Succession planning has moved to the top of the practice management priority list for tens of thousands of advisory firms. As the average age of founder/advisors creeps ever closer to traditional retirement age, the profession is asking itself a lot of hard questions about how to keep these businesses alive – and take care of clients – after the founder retires.
These questions were everywhere at the recent Insider's Forum conference in Dallas. In the opening keynote presentation – a debate between Mark Hurley of Dallas-based Fiduciary Network and Insider's Forum co-producer (and author of this article) Bob Veres – Hurley told the audience that the vast majority of advisory firms were not viable companies, and had zero transferable enterprise value. Yet many successors are paying for ownership at rich multiples.
In a breakout session the next morning, Deena Katz at Texas Tech University and Cheryl Holland of Abacus Planning Group in Columbia, SC gave a presentation on how advisory firms could compete effectively for an alarmingly small pool of younger advisors. This, they said, was becoming a high practice management priority, since some observers think the number of incoming advisors is inadequate to replace the number of advisor retirees over the next 10 years.
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In a later breakout session, Philip Palaveev, of The Ensemble Practice in Seattle, offered guidance on how to create a multi-partner firm, and talked about how that business structure simplifies many of the thorniest succession issues. Merger/acquisition consultant David DeVoe of DeVoe & Co. in San Francisco, Greg Friedman of Private Ocean in San Rafael, CA and Tim Kochis of Kochis Global (formerly of Aspiriant) continued the discussion by defining the formula for successful mergers (which, ironically, Hurley had earlier declared to be virtually impossible for advisors to consummate because of their negotiating naiveté).
At the end of the Insider's Forum conference, a panel discussion featuring Ross Levin, of Accredited Investors in Minneapolis, Marjorie Fox of Reston, VA-based Fox, Joss & Yankee, and Joe Sheehan of the Moneta Group in St. Louis, explored the challenges that founding advisors face when they transition leadership and control to the next generation.
Interestingly, most of what you read and hear about these complex succession issues – including much of the material in the aforementioned sessions – is told exclusively from the perspective of the founding advisor. How do you select your successors? How do you train them to do what you do? What are the qualities of leadership you look for? How much equity should you sell them, at what pace, at what price?
One of the most talked-about presentations at the Insider's Forum meeting turned that perspective around, and provided an eye-opening look at all these succession planning issues from the successor's side of the table. I moderated a panel discussion that was supposed to feature Casey Bear, the successor and COO at Cranbrook Wealth Management in Troy, MI, Jay Hummel, COO of Lenox Wealth Management in Cincinnati, and Eric Hehman, CEO of Austin Asset Management in Austin, TX.
As it happened, Hehman had to cancel his appearance due to a family emergency. What follows is a combination of what was said in the presentation and an interview that took place two weeks before the conference. Together, they opened up a window into how a lot of important succession planning issues look to the successors: advisors who are either taking the reins now, or who will be running the profession's thousands of advisory firms in the relatively near future.
At the end, they offered some great advice for both founders and successors as they work through the succession issues.
And here's the most interesting part: the biggest and most important challenges they face have nothing to do with deal terms, equity sharing or valuation.
Founderitis
One of the most complicated issues that successor advisors have to navigate is what Hehman called "Founder Syndrome" or "Founderitis." The term is attracting its own body of literature, but it can be loosely defined as situations where the personal identity of the founder is tied to the business, and to being the authority figure there.
In the financial services universe, Founderitis manifests itself in two different parts of the founder/successor relationship. You can often spot future successors among the newly-hired advisors as the ones who immediately look for ways to make their firm more efficient and professional. But in many cases, for no visible reason, their suggestions fall on deaf ears.
Hehman came into the planning profession with a degree in business economics from the University of Texas at Austin. At the time he was hired, Austin Asset Management was a solo practice led by a charismatic founder who attracted clients through his local radio show. Hehman suggested what he thought were obvious steps to turn the practice into a business, and was puzzled when his suggestions were summarily rebuffed.
"John Henry [the company founder] would explain to me that this is how we have done things, and it has worked in the past," said Hehman. "It took me a while to realize that every time I proposed a change, it was being received as a criticism of how he was running things. If we were ever going to move forward, I was going to have to reassure him that I wasn't going to discard everything he had ever done, and dismiss or discredit all of his contributions and management decisions of the past."
