TAKE 2: The New Direction of SUCCESSION PLANNING. By Angie Herbers

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1 By Angie Herbers

2 TAKE 2: About Angie Herbers, Inc. a ngie Herbers Inc. is a business management and human capital consulting firm located in Manhattan, Kansas. Our company focuses on working with business owners, particularly financial advisors, who have the desire to grow. We specialize in working with advisory firms to develop great employees through the use of proven organizational structures, training programs, compensation and benefit packages, productivity tools, employee motivation, and succession planning. To learn more, visit our website at About ANGIE HERBERS, INC. 2

3 TAKE 2: Amor Vincit Omnia n In Loving Memory Of Teresa Conde Associate Consultant Angie Herbers Inc. n Dedication TERESA CONDE 3

4 TAKE 2: Table of Contents Table of Contents Executive Summary: The Need for Better Succession Plans Preface: Stop! Don t Go Any Further Until You re Prepared Part I: Introduction The Challenge of Succession Part II: Bad Advice The Flaws in Conventional Succession Planning Part III: A Better Way The Elements of a Successful Succession Part IV: Designed to Grow Creating the Growth to Fund Succession Part V: P4 Principles Motivating Employees to Help Grow the Firm Part VI: Don t Forget the Successors Fully Understanding the Role of Junior Partners Part VII: Action Plan How to Build a Successful Succession Table of Contents TAKE 2: THE NEW DIRECTION OF 4

5 Executive Summary THE NEED FOR BETTER SUCCESSION PLANS TAKE 2: The scope of the succession problem in the independent advisory industry is well documented, and well-known. The Baby Boom Generation of advisory firm owners are on the brink of retiring over the next 10 years or so, with some sources estimating that as many as 50,000 of their firms with $4 Trillion in client assets either changing hands or closing their doors. The vast majority of the owners of these firms would prefer to transition ownership to their junior partners in an internal succession. Yet, despite limited time to achieve this goal, very few have taken the steps necessary for a successful outcome. that offer quick and easy solutions. Moreover, they often spend only a short time helping to implement these plans, and then move on to the next job. Thus, they typically have little or no involvement with the outcomes. Yet, in our experience, the internal succession of advisory firms presents numerous challenges that rarely have easy solutions and virtually none of them are quick. The often overlooked potential problem areas of internal succession, which every owner-advisor needs to understand, and have strategy for over-coming to manage a successful transition are described below. According to a recent industry survey by Signator Investors: only 11% of independent advisors have a succession plan in place; just 20% of advisors are certain about what they will do with their practice when they retire; and roughly 30% of firm owners have a successor advisor on staff, leaving some 67% who plan to hire one in the future. In addition to a lack of adequate planning, and the difficulty of finding (and training) appropriate successors, the industry has been hampered by a lack of sound guidance through the succession process. Succession experts often use models designed for other industries, with templates Over-focus on valuation. While the buyout value of the firm is certainly a factor in a succession, it is not nearly as important as many buyers and sellers seem to think. First, unfavorable deal terms can render any valuation a moot point. Second, as we will see below, the key to virtually every successful advisory succession is firm growth. It provides the capital to finance the buyout, as well as controls its duration. Lack of financing options. This is the major challenge for virtually all internal succession plans. Unless owner-advisors are willing to practically give their firms away to their junior partners, there are only two viable options that can be combined into a successful succession plan financing the acquisition through the Executive Summary THE NEED FOR BETTER SUCCESSION PLANS 5

