WHITEPAPERSuccession Planningfor Advisory FirmsFive Steps to a Successful Transitionand a Secure FutureAdvent Software
TABLE OF CONTENTS  Succession Planning: Heed Thy Own Advice  The Five Steps to a Successful Transition 1. Define Your Goals 2. Weigh Your Options ៑ Selling Your Business ៑ Merging with Another Firm ៑ Transitioning Ownership Internally ៑ Choosing and Grooming Your Successor 3. Structure the Transaction and Transition 4. Check for Compliance 5. Communicate the Change to Clients  Technology and Continuity  Conclusion: Plan Now, Play Later  About Advent Software
advent.com/blackdiamond 05Succession Planning:Heed Thy Own AdviceHaving spent their whole careers helping others plan for the future,many investment advisors find themselves without a plan for their own.With the majority of RIA firms now run by people in their fifties, theissue of succession planning has taken on greater urgency as the indus-try has matured. Recent surveys by custodial firms report that at anygiven time, a majority of advisors do not have a succession plan inplace. Most, however, hope to pass their practice on seamlessly to aworthy successor, reaping the rewards of a life’s work and causingbarely a ripple in performance or assets under management.If so many advisors have a similar vision, why aren’t more of them actu- Retirement may seem likeally taking the steps necessary to make it a reality? Planning also takes a long way off, but whattime, and that is a precious commodity for busy advisors. Younger would happen to your firm—advisors in particular may feel they have more immediate and pressing and your family, clients anddemands and that the question of succession is years away. Those employees—if you were hit bynearer to retirement age may simply be unprepared psychologically to the proverbial bus tomorrow?imagine handing the reins to someone else.Nevertheless, a formal succession plan is important for a variety ofreasons. First and foremost, of course, is looking out for the financialsecurity of yourself and your family. Other people, however, also have astake in your decisions. Clients are more likely to stay loyal if they arereassured that a plan for continuity is in place and they can expect asmooth transition to new leadership. If you have employees, they toowill want to know whether they have a future with the firm after yourdeparture. A plan for continuity may also add to the market value ofyour firm by lessening the likelihood that it will lose clients and assetsonce you depart. Last but not least, regulators are likely to look morefavorably on firms that have a succession plan in place, signaling thatthe firm is looking out for its investors’ best interests.Failure to plan, on the other hand, can have unfortunate conse-quences. You could end up in a “distress sale” situation in which youcannot get the full value you expected. And you could be turning yourclients over to a new owner who doesn’t share your philosophy or wholacks the requisite talent and experience to manage assets effectively.Deals made in haste carry the risk that they will break down.And then there is the sobering reality that anything could happen atanytime. Retirement may seem like a long way off, but what wouldhappen to your firm—and your family, clients and employees—if you This communication is provided bywere hit by the proverbial bus tomorrow? The unexpected is a key Advent Software, Inc. for informational purposes only and should not be con-reason why the time to start planning for succession is well before you strued as, and does not constitute,have to. This document will help you start that process by setting out legal advice on any matter whatsoeverthe five steps to successful succession planning for advisory firms. discussed herein.
WHITE PAPER The Five Steps to a Successful Transition 1. Define Your Goals Transitioning full or partial ownership and day-to-day management of your firm to others can take many forms. What is the ideal scenario for you? ៑ Do you wish to ensure continuity of your firm’s operating philoso- phy, style and approach to clients? If so, that would seem to point It is not uncommon for to an internal successor who has learned from you and shares your advisors who love what philosophy. It is not impossible to find such an individual outsidethey do to keep a few clients, the firm. It will take longer, though, and require a more thoroughbut back away from running and careful screening for the right match.the business. ៑ Do you intend to “keep your hand in”? It is not uncommon for advi- sors who love what they do to keep a few clients, but back away from running the business. You will need to define a working rela- tionship with the new ownership that enables you to focus on your clients and their investments. ៑ Are you interested in some form of equity participation after you hand off the day-to-day operations? If you are confident in your suc- cessor and the continued growth of the business, this is an option to consider that will enable you to share in the firm’s success and build additional wealth. ៑ Do you want to walk away altogether one day and not look back? That’s a valid choice too. But you will be more comfortable doing so if you know you’ve left your business in good hands. Only you have the answers to these questions, which may require some soul searching on your part. Figuring out your ideal scenario in advance will influence every other step and decision in the process, including your choice of a buyer or successor and the terms of the transaction. 2. Weigh your options Assuming you don’t want to simply dissolve the business at some point in the future and send your clients elsewhere, there are three primary options for transitioning ownership—selling, merging or cultivating one or more internal successors.
