A March 2008 study by Tiburon Strategic Advisors, “Financial Advisors Mergers & Acquisitions: A Comprehensive Overview of Succession Planning, Firm Valuations, & the Growing Market for Financial Advisors,” found that more than half of the fee-only financial advisers and independent (registered) representatives are over the age of 50 and face retirement in the next 10 to 15 years. However, only 45 percent of the fee-only advisers and 29 percent of independent reps have succession plans in place.

The lack of succession plans raises a problem. The advisers’ businesses have become valuable assets, and they now face the same transition decisions that their clients have encountered. There is often a critical difference, however, between wealth managers and other professional service providers, such as those in legal, tax, and medical practices. Those professionals typically begin planning for ownership transition and client retention well in advance of the senior principal’s retirement, and the models for structuring and financing the younger associate’s purchase of the older owner’s equity are established.

Financial advisory firms lack those established protocols, and most principals don’t focus on transitioning clients until they are seriously considering retirement. The combination of high valuations and short transition horizons creates a problem: How can younger associates afford to buy into the firm if the owner wants to retire in a few years? As a result, the challenges of ownership transition and client retention have become inseparable.

Transition Options
One transition option involves selling to outside buyers. Another option is to bring a new partner into the firm who has sufficient personal capital for a buy-in. The third alternative is selling to existing staff, which could include junior partners and key employees.

According to a 2006 survey by Rydex AdvisorBenchmarking.com, internal succession is the most popular option among registered investment advisors (RIAs). Twenty-nine percent of respondents preferred to sell to an existing partner, and twelve percent preferred to sell to an existing employee. In contrast, only 18 percent preferred selling to an unidentified (12 percent) or identified (6 percent) third party.

Direct Transitions
Smaller firms have fewer assets under management (AUM) and typically fewer clients, which makes ownership and client transfers relatively straightforward. Thomas Barrett was the sole professional at Helm Investment Management LLC in Denver, Colorado, until mid-2006. Barrett, 61, an attorney and CPA, had a strong background in business succession planning; he realized it was time to implement his own plan. He began seeking a junior partner, and that search led him to Jay McCormick, CFA, who had been working as an investment analyst at another company.

Succession planning was part of their discussion from the onset, and McCormick agreed to purchase 49 percent of the firm’s equity when he joined, with financing provided by a five-year note. McCormick plans to buy the remainder of Barrett’s shares at the end of the five-year period, although there are no firm plans in place for Barrett to retire then.

Team Approach
Syverson Strege & Company in West Des Moines, Iowa, has a staff of 20 and approximately $256 million of AUM. According to Lance Gunkel, CFA, the firm’s founders, Johnne Syverson and David Strege, CFA, began planning their firm’s transition about two years ago. Gunkel says the ownership transition is taking place in phases. In the intermediate phase, key employees receive stock options and warrants. The warrants allow employees to purchase shares of the firm’s stock at a discount to the estimated fair value. The warrants have a 12-month exercise period, and the firm offers financing over five years if the warrants are exercised within the first six months.

Transitioning clients from the senior partners to younger associates was initially a challenge because Severson and Strege had worked with some of their clients for decades. The firm learned from those initial experiences and changed to the service team model. Every client now works with a team of three staff members, one of whom is a wealth coach and team leader. The second in line is the team’s financial analyst, who over time eventually becomes a lead wealth coach.

Syverson Strege & Company has transitioned approximately 15 clients between advisers with another 10 transfers scheduled for the next 12 months. Gunkel says the transitions have gone much better under the new structure, largely because the clients are more comfortable with the financial analyst and are more confident in his or her skills.

Advisory firm Greenbaum and Orecchio Inc. in Old Tappan, New Jersey, is approaching its first major leadership transition when the firm’s founder and president, Gary Greenbaum, CFA, will retire next year. The firm also uses a team approach, with five wealth managers supported by senior advisers and financial planning analysts servicing 250 clients with AUM of $450 million.

Similar to Syverson Strege & Company’s approach, the Greenbaum and Orecchio management regularly introduces all the team members to clients. Having the senior advisers and financial planning analysts work closely with clients helps the clients develop confidence in those advisers’ abilities, according to Mark Willoughby, CFA, principal. He estimates that the firm has transitioned roughly 10 percent to 15 percent of its clients among advisers, and the client-retention rate is consistently in the 95 percent range.

Facilitating Large Transactions
As noted previously, large firms’ high valuations can impede internal succession plans because it can be difficult for owners of large firms to sell internally without accepting a significant discount on their equity. In response to the transition-financing problem, Mark Hurley of Fiduciary Network LLC in Dallas, Texas, developed an innovative solution. Hurley facilitates internal succession plans by providing external capital infusions that allow firms to accomplish multiple goals. Unlike roll-up or consolidation deals, Fiduciary Network does not take ownership of the advisory firm; in essence, the company buys part of the advisory firm’s cash flow. To date, the company has completed four transactions, and Hurley says another 28 transactions are in various stages of completion.

Hurley called on the owners of RegentAtlantic Capital LLC in Chatham, New Jersey, as he was starting Fiduciary Network. The strategy appealed to the owners because the older partners controlled roughly half the equity and wanted to sell their positions to their younger partners instead of external buyers. Chris Cordaro, CFA, wealth manager, says the financing deal fit well with the firm’s ongoing strategy of transferring clients to junior associates. The size of RegentAtlantic’s staff also gives it flexibility in transitioning clients that smaller firms lack, Cordaro believes. Additionally, he notes, the likelihood of finding a good client-adviser match and retaining the client improves when there is sufficient lead time to plan and implement the transfer.

In sum, effective succession planning involves financing and business development strategies. The optimal solution depends on the size and composition of the firm’s owners, management team, and client base. 

Ed McCarthy is a freelance financial writer in Pascoag, Rhode Island.