Passing on the baton
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Passing on the baton


Succession planning is a critical aspect of running any business and for financial planners putting an effective plan in place can see the value of your practice increase significantly. Rachael Micallef and Chris Kennedy investigate


After several years of confronting waves of regulatory change as well as market turbulence, the average financial adviser could be forgiven for not having devoted a huge amount of time to implementing a succession plan.

But it is critical to have an effective succession plan in place, especially with practice valuations also having taken a beating over the course of the global financial crisis, to ensure advisers are able to realise the value locked within their businesses.

Forgotten but critical

Business Health director Terry Bell says he is constantly amazed by how few principals have an effective succession plan in place.

“It’s one of those things people put off because they don’t want to do it, or it’s hard or it’s confronting or it’s never the right time,” he says.

The latest Business Health/Securitor Future Ready white paper has analysed more than 300 planning businesses since the previous Future Ready paper was released in 2010 and found the proportion of practices with an effective succession plan has actually dropped.

The paper found that only 29 per cent of practices in the marketplace have a clearly documented succession plan or buy/sell agreement, well down on the 46 per cent found in 2010.

Of those that do have a clear plan, only 53 per cent have a successor who has formally agreed to the plan, and with the average age of practice principals in Australia nudging 60, the decline in the number planning for succession is “extremely disturbing”, according to Business Health.

Mr Bell, however, says the benefits of a sound succession plan are immediate – and that practices with an effective plan are, on average, almost two and a half times more profitable than those with no plan at all.

While this might seem counter-intuitive, it’s a bit like planning to sell your house and giving it a new coat of paint.

“People think, ‘If I’m going to sell I’d better get my business looking better, so I’ll document my systems and processes and I’ll get a database in.’ By doing that, the business boosts its profits in the meantime,” Mr Bell explains.

Before you begin

There are several options when the time comes to move on, but any good succession plan should take into account the long-term strategy of the business.

Sitting down to determine where the business is heading is the first step in forming not only an effective succession plan, but also a long-term business plan.

“That old saying, ‘that you should start with the end in mind’ is a good plan, because in essence to have a business ready for sale is to have a business in tip-top shape,” Elixir Consulting’s managing director, Sue Viskovic, tells ifa.

“It’s important for the long-term planning of the business because you’ll find that if you’re running a really good, tight business, your options for succession are greater,” Ms Viskovic says.

Director of practice sales brokerage Forte Asset Solutions, Stephen Prendeville, agrees that succession planning is generally left far too late and says principals should be re-examining their plans at least every two years – especially since so many sales are forced on business owners by unexpected health or lifestyle issues.

“You want to manage your business [so that] you’re always ready to sell next year,” he says, adding “there a number of things you can do to prepare”.

The most important of these is client segmentation. “The more information you have on clients, the more confidence a buyer will have in what they’re buying,” he says.

Mr Prendeville says that by keeping detailed and organised records of the practice’s entire client base, such as clients’ ages and locations, amounts and types of investments, remuneration ranges and types of employment, a planning business can add a significant amount to its asking price.

“With one business I valued, we put [client segmentation] in place – the financials didn’t change but the business was re-valued upwards by $300,000 because they had that information at their fingertips,” he says.

“The underlying lesson is you must know, intimately, all facets of your business, and be able to showcase that in a timely fashion – particularly when creating an information memorandum when you bring all information available into one spot.”

So what options are there?
Often the preferred option for a principal is to hand over the business to a younger partner or family member who is already familiar with how the practice is run. This isn’t the only option, however, and in many cases there is no viable successor within the business, meaning the principal has to look elsewhere. Generally, this means either trying to sell the practice on your own or through a broker, or looking to the dealer group licensee for assistance.

Internal succession

According to JNP Capital, selling internally can help maximise the return for a business.
“Because of the continuity in internal succession, the risks are potentially lower,” JNP Capital director Jason Phillips says.

“When you’ve worked with a staff member for five or ten years, you’re fairly confident they can run the business or client base and you can potentially feel comfortable that you’re going to get the maximum amount from the business.”

Companies often provide arrangements in which the potential successor receives a share in the equity of the company each year until they have accumulated enough to buy the principal out and take over, according to Mr Phillips.

Hays Group associate director Nicholas Conigrave says this method of internal succession gives companies time to groom potential candidates over a number of years to ensure the purchasing adviser will be a cultural fit for the business.

“Organisations, by their nature, are entities unto themselves; they’re not just collections of bricks and mortar,” Mr Conigrave says.