Hummel gives Lenox a set of management credentials that are rare in the planning world. A former Deloitte consultant, he had helped the Procter & Gamble organization reorganize after its acquisition of Gillette, and in his spare time helped bring the firm into compliance with the new Sarbanes Oxley legislation.
Reorganizing a Fortune 500 giant turned out to be a minor challenge compared to navigating the psychology of successful advisors in their transition years. "When they ask you to lead the firm," Hummel said, "nobody tells you that you have to do it in a way that is very respectful to the people who built the company, and that you have to be careful not to step on their toes as you go through that transition. The founders gave up a large part of their life to build a very successful business," he added. "The most difficult part of taking over leadership turned out to be the emotional component that was tied to those sacrifices."
Even simple issues like replacing software or changing the way the departments are organized raises invisible questions that the successor has to be able to see floating in little bubbles above the heads of the founders. Do I really want to let go of the systems I built and am comfortable with? If we make the change, does it mean I'm admitting I was wrong in the first place?
"What was really challenging to me," Bear said, "is that it all looks so pragmatic and obvious on paper. Here is where we are, here are the issues, here is where we need to go. I feel like I could have gotten there in six months."
As a former tax attorney who left a successful advisory practice (and gave up his partnership shares), Bear found it difficult at first to understand why the founder at his new firm wasn't signing off on his efforts to build a more solid organizational structure. "I finally figured out that you have to balance change with the emotional issues of the founder," he said. "Every suggestion has to be framed so he doesn't think you're putting him down."
This is more than just resistance to change that you often encounter with older adults; Bear ties it directly to the founderitis concept. "He had so much pride and emotion in what he had built, and I was coming at him with data and facts and projections," he said. "You have to give the founder some praise and be careful not to talk down about what he did," he added. "It had nothing to do with the analytics of it, or what vendor we are going to use. It was all the softer emotional stuff of me trying to find a way to demonstrate the value but not put him down or insult what he had built over the last 25 years. Once I did that, in the next 12 months we just blew through everything."
In other words, the successors had to get better at messaging when they communicated with the founding advisors. "The phrase that I used with John Henry is: you blazed the trail; my job is to pave it," said Hehman. "I have seen the gravel, and I know where it is, but it is real bumpy and dusty, and we need to get some pavement on it, so we can actually run a smooth operation across this road. For whatever reason, that clicked with him."
Hummel phrased it differently. "I talked about digging a mine," he said. "The coal miners dig, and then they put supports up behind the digger. If you just keep digging, you're going to end up collapsing the mine."
Founderitis and retirement
Founderitis can morph into an existential crisis when the founder begins easing out of the business into retirement.
"Who is the founder outside of this identity that is part of the firm?" said Hehman. "They gave up everything to start this business. Their social connections are tied to the business, for decades their energy went there and nowhere else, their family outings were cut short because they were working on weekends or making sales calls in the early days of the business. Suddenly the succession issue is staring them in the face, and they look up, and the business is all they have."
Hehman says that when succession became an active discussion, he spent more energy on this unseen issue ( "I am scared to not be in charge any more. If I'm not, who am I?" ) than anything else. "Where the rubber met the road for us," he said, "was: okay, so what am I doing on Monday if I'm not sitting in the corner office? What am I doing on the first of October when I don't have to be in a client meeting? How do I feel about that?"
To make matters more complicated, said Bear, the founder can see the business as one of his/her children, as the legacy. "In a lot of cases, they might be willing to step away from the day-to-day duties," he said, "but they still want to have some control over how the firm is managed, what it does, how the clients are taken care of."
How do you address these issues? Hehman said that in many cases, the successor has to help the founding advisor paint a picture of what retirement is going to look like, and help define the steps that will lead from here to there. "We can usually do that better than they can do it themselves," he said, adding that founders tend to think of their involvement as all or nothing, as sitting on the throne or banished from the kingdom.
"A lot of our tactical work revolved around: how are we going to transition these clients?" he said. "Will you still have to be in meetings in three years? How are we going to make it so we don't have to worry about you creating clients for us?"