advent.com/blackdiamond 05Selling Your BusinessAdvisors who want a speedier transition and potentially more immedi-ate financial gain, and who are not interested in grooming a successor,may decide to find an outside buyer. The key attractions of this optionare quick cash and the ability to walk away from the business and pur-sue other interests. A sale, however, can result in major cultural andoperating changes that could be jarring to clients and employees—and cause some to leave. It is especially challenging if the firm is closelyassociated with you personally. And principals who are used to calling Careful selection of athe shots may chafe when they find themselves reporting to a boss. successor and thorough due diligence are paramount toThose who plan to sell should focus on creating the type of firm that is mitigate the risk of failure dueattractive to buyers, one that has achieved critical mass and is not to mismanagement or adverseoverly dependent on any one individual to continue operating markets.smoothly. Sellers also need to put a price tag on their firms. There are anumber of valuation methodologies for financial advisory business, andan accountant who knows your business well is most likely bestequipped to advise you on which approach is right for you.Merging with Another FirmA merger with a compatible firm, particularly one with younger man-agement, can give you much more control as to the future direction ofthe combined firms and is more likely an easier sell to clients. For manyadvisors, a merger or “acquire to hire” is a way of bringing in a quali-fied successor with a book of business and proven leadership experi-ence from outside the firm.If your goal, however, is not just to grow the business but to have alogical successor, the plan must be built into the negotiations and yourdue diligence on the prospective partner must be all the more rigor-ous. And, of course, some mergers go smoother than others; conflict-ing corporate cultures or clashing personalities can derail even themost logical merger.Transitioning Ownership InternallyInternal succession is an attractive option for advisors who wish tomaintain some connection with the firm as discussed earlier—forexample, as an advisor to select clients or a silent equity partner. Forothers it is simply the best way to ensure continuity of the firm’s invest-ment philosophy, operating style, and client and employee loyalty.In a 2010 custodial survey of RIA firms, most advisors said they wouldprefer internal succession of their firms—yet the lack of a designatedsuccessor was the main reason for not yet having a plan.* This suggeststhat identifying a successor is a big challenge and, for advisors whowant to go this route, a high priority.*RIA Sentiments on Business Conditions, Succession Planning and Valuation, TDAmeritrade, May 2010
WHITE PAPERChoosing and Grooming 3. Structure the Transaction and TransitionYour Successor There are a variety of different financial mechanisms for transferring firm ownership, most commonly including:To choose a successor, you first need to ៑ An earn-out, in which the buyer makes an initial payment at anidentify a candidate (or candidates) withboth the proven ability and the genuine agreed amount, and subsequent payments are dependent on thedesire to run the firm. Internal succes- business continuing to meet specified goals. The seller bears asors may come from the advisor’s family, measure of risk that the business may fall short of those goals, butfrom within the firm, or be recruited from also has some upside potential should the business exceed them.outside the firm. It may be one individ- Earn-outs protect the buyer from paying full price for a businessual or perhaps two or more people who that subsequently falters.want to be partners. In any case, itshould be someone you have had or ៑ A buy-in, in which the buyer makes an initial payment followed bywill have the opportunity to work with payments over time. Here, the buyer assumes more risk and theand observe over a long period of time. seller is assured a certain price upfront. However, unlike an earn-Grooming a successor and makingclients comfortable with the plan is a out, the seller does not gain anything if the business outperformsprocess that can take years—as much as expectations during the transition.five to ten years, some experts say. ៑ An equity transfer via an employee stock ownership plan or stockIn the process, the succession candidate options that give successors a degree of ownership on which theyneeds to be subjected to a degree of can build and eventually buy out the balance of the seller’s equity.due diligence so you are