“Internal candidates understand the nature and the complexity of the organisation and they come with an enormous amount of tacit knowledge which you’re not going to get from an external candidate.”

Mr Bell adds that internal succession is often seen as preferable because there is less perceived disruption to staff and clients when compared to a sale to an external owner.

This is especially true of self-licensed businesses where independence from major dealer groups may have been an attractive point of difference for many clients.

However, Paul Tynan, chief executive of practice brokerage Kenyon Partners, notes that a lack of access to finance can often restrict internal succession. Frequently, a business may have the ideal person to take over but they are restricted by a lack of capital, he says.

External sale and equity partnering

There is sustained demand within the market for quality financial planning businesses, meaning principals will often have the option to find an external buyer should they choose to go down that route.

There are several broking firms that specialise in linking buyers with vendors, and according to some brokers, there is particular demand from institutions. But this, Mr Bell cautions, won’t always be the case.

“A lot of people are sitting out there thinking, ‘an institution will buy me’,” he says, “but I don’t think they will [continue to]. I think eventually they’ll stop.

“They still are at the moment but they’re buying scale to a degree and that will eventually stop. Every acquisition costs money and takes time and brings a resource requirement and possibly a risk.”

For the moment, however, practices under an institution are likely to get some help ‘from above’, according to Mr Prendeville.

“That assistance is seen either in the facilitation of the transaction or the provision of transition services, or financial assistance,” he says.

“That could be a lowering of dealer fees or the provision of additional personnel. The dealer groups are also suffering from lack of growth so they’re doing everything they can to assist underlying practices to grow.”

Some groups, such as AMP-aligned ipac and Countplus subsidiary Total Financial Solutions, offer an equity partnering program. This strategy allows the dealer group to take a stake in a planning business and acquire it over an extended period of time – usually somewhere between three and 10 years.

This allows the principal to remain in the business and usually ensures a smooth transition for staff and clients, although the final acquisition price is usually subject to certain conditions and performance hurdles.

Dealer group succession and buyer of last resort

Advisers whose businesses are tied to a dealer group or bank may also have the option to sell directly to the licensee, while some institutions still have a buyer of last resort (BOLR) option in place.

BOLR options are a guarantee from the dealer group that they will purchase the business from the exiting adviser – theoretically, once they have exhausted all of their other sale options.

Typically, BOLR options value the income rights of a practice business at three times the firm’s annual recurring revenue.

“It’s almost like a safety net for advisers,” Russell Investments’ head of advice capability John Nolan says.

“But what has happened over time is that as advisers are less willing to take on risk and less willing to buy people’s businesses, so over time that ‘buyer of last resort’ [option] has become ‘buyer of first and only resort’.”

With so many options for succession, navigating the sale process can be daunting for advisers and Mr Phillips recommends seeking the advice of a business broker.

His own business, JNP Capital, is an independent business broking and advisory firm, specialising in accounting and financial planning practices, which helps find appropriate purchasers through a process of strategic review, interviews and assessment.

“The process of succession planning varies from one practice to the next,” Mr Phillips says, “so the way I do it is work out what you want to do then we go forward and determine what the best outcome is and what the best terms are.”

AMP’s director of financial planning, Steve Helmich, says AMP benefits from having a strong training academy in its Horizons initiative that provides a stream of willing successors when principals within the network are ready to move on.

“If you’ve got a high number of people coming through that model with the desire to become a business owner, that solves some of the problem,” he says.

The group has no plans to phase out its BOLR arrangements, which Mr Helmich describes as part of the “circle of life” of planning businesses.

“If planners come back to us [when planning for succession], we can help them sell to new planners, or if the practice comes back to us we might split it up and sell it to new planners,” he says.

“They don’t sit idle; they sell fairly quickly, and I think that’s a strength of the academy. We try and match clients to planners and look at the demographics. One of the things that is important is ... to make sure the culture of the new planner fits with the practice they’re going to. We try and do that even in Horizons as they’re coming through.”

Never too soon

It can take years to see a succession plan through effectively, and so it is never too early to start getting organised. The exact timeframe needed for a successful transition, however, varies from business to business.

One of the biggest problems planners face when it comes to succession planning, according to Mr Phillips, is not leaving enough time to see it through effectively.

“You’re not going to do that overnight, some practices might need five years and some might need 18 months,” he says.

“But very few firms have a long-term plan and when they look at business planning they don’t look beyond the next 12 months.”

The type of succession chosen to transition the business also has an effect on the timeframe needed to adequately plan for departure.

