Your Practice: Alternatives to Traditional Succession Planning (2014).

$2M

$1.5M 61% of financial advisors believe $1.5 million is needed for retirement

42% of financial advisors believe $2 million is needed for retirement

HOW MUCH IS NEEDED FOR RETIREMENT? ADVISORS BEHIND IN RETIREMENT SAVING

50%saved half of what they

estimate they will need in retirement

11%saved enough

to retire comforably

The Importance of Succession Planning for Financial Advisors 5

On the other hand, reaching a “magic number” by a certain date is not the only possible solution to the retirement conundrum. For a combination of social, financial and personal reasons, the boomer generation has reimagined their retirement lifestyle to include at least some work. Rather than endless golf  courses and sunning on the beach, the boomer trend looks more like a downshifting than an ending. Many boomers aspire to shift to more satisfying work that can continue into their 70s and beyond.

This trend fits well with the typical advisor profile, since many advisors feel that their identity is closely wrapped up with working and their relationships with their clients.

Providing Continuity of care for clients

Another approach to the topic of succession planning is to think in terms of business continuity: What would happen to the advisor’s clients, employees and family in the event of the unexpected absence of key personnel in the firm, or a natural disaster of some sort?

Business interruptions can take many forms, including the sudden death of a principal, a natural disaster such as Hurricane Irene of 2011 or Hurricane Sandy of 2012, a political situation or a cybersecurity threat. Advisors owe a fiduciary duty to their clients to have an up-to-date plan describing the steps that a firm will take to protect their accounts in case normal service is interrupted. Investors are exposed if their advisors don’t have contingency plans in place. “…it makes good business sense to develop succession plans, and particularly so as investment fiduciaries,” said Duane Thompson, senior policy analyst at the fiduciary training firm fi360, to Financial Planning.8

8 Kennith Corbin, Got a Succession Plan? State Regulators May Soon Require It (Financial Planning, April 23, 2015).

It’s clear that succession planning is important in many ways – for the sake of continuity of care for clients, for regulatory compliance purposes and of course, for providing funds for the advisor’s retirement.

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Regulatory pressure for business continuity and succession planning

Regulatory drivers add yet another layer to the question of succession planning for financial advisors. NASAA, the association of state securities regulators, published a model rule in April, presenting a uniform set of requirements for business continuity and succession plans to protect investors from unexpected circumstances.9 The SEC is also concerned about the vulnerability of investors in the event of unusual business disruptions.

The model rule, which states can consider for adoption, essentially requires advisors to have formal plans in place for backing up and recovering records and for communicating with customers, regulators, employees and vendors in case of a significant business interruption. It also asks for a succession plan designating who would assume key responsibilities in the event that senior leaders become incapacitated.10 The likelihood that many states may adopt this model rule makes business continuity planning and succession planning even more of a pressing topic for financial advisors to address.

Succession planning can unlock more business value

It’s clear that succession planning is important in many ways — for the sake of continuity of care for clients, for regulatory compliance purposes and of course, for providing funds for the advisor’s retirement. On this last front, the ultimate worth of an advisory practice can vary greatly depending on how the advisor’s exit is structured.

Even a thriving practice with relatively strong revenue may not fetch enough in the market to fully fund a comfortable retirement. The average annual income for an advisor is around $160,000, while the average sale price for a practice is about $500,000. Obviously that leaves quite a gap when it comes to meeting a retirement goal of around $1.5 million to $2 million. According to the CLS Investments study, it appears most advisors are counting on the sale of their business to fund their own retirements. In fact, 40 percent said they expect the proceeds to generate 26 to 50 percent of what they will need.

9 NASAA Model Rule on Business Continuity and Succession Planning Model Rule 203(a) - 1A or 2002 Rule 411(c) 1A (Adopted April 13, 2015).

10 NASAA Model Rule on Business Continuity and Succession Planning Model Rule 203(a) - 1A or 2002 Rule 411(c) 1A (Adopted April 13, 2015).

The Importance of Succession Planning for Financial Advisors 7

11 CLS Investments, LLC - CLS Advisor IQ Series, Reinvent Your Practice: Alternatives to Traditional Succession Planning (2014).

12 Ann Marsh, Alternative Strategy for Retirement: Don’t, (Financial Planning, August 27, 2014).

Just a small fraction of survey respondents — 14 percent — were confident that the proceeds of a sale would generate all of their retirement income.11

This situation suggests that a straight sale at retirement age may not be the most viable option for many independent advisors. Some experts believe that advisors who seek to sell their firms won’t get the price they’re after — and would be much better off if they delay retirement as long as possible.12 Yet if an advisor delays retirement for too long, the firm may begin to lose value as the average age of the client base goes up and the asset base goes down.

To get more value out of a sale, advisors may want to consider a variety of deal structures beyond a traditional sale. A well-conceived succession plan can add value by providing for the continuation of the firm as the founder begins to step back and leadership transitions to the next generation.

PROCEEDS FROM SALE OF PRACTICE DO NOT MEET RETIREMENT FUNDING NEEDS

Average annual income$160,000

Average sale price$500,000

EXPECTED SALE VS. RETIRMENT SAVINGS GOAL

26% 50% Funds still needed

40% of advisors surveyed expect the sale of their practice to generate 26% to 50% of what they need for retirement savings.

14% of advisors surveyed expect the sale of their practice to fully fund their retirement savings.