6 firm growth, and lengthening the time allocated for the transition of ownership to occur. Wrong incentives. This issue pertains to identifying the growth drivers. Our experience in working with independent advisory firms and other businesses has taught us that people will tend to do what they are incentivized to do. Without significant motivation to grow the firm, junior partners may not get as much help from senior advisors approaching retirement, as they need to meet the plan s growth projections. Moreover, if the compensation for junior partners increases too fast, it can have a dampening effect on their motivation, particularly in the early years of a succession, when generating firm growth is most important. Unrealistic assumptions. In our experience, transition plans that are based on a too conservative growth rate, and projected over too short a time period, usually prove to be unworkable. When it comes to succession planning, firm owners need to start early, providing time for firm growth to underwrite the buyout, and tying junior partners to the firm. This strategy eliminates turnover, which can be disastrous to any plan. Elements of a Successful Succession Every succession is different, and consequently, there are no templates or turnkey solutions. Nonetheless, there are guidelines that owneradvisors can follow in order to prepare for the most common events. Through our ongoing experience with succession planning and overall management of independent advisory firms, we have found that, to achieve the growth needed to underwrite an internal buyout, a succession plan needs to contain four key elements outlined below. Establishing the right incentives to grow the firm. A successful succession plan will motivate both the owner and the junior partners to increase revenues and maximize profits. Often, the combined incentives can result in acquiring equity faster and/or completing the transition sooner. With that said, it is also important to be sure that both the buyers and the sellers are working toward an outcome that both parties desire. Allowing time to adequately compound the growth. Because growth compounds annually, adding just a few more years to a succession plan can yield dramatic increases in the payout to the owner(s), and substantially shorten the time that junior partners are paying for their equity. Properly preparing the junior partners to drive that growth. In a firm built for maximum growth, the primary job of associate advisors is to become leader advisors, tasked with turning a cost center into a revenue generator. Typically, after two to three years of hands on experience, firms find that their associate advisors are truly ready to start working with clients, and are well on their way to becoming productive lead advisors working with clients on their own and eventually becoming owner-advisors. Executive Summary THE NEED FOR BETTER SUCCESSION PLANS 6

7 Supporting all the firm s employees to contribute to that growth. Firms prepare their employees to succeed by basing a significant portion of their compensation on the success of the firm, creating a flexible and supportive work environment, and supplying the tools necessary for employees to excel at their jobs. Don t Forget the Successors The challenge of driving that growth will fall on the junior partners. In fact, the entire succession will depend on their ability to assume the roles of senior advisors: providing the highest levels of client service, forming solid relationships with the firm s existing clients, and attracting new clients to the firm. Action Plan: How to Build a Successful Succession 1 Establish Trust. The foundation of a successful succession is the bond of trust between the firm owner and its junior partners. We believe that this is also an essential ingredient in any successful firm, and it is never too early to start establishing this trust. 2 Educate Junior Partners. Passing on knowledge, in particular that pertaining to the finances and structures of succession, is the key to success. This is the most important element of a succession plan. Because there s so much information and misinformation out there about succession, junior partners need to understand the various models that they might hear about, and the pros and cons of each. 3 Create a Deal that Works for Everyone. A good succession plan should include a sufficiently long timeline, combined with reasonable growth projections to pay the owner a reasonable value for the firm, while allowing the junior partners enough profit sharing to substantially increase their total income and pay for their new equity. 4 Don t Focus on Valuation. Only after an agreement has been reached on the structure of the succession should the parties begin the discussion about the subject of the firm value. If you talk about valuation first, the junior partners will focus solely on a price, and there s a very real chance that the deal will spiral out of control. 5 Start Early. It is never too early to start transferring ownership to a successor advisor, once the owner is sure who that successor is. The increased motivation will help drive firm growth, which is the key to internally funded succession plans. Executive Summary THE NEED FOR BETTER SUCCESSION PLANS 7