Hummel added that it's important to have a role description for the founders who are phasing out their involvement with the firm. "It can be titled whatever you want," he said, "but when the people staying around are watching the founder do a little bit less, you want them to still be respecting the contribution that is being made. I think it helps to have that discussion of: here is the value that you are still bringing, and be able to articulate that to the organization."
In many cases, he said, painting that picture of the next career phase, and creating that role, is not complicated. "They're the ones with the relationships, he told the audience." They have sat at kitchen tables and brought in many of those clients. I want them to come into meetings and feel like they can stop by the office and continue to build the relationships with the clients."
Ideally, the transition gives them a chance to shed responsibilities they never asked for in the first place. "They should be doing what they love," Hummel added. "They love helping people. They love seeing their clients. They love being connected with them on a personal level. And I think creating a role for them to be able to maximize their time doing it – I find immense value in that, as we think about our company in the future."
Founderitis can show up in another context: the founding advisor often feels somehow incomplete as he or she is phasing out, that there isn't enough gratitude among the people who are taking over the firm he or she built.
Hehman addressed this is an especially creative way. "One of the very first documents I ever put together for John Henry, almost seven years ago, was something called 'Celebrating Success,'" he said. "It was a document full of all the great things that he had done, that the business had accomplished, as a way to show him that I care that he has been in this role and he has sacrificed so much."
This helped the transition process, but there were still issues to be resolved. When Hehman took over the CEO role, he also took over the founder's large corner office. "We had a meeting scheduled, and he came into my office, which used to be his," said Hehman. "And it physically affected him to know that I was in the office that used to be his. We had to stop and talk about it. A conversation like that," he added, "is much harder to work through than: how do I solve the numbers and how do I create the spreadsheets?"
Return on ownership versus return on labor
Speaking of numbers, the successors believe that the transition becomes much easier for the firm as a whole if the successors can get the founder to appreciate the difference between compensation for ownership and compensation for the work that is actually done. "I get a call every three to six months from somebody who tells me, my owner is gone for two months, somewhere abroad, and I am supposed to be here holding down the fort and making the firm profitable so he can earn his 30% profit margin," said Hehman. "That is a challenging spot for the successor to be in."
"If you can separate the compensation for labor from the return on ownership, that whole discussion gets easier," added Bear. Hummel took the discussion back to evolving job descriptions. "We have looked at it and said, what is the deliverable, what are you doing day-to-day, and what are the results you are bringing to Lenox," he said.
Then he looked at the roles that the founders are giving up and puts a value on them. "If you used to be chief investment officer, and I need to pay $220,000 for chief investment officer responsibilities," Hummel said, "then we have to think about your overall compensation, because I have to replace that function. We can't afford to pay you, even if you are the founder, for a role that you are not doing. And I need cash flow to be able to replace you. I think," he continued, "if you can get to the concept of: what skills do we have to replace on the open market, it really helps the conversation."
At Hehman's firm, the reward for doing the work and for running the firm had been commingled for so many years, it was hard to unravel. "I had to say: look, if we're going to scale down your client involvement," he said, "and scale down your responsibility to the firm, then over the next three years, we are going to cut your pay by 50% so that I can afford to engage other people in management roles so they can do the things that you won't be doing."
At the end of those three years, the founder had no client responsibilities and no rainmaking function. "He comes to quarterly meetings and sit on several boards in town, and functions as a card-carrying member of the firm," said Hehman, adding that the founder is also able to take two-month vacations away from the office.
Bear warns that the successor can't take this concept too far. "I don't think you can say to the founder: you need to cut your salary so that I can have more," he said. "That is a different conversation. I think you have to balance the founder's economics with the initiatives you want to pursue. If you come in and ask for a bloated salary, and you don't bring in business, and the first things you want to do are two $50,000 projects and a $75,000 project, and that money is coming right out of his compensation in order to grow the firm and your share of it, he isn't going to like you at the end of year one or two. We are able to make investments that are not coming out of his pocket.
"For us," Bear added, "we had to create a situation where the firm is able to pay me, and some of these investments that we are putting back in the firm, and the founder will still make more money than he did four years ago."