satisfied thathe or she is the right person to take over Internal succession transactions also typically entail some type of long-the business in every way—from creden- term financing in the form of a promissory note or bank loan.tials and licensing to track record, man-agement style, rapport with clients, and Of course, there is no guarantee that the business will continue to berespect from employees. Even if you successful under a new owner. Unforeseeable market conditions canthink you know the person very well, certainly have an impact and there is no risk-free method of transfer-legal experts recommend a formal finan- ring ownership. That is why the careful selection of a successor andcial and criminal background check. thorough due diligence are paramount to mitigate the risk of failureFinally, how will you be ultimately com- due to mismanagement or adverse markets.pensated? Is the candidate in a financialposition to buy the business outright—or will some kind of structured financing 4. Check for Compliancebe necessary? There are a number of regulatory issues to be aware of in the transferWhen you are confident you have a of ownership of an advisory firm. First, the basics: document your duegood succession candidate, you will diligence and get written confirmation that the successor:want to establish a timetable for turningover control and gradually reducing your ៑ Is duly registered with the appropriate body (state or SEC)degree of involvement. Successors may ៑ Has never been convicted of a violation of the Advisers Actbecome antsy and question your com-mitment if the timing of succession is ៑ Is current with all license examinations and certificationsvague. A timetable also helps clients and ៑ Has no conflicts of interest or impedimentsemployees get comfortable with thetransition and may prevent or limit In addition, prepare to update the firm’s Form ADV when new princi-defections. pals take over. It is essential to consult with a compliance attorney or consultant who can help you understand and address the legal and regulatory implications of an ownership or entity change. These include such issues as confidentiality and privacy policies, restrictive covenants
advent.com/blackdiamond 07(non-solicitation or non-compete agreements), licensing and registra-tion requirements, and continuity of business contracts that the firmentered into prior to the transition.The SEC’s primary concern, as always, is that clients are protected—another good reason to have a succession plan in place well before theactual succession takes place.5. Communicate the Change to ClientsYou will need to decide when and how it is appropriate to announcethe succession plan to your clients. However, generally speaking, “earlyand often” is a good guideline to follow. Reassuring clients that a planis in place and giving them time to get used to the idea should helpretain them.Following the announcement, it will be important to introduce the suc-cessor to all the firm’s clients, either informally, such as at a reception,or in a more formal setting such as quarterly client meetings. Few pro-fessions are as grounded in personal relationships as the investmentmanagement business. Make sure that the time between announce-ment and actual transition is adequate to allow the successor to culti-vate his or her own relationships with clients. After all, keeping clients isone of the main reasons for succession planning, and your client base Succession planningis the main asset that the successor has “bought.” offers a good opportunity to review, revise and renewTechnology and Continuity your technology framework— especially if you haven’t doneContinuity is the key reason for internal succession—continuity of so recently.investment style, of management from within the firm, of staff, and ofclient relationships. That said, continuity of processes and practices isalso important, and that is where your technology platform can be anasset.It helps smooth the transition to have technology that centralizes clientdata and makes historical data easy to find. Technology provides conti-nuity in reporting for clients. It helps ensure that composite creationand performance calculation methodologies stay the same. Transitionwithin the firm means that successors and staff are familiar with the sys-tem. And because you are planning for the long term, it is important tohave the confidence that your system won’t become obsolete, and thatit is backed by a provider who will be there to support the new team. Infact, succession planning offers a good opportunity to review, reviseand renew your technology framework—especially if you haven’t doneso recently.