8 TAKE 2: Preface: STOP! DON T GO ANY FURTHER UNTIL YOU ARE PREPARED I spent my early childhood living in, literally, the middle of no-where-ville, on a 10,000 acre ranch in Western Kansas. The ranch house as we call it sat on a long dirt road, simply named North Kansas Road. The scenery along this road was beautiful long green pastures with rolling hills bordering a State Park. The road itself was of pretty good quality, as dirt roads go, except for a blind left turn that swung you westbound, straight into the sunset. If you were going too fast, or were blinded by the spectacular sunsets over the plains of Kansas, or if it had recently rained, you were in danger of encountering the car-eating potholes just around that curve. I was afraid of that road. Weighing less than 40 pounds, back in the day when child seats and seat beats were only for sissy city folks, you can imagine how much I got thrown around the back of our car. I was also afraid that someone else would get hurt and some did. So, I would warn people about that curve, particularly the school bus driver. Sadly, no one ever listened and some of them did get hurt and more than a few cars paid the price. For years, every time I saw a car go by the ranch house, I fantasized about standing at that curve, in the middle of that road, holding up a stop sign. I know that it seems silly, but I m reminded of that road quite often when I m thinking about succession planning in the advisory industry. In many ways, succession planning is very similar to traveling that road for the first time. For many owners, transitioning their firm to the next generation can be a dramatic left turn into the sunset. Suddenly, they are blinded to the dangers that lie ahead. Unfortunately, I have seen more than a few owners go into that turn way too fast and wreck their businesses. I have also seen them lose everything they spent years building because they didn t plan for what they couldn t foresee. I ve sat there many times, telling them about the potholes of an unrealistic plan, and the drastic consequences that can follow. Most listen patiently, simply nodding their heads, as if in agreement. Yet, they still go right ahead, doing all the things they were warned about, with all the predicted results. Fortunately, though, I m in a unique position when it comes to succession planning. Many of our clients have on-going, long-term relationships with my firm. We have enjoyed working with them on retainer, year after year. Consequently, we have developed trust, so that many of them implement our succession plans. We also benefit from an opportunity to see how plans created by other experts really work, as well as where they go haywire. I can t tell you how many times I have cleaned up the messes Preface STOP! DON'T GO ANY FURTHER UNTIL YOU ARE PREPARED 8

9 of other experts, and the advisors themselves. These were often the same messes I was trying to get them to avoid in the first place. At some point, they eventually listen; still, all too often, the lost time and lost staff make the eventual payout far lower than it could have been, if the successions go through at all. Once again, I find myself imagining holding up a stop sign in the middle of the road for owner-advisors contemplating succession and saying, Stop! Don t go any further until you are prepared. The good news is that I am now more persistent than I was as a child. I have not given up on informing business owners of the road they are traveling. Thirteen years ago, when starting my career as a consultant to advisory firms, I made it my sole mission to bring all the looming succession issues to the forefront of the industry. Succession isn t just about how to transfer a company. It is about building career tracks, training the next generation of talent, hiring and retaining top talent, creating incentive programs that work and developing a solid organizational structure. To support this mission, we created a research division within my company and all of our research has been recently released. It started with our first white paper and five-year clinical research project P4: Creating Great Business by Creating Great Employees, which explains exactly how to retain the next generation of talented individuals and build effective compensation programs. Part 2 was our white paper Diamond Teams, which delineates a proven method that can be applied to build a solid organization structure with career tracks. Finally, we are releasing this white paper Take Two: The New Direction of Succession Planning to educate owners and successors on how to internally transfer an advisory firm. In our consulting business, one of the core values Angie Herbers Inc. strives for is increase the value. This is the message to all business owners: that we do all we can through education, writing and consulting to help business owners We do all we can through education, writing and consulting to help business owners and firms travel down a safe road to achieve whatever goal they set out to accomplish. and firms travel down a safe road to achieve whatever goal they set out to accomplish. Today, I am writing this white paper to educate firm owners about the successes we ve seen with succession planning. My goal is also to warn them about the potholes, in hope that, in the end, when they decide to make that turn into the sunset, their transition will be just as meaningful and rewarding as the road traveled to get there. Preface STOP! DON'T GO ANY FURTHER UNTIL YOU ARE PREPARED 9

10 TAKE 2: Part I: Introduction THE CHALLENGE OF SUCCESSION Succession planning is the #1 challenge facing the independent advisory industry today. It is estimated that some 50,000 Baby Boom owner-advisors are poised to transfer an estimated $4 trillion in client AUM to the next generation of advisors within the next 10 years or so. The success or failure of those successions will shape the future of independent advice for decades to come. Yet, by many accounts and based on our own experience many firms are woefully unprepared to make the transfer of ownership when their current owners retire. In recent years, this issue has received much attention, which has led to numerous studies yielding extensive data. For instance, findings of a survey released last July by insurance giant John Hancock Financial Network s renamed broker-dealer Signator Investors revealed much the same situation we ve been hearing about. According to the survey, only 11% of independent advisors have a succession plan in place, and just 20% are certain about what they will do with their practice when they retire. At the same time, some 30% of firm owners have a successor advisor on staff, while the rest, under severe talent shortages, plan to hire one Only 11% of independent advisors have a succession plan in place. in the future. Not surprisingly, advisors two primary succession concerns were training a younger advisor to succeed them (66%), and financing the transition (69%). Perhaps even more distressing is our observation that many of the firms that have turned to succession planning consultants to help them prepare are getting advice that at best will cost firm owners millions of dollars in equity upon transfer of their firms. In the worst scenario, the proposed solutions will prove unworkable, resulting in multi-year delays in their retirement, or even no transfer at all. As business consultants for advisory firms, we work with many of our clients to develop and implement succession plans. Occasionally, a firm will prefer to bring in a succession expert, either to save money by using their existing template plans, or to get a second opinion on a plan that we ve created. At first, we welcomed outside perspectives, as an opportunity to potentially uncover better solutions for the myriad of succession issues, and/or to confirm that our strategies were on track. In some cases, our clients used all or part of their plans. Part I: Introduction THE CHALLENGE OF SUCCESSION 10