Different roles in different eras
One of the biggest challenges for successors is that many founding advisors have the unspoken belief that, if a successor is going to take over the firm, he or she must first go through a rite of passage that includes the most painful, difficult experiences that the founders did.
"I get really tired of hearing about how people were cold-calling to start the business," said Hummel. "Don't get me wrong; I have a lot of respect for people who did that. I appreciate the huge risks that the founders took to go fee-only, to go independent, to break away from the brokerage environment. I know that they worked very hard to get there, that they had to put in 60-hour weeks for years, and all the sacrifices that entailed.
"But," he continued, "that doesn't have any bearing on what the firm needs me to do now, or how to build the future value of the firm going forward. People in our age demographic are bringing a different skill set to the company, because it is needed. I could never cold-call as well as our founding group. But they won't manage the firm the way I manage the firm. The company needs different skill sets now as it grows and matures, and everyone around the table has to respect that."
Bear ran headlong into this mindset at his predecessor firm. "I was the youngest of three partners at a firm before I took the CEO role with my new partner," he said. "And one of the top three reasons that I left was the majority owners started their business cold calling in the 1980s, and there was always this tension that I never had to do that. There was this tension: you make way too much money, you never had to make cold calls, and they could never get past that. I went to law school," Bear said. "I developed a skill set. I brought in clients. I did different things than they did, and I don't want to be put in an inferior position because you hated 10 years of cold calling so much."
Hehman said that his founder had a lot of trouble with the fact that he had never been a salesperson, had never had to fight against the insurance industry or bring in business when there was no firm, no presence and no footprint in the market. "I had to show him what the needs of the business are now versus what they were 10 or 20 years ago," he said. "But in the meantime, I felt like I had to prove over and over again how the needs of the business had changed, to where it actually was clear to him: your best investment in me is for you to benefit from me managing this thing."
Bear suggested that successor advisors address this issue directly, even if it is never articulated by the founders. "You can say to them, as I did: It is not that we don't respect what you have done," he said. "It is not that there is not a tremendous amount of value in what you did. But remember that you have been compensated for it along the way. These decisions you made, these actions you took 20 or 30 years ago have created a nice lifestyle and a valuable business. The successors don't want to be captive to your experiences when you were in the early stages of your career. Our careers and our circumstances are different."
Value measured by work product
One of the most interesting issues that the successors brought up was a genuine generational difference in how founders and successors measure the value they bring to their clients. In the early days, advisors were astonished that people would pay them for advice; they felt like they had to produce textbook-sized financial plans to justify their fees. The huge binders are gone but the mindset continues in detailed plan documents.
Younger advisors take it for granted that the work product is the advice, not the binder full of analysis.
"These older generations seem to love paper," Bear told the Insider's Forum audience. "When they are at a desk and typing, and producing work product, that is how they define value. My partner will put a four-page something together, and he'll say: what do you think of this? I'll say: it's good, a little wordy, but let me show you what I would do. And I set it on the other side of the desk, pick up the phone and say: Hi, Dr. Smith. I talk to him for two minutes, and he has my recommendations. My view," he added, "is that these long documents don't generate a ton of value to the client, but they do make the advisor feel important."
Hehman will address this issue with a simple question. "We have a good enough relationship now," he said, "where I can say: is that about the client, or is that about you?"
Transfers of ownership
By now, the reader is wondering – as many Insider's Forum attendees were wondering late in the panel discussion – when, if ever, the conversation is going to get to all the things that most succession planning articles and speeches focus on: the financial stuff. How do you value the shares that you're selling to your successor advisors, and what does that transaction look like from their side of the table?
The first thing to understand about the successor's perspective is that many of the industry standard internal studies that you read about are seriously flawed.
"I think many founders think they can have everything," said Hummel. "I get a successor group, I get a lifestyle, I get to keep my compensation the same, and I am going to maximize the equity value of my company in the sales transaction to my successors. You cannot," he said, "do all of that at the same time."
Bear agreed. "I honestly think that if you are 100% committed to maximizing the value of your practice, then you should sell to an outside buyer," he said. "But if you want that legacy, then you will have to provide a discount when you sell the firm."