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Types of deal structures

Working on a succession plan well ahead of the desired retirement date allows for more planning options and can add significantly to the advisor’s total compensation. These days, advisors have many options for structuring a sale and more flexibility as far as financing, front- and back-end payments, and collaboration. “The new trend in the industry is longer term transitions where both the buyer and seller work collaboratively for three to five years after the sale has occurred,” according to a study by Succession Resource Group (SRG), commissioned by Ameriprise.13 Longer transitions offer the retiring advisor the opportunity to earn additional income for retirement by helping the successor for a period of time.

Here is a look at some general types of deal structures.

Traditional sale

In a traditional sale, the advisor sells the book of business in one single transaction. During a fairly short period of collaboration – typically six to 18 months – the seller helps smooth the transition of clients to the buyer.

Factors that can affect the valuation of the deal include: length of tenure of clients, average age of the clients, account assets, non-recurring and recurring revenue sources and the growth rate of the firm. Experts say down payments can range from approximately 15 percent to 40 percent, depending on the quality of the business. The balance of the sale price is financed by a promissory note or earn-out arrangement. Valuations can range from roughly one- to three-and-a-half times revenue.14

Gradual or partial book sale

An advisor may wish to monetize a portion of their business by selling a certain segment of clients, commonly to buyer within the same broker dealer network, while retaining the balance of the accounts. This is known as a partial book sale. After closing the deal, a period of collaboration between the seller and the buyer can extend for three to five years. This strategy allows the seller “to judge the success/failure of the deal before transitioning their ‘A’ clients to the buyer,” according to SRG.

13 Deal Structuring and Succession Trends for Advisors, Succession Resource Group (2012).

14 Deal Structuring and Succession Trends for Advisors, Succession Resource Group (2012).

The Importance of Succession Planning for Financial Advisors 9

Sell and stay

If the advisor wants to transfer ownership of the business but continue working for a period of time, the deal can usually be structured as a type of merger, or a “sell and stay”. In this case the advisor sells the book of business but continues working with the same clients through a contract with the buyer. The seller receives a down payment at closing, an employment contract for the collaboration period, and a promissory note for the balance.

Internal succession

An advisor may envision one day handing over the reins of the business to a junior partner. Internal succession — meaning the practice is sold over time to an employee, family member or team — is becoming popular, especially with smaller firms. Such deals are complex to plan, but can yield rich benefits for all parties. Many advisors care greatly about ensuring the continuity of the firm they’ve built and value the idea of finding a successor among trusted associates.

It is often the case that the junior advisor does not have much capital available, or may not be experienced enough yet to assume the lead role. Also at issue is whether a firm is ready to be sold. It may be that much of the value of an advisory firm is closely tied to the active participation of the founder.

An internal succession can be planned over a number of years, giving time for an advisor to groom and develop the successor, install a strong team, and foster client relationships with the new person or team who will eventually become the new leadership. When succession planning begins well in advance of the advisor’s planned retirement, the advisor gains greater ability to ease out gradually while preserving the company’s value and setting it up for continued growth. The owner can delegate some responsibilities while staying hands on with a smaller group of top clients. This strategy can be more enjoyable and help the senior advisor avoid burnout.

Unlike an outright sale, an internal succession involves a long collaboration period. Often the junior advisor pays little or nothing upfront, and the senior advisor extends financing over a long period that can span as long as 10 years. The successor pays off the debt over time; meanwhile the founder receives an income stream for a longer period.

The new trend in the industry is longer term transitions where both the buyer and seller work collaboratively for three to five years after the sale has occurred. — From a study by Succession Resource

Group (SRG) commissioned by Ameriprise

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By identifying a successor well in advance, the advisor may reap the benefits of a satisfying later career while preserving more value and growth potential for the firm.

Preparing to let go

Considering the complexity of decisions surrounding succession planning, it’s no surprise many advisors avoid thinking about the process. Part of the challenge involves an emotional process of letting go that some may not be ready to face. After all, financial planning is by its very nature a hand-on endeavor. “It’s no secret that successful independent financial advisors are control freaks. The draw toward independence in our industry starts with the appeal of being the boss,” explains Jason Card of J.W. Financial, in a recent Financial Planning article.

Naturally, there may be some resistance to the very notion of one day no longer being the boss. Card adds that throughout the industry, in order to prepare their businesses to thrive after they’ve left, advisors need to set up systems that allow them to release control. “You’re trying to sell a business, not your own work — because, after all, the idea is to eventually stop working.”15

15 Jason Card, Not Quite Ready to Sell Your Firm? Here’s How to Get There. (Financial Planning, April 27, 2015).

When succession planning begins well in advance of the advisor’s planned retirement, the advisor gains greater ability to ease out gradually while preserving the company’s value and setting it up for continued growth.

The Importance of Succession Planning for Financial Advisors 11

Conclusion

Without a well-executed succession plan, many independent advisory firms may fall victim to the most common of small business fates – which is not to outlive the founder. The same independent spirit which drew the financial advisor to start a practice can become a hindrance when it comes to selling the business. A succession plan preserves the value of the firm by determining an orderly way for the founding advisor to step back and allow the next generation of leadership to step up.

When thinking about the long-term future of a financial advisory practice, starting the process far in advance will preserve more options and allow more time for identifying the right successor or team. Prudent succession planning helps the financial planner provide the firm with a smooth transition that is best for clients while increasing the income stream for retirement.

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