11 Unfortunately, the majority of our experiences with outside plans have not been good. Our ongoing relationships with our clients put us in the unique position of having to implement these succession plans, giving us a hands on view of how they workout. All too often, the results are far from those projected. That is not to say that today s crop of succession consultants are misleading their clients. Rather, the widespread practice of transferring ownership of independent advisory firms is less than 10 years old. Moreover, in many cases, the application of traditional business M&A models have yet to be modified to fit the peculiarities of advisory firms, especially the recurring revenues streams we have in this industry. In addition, most succession consultants limit their involvement to the creation of the plan, with little or no on-going contact with the firms in which those successions are implemented. Consequently, many consultants never see how their plans actually work out in the real world, nor have the responsibility of fixing any problems those plans often times create. Here s an example of a succession plan that was recently proposed to one of our clients, which illustrates many of the inherent flaws that we encounter in such plans. The sole owner, in his early 50s, wanted to transfer one-third of his firm each to his two junior advisors over the next 10 years, and eventually the remaining 1/3 when he is closer to retirement. The succession expert valued the firm s current $1 million in annual fee revenue at roughly $2.5 million, based on a multiple of factors, including the assessment of the client base, firm s future prospects, and the current market value of similar firms. Assuming a 5% annual growth rate, he then projected the firm to be worth about $4 million at the end of the 10-year period. The application of traditional business M&A models have yet to be modified to fit the peculiarities of advisory firms. So far so good. However, the key issue in any succession plan rests on answering the question Where does the money come from to buy the firm? In the vast majority of cases, the junior partners don t have a couple million dollars stashed away; and to date, banks have been understandably unwilling to lend millions to firms whose sole revenue sources are client assets that could walk across the street on a whim, or disappear in a market downturn. (At present, we are also witnessing that many banks increasingly see independent advisors as competition for their own investment management units.) Part I: Introduction THE CHALLENGE OF SUCCESSION 11

12 In our example, as is common practice in internal buyouts in many service industries, the consultant s succession plan called for the firm to lend the junior advisors the funds required to purchase equity up front. Under the arrangement, they were required to pay the loan off in yearly installments, out of increasing profits from their ownership stakes. In this case, at the end of the 10-year period used in the estimates, the plan projected that they d own their 66.7% equity free and clear. Unfortunately, to finance this buyout, the consultant looked to the owner-advisor to reduce his compensation from his current $400,000 per year to an annual average of $270,000 over the 10-year period a total of $2.7 million, instead of the $5.5 million he would have received from his current salary and profit (at the projected 5% annual growth rate). [WORD OF ADVICE: If a succession plan requires the firm owner to significantly reduce his/her compensation to make it work, it is the first indication that it is not viable.] The owner was, however, projected to receive an additional $2 million in payment for the 2/3 equity in his firm; bringing his total take to $4.7 million which still leaves him $800,000 short in cash flow. In addition, in return, he gave up 2/3 of a firm valued by the consultant at $4 million by the completion of the plan, or $2.7 million, bringing the total projected cost to the owner for selling the majority of his firm to $3.5 million (Figure 1). Of course, the consultant s spreadsheets did not present the case quite this way so negatively. Figure 1: The Cost of Succession Here s how one owner-advisor would have fared under the proposed 10-year succession plan. No Succession Consultant s Owners Gain/ Succession Plan (Loss) Annual Compensation $5.5 Million $2.7 Million ($2.8 Million) Owner s Equity $4.0 Million $1.3 Million ($2.7 Million) Payments for 2/3 Equity $0 $2.0 Million $2.0 Million 10-year Totals $9.5 Million $6.0 Million ($3.5 Million) Assumptions: valuation at 2.5x annual revenue, 5% annual growth rate, 4% interest on note, and 66.7% buyout over 10 years. Part I: Introduction THE CHALLENGE OF SUCCESSION 12