Hehman offers a view of actual numbers from his side of the table. "Younger advisors have called me and said: my company is giving me a chance to buy in," he said. "I say: what are the terms?
"They want me to buy in at 2.65-times earnings.
"Are you kidding me? And you've been there how long? What percent are they going to sell you?
"Two percent.
"There is absolutely no reason for you to do that."
Bear was even more forceful on the subject. After appearing in a panel discussion at a national conference a year ago, he fielded similar phone calls. "I had to say to them, your $140,000 is giving you nothing," he said. "You have no say, there is no succession agreement, nothing behind this except a 70-year-old guy randomly walking down and saying: I'll sell you 4% of the company for $140,000."
As an alternative, Bear offered his own succession arrangement. "It started with me saying, why should I have to go to my wife and say: honey, we are going to spend $200,000 a year of after-tax income to buy illiquid unmarketable shares of a company in which the founder can do whatever he wants. I don't want to arrive at age 55 with $320,000 in a 401(k) owning 80% of his business."
The alternative? Bear and his founding advisor partner have frozen their salaries, and have a phantom stock arrangement where they split the profits, with more of the profits going to Bear every five years. He calculates that this arrangement will make him independently wealthy by age 55, and capable of retiring just as he would advise any of his clients. In 12 years, the agreement calls for him to buy the firm for one-times total revenues.
Isn't that a pretty big discount? "That is total firm revenue, which includes my clients that I brought over, and all of the clients I acquire between when I started and then," Bear explained. "If you run it as buying just his clients, then the multiple looks more generous."
On a spreadsheet, with the growth of the firm, and its increasing profitability, the founder continues to make a higher income each year through his 70s, which generates more total dollars, on a net present value basis, than if he were to sell the firm at a generous multiple today. And he continues to do what he enjoys: meet with clients and help them make great financial decisions.
Is this the model of the future? "It has worked for us," said Bear. "But I think you need the right type of people and the right motivation to make it work."
Hummel has purchased a much smaller percentage of a much larger entity, but he, too, has looked at the deals being offered to successors, and he sees another flaw. "When you look at the math on the book of business," he said, "they calculate a very high retention rate, because no one ever seems to leave these firms unless they die.
"That was true in the last 10 years," Hummel continued. "But in the next 10 years, that is going to change. Simple things like eSignature technology is going to make it easier to switch advisors, and if the belief is that retention is high because the industry retention is high, then way too much of the value is accreting to the owner and founder for bringing the book of business in, and not enough of the value is assigned to the successors who are taking care of the clients every day, and driving that high retention rate in the future."
Advice for founders
So what advice did the panelists have for founders who are entering the succession (or pre-retirement) phase of their careers? "The number one thing to do is make sure you are ready to give up control," said Bear. "I don't know how you test yourself on this," he admitted, "but make a list of what you want to accomplish with this person who is going to succeed you. Are you going to be able to let them do the things that they believe need to be done to make the firm better? If you are not," Bear added, "it doesn't matter who you get, and it doesn't matter what the economics of your deal are; it is going to fall apart. Anybody with an entrepreneurial spirit that is going to come in and be excited about this, if they feel handcuffed, there is no amount of money or equity split that is going to cure the problem."
Hummel added that the tone of the arrangement also matters. Meaning? "I see a lot of founders telling their successors: you should be very thankful that I am giving you the opportunity to buy equity in my firm," he said. "Sitting in our seat, we ARE very thankful. But the tone has to be: we are very glad you are here to be a part of our team. We are business partners. This isn't a charitable transaction. Usually you are hiring that person because they have the skill set you need, because you believe they are going to help you drive your firm. You are not hiring them out of the goodness of your heart."
Hummel added another bit of advice that may shock some founders who are reading this. "The founders have to be careful about the rate at which you leave the day-to-day operations of the firm," he said. "Even if you have a great successor group coming in, you have to be careful as a founder not to say, you have performed really well for the first year; I'm out of here. The succession group, no matter how good they are, still needs the founder around – especially if the company hasn't really integrated systematic changes around the fact that the founder might be leaving."