13 Part II: Bad Advice THE FLAWS IN CONVENTIONAL TAKE 2: The transition of independent advisory firms presents numerous challenges that rarely have easy solutions. The above example illustrates many of those challenges, which led the consultant to propose what we deemed an unacceptable solution for our client. It was based on limited financing options, too short of a timeframe, low annual firm growth, lack of appropriate incentives, and too much focus on firm valuation. It is important for owner-advisors to understand each of these potential obstacles before they embark on a succession plan, so that their strategy can include workable solutions for each one. Over-focus on valuation. This is a mistake made not only by many firm owners, but also by a surprisingly large number of junior advisors (which we ll discuss in detail in Part VI). The succession plan described above is a classic example of how an owner s attention can be drawn to the valuation of the firm projected to be $4 million, in that case and away from the actual deal terms and their potential consequences. While the buyout value of the firm is certainly a factor in a succession, it s not nearly as important as many buyers and sellers seem to think. First, as we ve seen, unfavorable deal terms can render any valuation a moot point. Second, as we will see below, the key to virtually every successful advisory succession is firm growth, as it provides the capital to finance the buyout, and controls the time it will take as well. Growth also controls the firm valuation the greater the growth, the more the firm will be worth. Consequently, firm growth creates an incentive for the owner to keep working hard, and for the junior advisors to maximize their contributions to the success of the firm. By focusing on valuation, rather than the far more important deal terms and incentives to grow the firm, both owners and junior advisors can lose millions of dollars. Moreover, it may take years to make the transition of ownership, and even jeopardize the succession itself. The wrong incentives. If our experience working with independent advisory firms and other businesses has taught us anything, it s that people will tend to do what they are incentivized to do. Additionally, the actual incentives in a given situation are often not those intended or even obvious to the parties involved or the experts. The example described above is a case in point. As in every succession plan, the key to success is the growth of the firm, even if projected at a modest 5%. The firm still has to grow 5% every year, for 10 years, for these projections to work out. Who s going to make that happen? Although, initially, the owner advisor will be the key driving force for growth, over time, the new partners will start to contribute more significantly. Thus, we have to ask ourselves, what are their incentives to grow the firm? In the case above, the owner s compensation Part II: Bad Advice THE FLAWS IN CONVENTIONAL 13

14 will be reduced, and he ll essentially give away two-thirds of his firm. Perhaps not right away, but soon, he ll realize the reality of the situation, and chances are that he will lose motivation to contribute to the firm s growth. While this is an extreme example, the point is that, without significant financial motivation to grow the firm, the junior partners may not get as much help from a senior advisor approaching retirement, as they need to meet the plan s growth projections. Although junior partners often do have the motivating factor of buying out the retiring partner sooner rather than later, if their compensation increases too soon, it can have a dampening effect on their motivation, particularly in the early years of plan implementation, when generating firm growth is most important. In our example, the expert recommended that the junior partners annual total compensation increase from $75,000 to $212,000 each. Even though they would have to make equity payments of $60,000, the remaining income would still equate to a hefty 103% annual pay hike. In our experience, with that kind of change in family finances, many employees have a hard time keeping their eye on the goal, especially when that goal is a decade away. Lack of financing options. As noted earlier, this is the major challenge for virtually all internal succession plans. In the above example, this was the problem the consultant was attempting to solve, however unsatisfactorily. Due to the understandable lack of outside financing options, unless owner-advisors are willing to virtually give their firm away to their junior partners, there are only two viable options, which can be combined into a successful succession plan financing the acquisition out of the growth of the firm, and lengthening the time allocated for the transition of ownership to occur. Unrealistic assumptions. Again, in the case above, at the consultant s projected 5% growth rate, a 10-year transition was unworkable. As Figure 2 shows, even with owner compensation Figure 2: The Power of Time Adding four more years to a succession plan dramatically improves the economics. Jr. Partner s 50% of Total Equity Difference Difference Profit Share Jr. Partner s Payments at 100% at 50% Profit Share to Owner Yr. Succession $2.2 Million $1.10 Million $2.5 Million ($300,000) ($1.4 Million) 14 Yr. Succession $3.9 Million $1.95 Million $2.9 Million $1.0 Million $950,000 Assumptions: valuation at 2.5x annual revenue, 5% annual growth rate, 4% interest on note, and 66.7% buyout. Part II: Bad Advice THE FLAWS IN CONVENTIONAL 14

15 held constant, the junior partners cumulative profit share (at 67% of the firm profits) of $2.2 million still fell short of the $2.5 million principle and interest (at 4%) they owed for their equity stake. A workable succession plan would rarely have the junior partners pay 100% of their profit share for the equity. Most workable plans would at best have the junior partners pay 50% of profit share, which would, in this case, leave a deficit of $1.4 million. To finance this deficit, the consultant decreased the owner s income. Consequently, the owner was paying for his own buyout. However, a 14-year transition would allow for $3.9 million in bonuses, which is more than enough to pay the owner in full ($2.9 million), even at the 5% growth rate. This is a perfect example of how a small change in plans can have serious consequences. Because firm growth compounds annually, adding just a few more years to a succession plan can yield dramatic increases in the payout to the owner(s). When it comes to succession planning, firm owners need to start early, providing time for growth to underwrite the buyout. Moreover, by tying junior partners to the firm, they eliminate turnover, which can be disastrous to any plan. As previously noted, firm growth remains the real driving factor behind any internally financed succession plan. In our example, the consultant projected a 5% annual growth rate, even though the firm actually had been growing at 17% a year for a number of years. As Figure 3 illustrates, a 10% annual growth rate over the next 10 years would provide the junior partners enough funding in annual bonuses to pay for their 2/3 stake in 10 years ($2.4 million). In addition, the owner-advisor would have taken home another $5.6 million in compensation. Figure 3: The Power of Growth Increasing annual firm growth from 5% to 10% also dramatically improves buyout economics. Jr. Partner s Total Equity Difference Difference Profit Share Payments to Owner at 100% at 50% % Annual Growth $2.2 Million $2.5 Million ($300,000) ($1.4 Million) 10% Annual Growth $4.7 Million $2.5 Million $2.2 Million ($150,000) Assumptions: valuation at 2.5x annual revenue, 5% annual growth rate, 4% interest on note, and 66.7% buyout. Part II: Bad Advice THE FLAWS IN CONVENTIONAL 15

16 Part III: A Better Way THE ELEMENTS OF A SUCCESSFUL SUCCESSION TAKE 2: As every succession is different, there are no templates or turnkey solutions. Still, there are guidelines that show owner-advisors what to prepare for. Because financing is the key to an internal buyout, and growth is the key to internal financing, the key to a successful succession plan is to substantially growing the firm. Through our on-going experience with succession planning and overall management of independent advisory firms, we ve found that, to achieve the growth needed to underwrite an internal buyout, a succession plan needs to contain four key elements: Right incentives to grow the firm; Time to adequately compound that growth; Proper preparation of junior partners for driving that growth, Support for all the firm s employees in contributing to that growth. Here s how we put all four together to create a solid succession plan for the firm in our example. To make the above succession work, first, we extended the period of the buyout from 10 to 14 years, to allow time for the firm s growth to finance the full value of its equity. Next, we restructured the deal to create better incentives for growth. We continue to pay the owner s current compensation of $400,000 a year, by adjusting his salary downward as his share of the profits grows. (In our view, it is unfair to expect the owner to take a pay cut. Thus, by keeping his salary constant, we let the growth of the firm pay for the succession.) We also kept the junior advisors at their current base salaries and revenue-based bonuses, but increased their profit participation in line with the growth in their equity share. Half of those profits are used to pay the owner for their equity each year. That way, the employees receive steady raises every year and bonuses based on firm growth with their take home compensation doubling by the 6th year, and continuing to grow (reaching $300,000 once their equity is paid off). Even at the expert s growth assumption of 5% a year, they will pay off their two-thirds of the firm $3.3 million in 11 years. At that point, the owner will have received $6.1 million in compensation, as well as the additional $2.4 million for two-thirds of his firm, a total of $8.5 million. To get the junior partners on board with this plan, we ran multiple growth scenarios and stress tests to increase the owner and junior partner incentives to maximize growth. The preceding compensation and payout was projected at the consultant s 5% annual Part III: A Better Way THE ELEMENTS OF A SUCCESSFUL SUCCESSION 16