Hummel's final piece of advice is to pick someone to replace you who buys into a common vision with you. "Personalities really matter," he said. "The reason John [Lame, the former managing partner at Lenox] and the board and I work really well together is I told him the day I walked in, if you want to make this a lifestyle business, if you want to keep the status quo, don't hire me. You're hiring an aggressive Type-A guy who is going to do everything to grow this firm, and we are going to create one of the best firms in the country or I'm not going to stay. You have to make sure that on both sides, you end up in a business relationship where your personalities work, where the long-term vision of the firm is consistent. Otherwise," he said, "I just don't see how it can work.”
Bear offered a last piece of advice: be sensitive to the risk that the successor advisor is taking when he or she takes on partnership responsibilities and makes a financial commitment to the firm. "When I left the old firm to join the new one, my wife was pregnant with our first child," he said. "It added a lot of uncertainty into our lives."
Advice for successors
What would the successors tell their peers, who are moving into leadership and ultimately ownership roles at their firms? Bear echoes Hummel's advice in reverse: don't be too eager to kick the founder out the door. "In our case, we get along, he doesn't micromanage me, and I want him around," he said. "He is a fantastic advisor. The longer he is active in the business, the more profitable the firm is going to be, and the more profitable I will be.
"And on top of that," Bear added, "our arrangement gives me a decade or more to meet his high-end clients, to start working with their kids, to bring in a younger associate and have them start working with the grandkids. So when he does bow out, there is continuity there."
Hehman echoed another piece of Hummel's advice to founders in his recommendation to successors. "Make sure the founder is ready to do what he or she says they are going to do, which is turn over the reins," he said. "I have seen instances where it sounds good, and they say they need to bring in a successor, and they make the hire, and then they have absolutely no intention of letting go of the power to make decisions.
Beyond that, Bear thinks that the best transitions take place when the founder is focused on the right issues. "Early in our discussions, we went out to dinner, and [the founder] said something that really crystallized things and told me that I wanted to work with him," he said. "He told me: I have been fortunate enough to sock a lot of money away, and this business is certainly worth something. But the most important thing to me is I want my clients to be taken care of. I love working with them; I want to continue to do that, and there are four employees who have been with me for 10+ years, and I want them taken care of.”
"We were supposed to get into numbers in that meeting," Bear said, "but he kept coming back to his clients, his employees, and the fact that if he never made another penny, his family would be okay. I said to myself: That is the type of guy I want to be in business with. When you look at that, when somebody is totally client-centric, the profits flow from that attitude."
Finally, Bear recommended that successors pay attention to something that is never discussed in the articles and presentations at most conferences. "Before you agree to some type of succession plan, when you are vetting somebody, look at how they run their own financial life," he said. "If they have not planned for themselves, and they are going to have financial issues down the road, those issues become your issues real quick. And in my mind," Bear added, "there are way too many advisors out there who have highly-profitable businesses, next to nothing socked away, and if they are looking at the business as the way to make up for the shortfall when they retire, I think a big caution flag goes up."
Kindergarten dispute resolution
At the end, after brief discussions about transitioning client relationships from the founder to the firm, and working through differences in communication styles, and the realization that the transition really is 80% or more psychological, Hummel offered his model for resolving the inevitable conflicts between founders and successors. It goes back to a process that many of us learned in kindergarten when we were trying to cut equal pieces of a pie among our siblings.
"A dispute comes up, and we sit down and discuss what is best first for our clients, then for the shareholders, then for the employees," Hummel told the group. "In all disagreements between the founders and the successors, we pretend that we don't know what side of the table we are on, and we talk about the way that we run the firm. When we get to the end, we say: what side of the table would you want to be on? Would you feel you were treated fairly on this side and that side?
"We pretend you are not on this side of the table or that side," he continued. "You don't know what side you are on. You are going to be an independent observer until we are done with this conversation, and then we are going to flip it and see if everybody would have been happy no matter what side of the table they chose to be on."
For many successors, this article may be their very first chance to put themselves on the other side of the table, and see a very different world. The successor panel produced an audible "buzz" at the Insider's Forum conference, a new perspective on the profession's issue of the hour.
Bob Veres'sInside Informationservice is the best practice management, marketing, client service resource for financial services professionals. Check out his blog or subscribe to get the Fee Samples report at: www.bobveres.com.
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