17 revenue growth rate. With the firm currently growing at 17%, we thought it was reasonable to look at what impact 10% annual growth would have on the plan (as we did in Figure 3). Based on our analysis, the junior partners would pay off the note for their equity in just 10 years, at which time, their full partner compensation will be $340,000 per year. The owner not only receives a total of $5.6 in comp, but also the $2.5 million for sale of his equity. This creates substantial incentive for both owner and junior partners to contribute to the growth of the firm. If the firm were to continue to grow at 17%, the buyout period would decrease to 7 years, which further motivates all parties to pursue this goal. Part IV: Designed to Grow CREATING GROWTH TO FUND SUCCESSION While the growth projections discussed in the previous section may appear recklessly optimistic to some (and indeed, for many firms they would be), we were comfortable with our plan because the firm in this example had previously implemented two additional strategies to maximize its growth potential. More importantly, its performance was a confirmation that they were working. Many advisors and so-called industry experts seem to believe that the key to achieving growth in an advisory firm is attracting new clients. While an expanding client base is obviously important, over the years, we ve found that rainmaking, as it s called these days, is more often a result, rather than the driving factor. Instead, in our experience, the biggest growth challenge for most firms is capacity, i.e., the ability to handle the additional workload that attracting, on-boarding, and working with new clients entails as well as giving senior advisors the time to be rainmakers. To create the capacity to handle additional clients, we worked with the advisory firm in our example (and our other clients, too) to prepare the junior partners to make substantial contributions to the growth of the firm by training them to work directly with existing clients, thereby leveraging the firm owners to bring in more new business. At the same time, our owners were advised to implement strategies to support and incentivize every employee to contribute to the firm s growth. Most firms today use their associate advisors to leverage their lead advisors. We believe this is a mistake for three reasons. First, inexperienced younger advisors are usually not equipped to take most of the busywork off lead advisors desks, such as filing, client data entry, application creation, and scheduling. Instead, Part IV: Designed to Grow CREATING GROWTH TO FUND SUCCESSION 17

18 those jobs are far better handled by trained and experienced client services staff. Secondly, professionally educated and careeroriented young advisors are rarely motivated to perform those jobs that even they can see would be better handled by someone else. They entered the industry because they like people which entails working with, talking too and helping people. Clerical type functions usually don t offer any sort of excitement for these young associates and often defeat the goal of their chosen profession. In fact, we believe this is the #1 main reason for the excessively high turnover rates among younger advisors in many advisory firms across the country. Most importantly, performing the predominantly clerical tasks that leverage lead advisors does very little or nothing to train young advisors to become lead advisors themselves. Finally, while leveraging lead advisors can help a firm attain limited growth, the level of growth necessary to finance a succession plan can only come from adding new lead advisors capable of working with new clients. Our organizational structure for training lead advisors is called Diamond Teams, in which one associate advisor works with two lead advisors and a senior advisor (as illustrated in Figure 4) to service a segment of a firm s clients, or in the case of a smaller firm, all the firm s clients. This structure enables firm owners and senior advisors to devote special attention to key clients, while giving them more time to devote to bringing in new clients. More importantly, the Figure 4: Diamond Teams TM Lead Advisor Senior Advisor Associate Advisor Lead Advisor primary job of the associate advisor in a Diamond Team TM is to sit in every client meeting of the team s lead and senior advisors. This exposure brings ample opportunities for listening, taking notes, and watching how lead advisors work with clients. Moreover, the associate advisors benefit from getting to know the clients themselves, and seeing how financial plans and investment portfolios are presented, how questions are answered, and how client problems are addressed and solved. Typically, after two to three years of this kind of hands on experience, firms find that their associate advisors are truly ready to start working with clients, and are well on their way to becoming productive and effective lead advisors working with clients on their own and eventually becoming owner-senior-advisors. Diamond Teams also provide a path for the firm to grow. When lead advisors are ready to take a greater role in recruiting more clients and management, they can split off to form their own Diamond Team, supported by two lead advisors, and associate. Alternatively, they can assume the senior advisor role in their existing team, freeing up the owner/advisor to focus Part IV: Designed to Grow CREATING GROWTH TO FUND SUCCESSION 18

19 TAKE 2: exclusively on rainmaking and managing the firm, as a step toward transitioning out of the firm altogether. The associate advisor, in turn, moves up to the position of lead advisor, and the firm hires another associate advisor. The growth potential of Diamond Teams is substantial. Our research shows that one four-advisor team can work with 225 to 250 clients with an average of $200 million in AUM. In other words, one team can often generate $1.5 million to $2.5 million in annual revenue. (Depending on the level of client service provided and the service model the firm employs.) Finally, as we have seen Diamond Teams produce much more, it is evident that the addition of one or two more Diamond Teams to a firm over a 10-year period can create quite a boost to the growth of the firm. Part V: P4 Principles MOTIVATING EMPLOYEES TO HELP GROW THE FIRM As previously noted, firm owners can implement another important strategy, with the potential to dramatically increase growth supporting their nonprofessional employees and motivating them to contribute to the success of the firm. Firms prepare their employees to succeed by linking a significant portion of their compensation to the success of the firm, creating a flexible and supportive work environment, and supplying the tools necessary for employees to excel at their jobs. We call these the P4 principles. They are simple, and can be implemented easily, once firm owners come to terms with the fact that it s largely their actions not recruiting or those of the employees themselves that determines their employees contributions to the success and growth of their firm. These four principles are described below. Preparation. Firm owners need to create a firm culture that fuels passion, purpose, growth, and happiness in their employees. Then they need to give employees the basic knowledge to work within that culture how to communicate, to ask questions, to learn to do their jobs their way. What s more, owners need to communicate their own passion for their business to their employees why what they are doing is important to the firm s clients and customers, and why each employee s role is important, too. Pay. Our research and experience has shown that perhaps the single most powerful employee motivator is a clear link between a portion of their compensation and the success of the business. The best way to implement this strategy is through revenue-based bonuses. Compensation rewards that increase as the firm grows creates Part V: P4 Principles MOTIVATING EMPLOYEES TO HELP GROW THE FIRM 19

20 a sense of ownership and, equally importantly, trust, which is essential to maximizing employee contributions to a firm s growth. Perks. There are many benefits that employers offer to employees, ranging from medical, through retirement, to lifestyle benefits. However, according to our research, the benefit that really motivates employees is creating a flexible work environment that can be tailored to each employee s needs and optimal work habits. For little or no cost, a firm can create unique and useful flexible policies that can be almost priceless to an employee, while sending the message that their individual needs and creativity are important to the firm. Productivity. There is probably no stronger message that a business can send to its employees than the quality of the tools it provides to help them excel at their jobs. Today, that usually means technology. The cost of cutting edge technology is minimal compared to the way it will make employees feel about themselves, their jobs and their firms. Implemented together, the P4 principles train, equip, and motivate all the firm s employees to make maximum contribution to a firm s success and to its growth. The employees, in turn, feel valued and become a major factor in creating the growth levels necessary to fuel a successful succession to the next generation. Part VI: Don t Forget the Successors FULLY UNDERSTANDING THE ROLE OF JUNIOR PARTNERS While the key to any internal succession plan is firm growth, as we mentioned in Part IV, after a plan has been in place for the first couple of years or so, the challenge of driving that growth will fall on the junior partners. In fact, the entire succession will depend on their ability to assume the roles of senior advisors. They will be expected to provide the highest levels of client service, form solid relationships with the firm s existing clients, and attract new clients to the firm. Yet, surprisingly, many firm owners fail to fully appreciate the essential role that their junior partners play in any succession. In his recent industry report Brave New World of Wealth Management, Mark Hurley and his colleagues at Fiduciary Network list four primary non-economic hurdles to wealth managers completing acquisitions of other firms. The fourth hurdle is titled Buyers and Sellers underestimate the degree to which wealth management deals are three-handed. Part VI: Don t Forget the Successors FULLY UNDERSTANDING THE ROLE OF JUNIOR PARTNERS 20