With internal transitions there is often a longer period of time need to plan as less senior advisers are trained over a period of years for a leadership role, and also acquire the equity of the business in a staggered fashion.

“In internal succession it might be a five or ten year timeframe where the principals sell down their business,” says Malcolm Arnold, MLC head of client succession.

“We’ve seen owners that may sell down a small 10 per cent share hold in the business over a number of years.”
Mr Arnold says that while external sales often involve a less prolonged timeframe, a warm handover of the principal to the acquiring advisers is common to ensure continuity of the business.

At a bare minimum, Mr Conigrave gives the succession process a timeframe of between 18 months and two years for principals preparing for their departure.

“If you don’t have a ready successor in place and if you haven’t thought about it than you are going to be under the pump to try and find the next candidate,” he aid.

“In these changing times, six months is an eternity if you don’t have a leader in the seat, driving the bus.”

Ms Viskovic agrees that while succession planning can be done in a smaller time frame if the business is in good shape, rushing to sell a practice generally won’t achieve the best possible outcome.

“Certainly from an actual planning perspective, I know some businesses that have made a decision and they’ve just decided they want out and they sell six months later,” she says.

“But arguably they would often find that they could have got a better price and a better outcome for their clients if they had a bit more time and effort in planning their succession.”

By looking at a succession plan as part of a practice’s long-term strategy, owners can get the maximum value from the transition process.

“The most successful succession transactions in my time dealing with planners have been ones that have started on day one, when they set up their practice,” Mr Arnold says.

“If you can do that from day one, you can have a very robust succession plan and can see the business as something that exists well beyond your time as an adviser.”

Valuing a risk business

According both to Mr Prendeville and Mr Tynan, a typical planning practice could currently expect to be valued at around 2.7 to 2.8 times recurring revenue. Due to their more stable, commission-based remuneration structure, however, risk practices are in higher demand and can fetch three times recurring revenue or even greater.

“I’m seeing risk practices transact at 3.3 to 3.5 times [recurring revenue]; the last one I sold was 3.75 times,” says Mr Prendeville.

“The reason for that is the robust nature of the income stream – it has indexed growth, it’s not at risk through [Future of Financial Advice reforms], and it’s not linked to economic or market conditions.”

Risk businesses are usually acquired internally, according to Mr Prendeville, with the underwriter assisting the transition to go to an aligned risk writer, so a lot of the transactions are within the institution or the dealer group or are assisted by underwriters.

Mr Tynan says practices that have moved to fully fee-for-service may be valued lower because there is less of a guarantee over the income stream.

Practices focused on self-managed super fund (SMSF) administration or individually managed account-style investing could be valued much lower, at around 1.5 times recurring revenue, due to the lack of a product margin, he adds.

While the valuation of planning businesses depends partly on how the transaction is being proposed, assets tend overwhelmingly to be traded as multiples of recurring revenue.

Mr Nolan, however, says this type of valuation can often be a shallow assessment of the true value of the business.

“It’s a really crude measure because there could be a horrible business that is mismanaged but generating a million dollars a year sitting alongside a really organised, methodical business that also generates the same number,” he says.

“Now, based on a multiple of revenue, you would write them both the same cheque to buy the business whereas one is clearly more valuable and more profitable than the other.”

Mr Arnold says that when a business is undergoing an internal succession or being sold as a whole it is more likely that the valuation will be based on an earnings before interest and tax (EBIT) multiple.

EBIT valuations provide a greater indication of how profitable the business is and how great a return the purchasing adviser is likely to see.

“From an accounting view it makes more sense to start to look at profit models,” he says.

“Businesses that are generating a better return and making more profit are arguably more efficient, and they will extrapolate more value for the buyers.”

Speed bumps

One of the commoner issues in succession planning, according to Mr Arnold, is access to capital for potential acquirers.

“Certainly a lot of the acquirers in succession transactions that we see tend to be the younger advisers,” he says.

“Their access to capital is generally restricted as their financial position hasn’t matured to where they have lots of assets to their name. So, their ability to raise finance can be problematic.”

Mr Prendeville adds that the reason most sales fall over is that the vendor and buyer are negotiating without a third party and it’s easy to individualise any perceived or actual criticism that occurs.

Having a third party involved keeps the emotion out of it, he says.

“[Vendors] are always questioning whether this is the best deal out there, then asking, ‘Is this the person I should be dealing with?” Mr Prendeville says.

“Where I find parties fall over the most is [when there is no] third party to remove emotion from the transaction, bring market knowledge and give confidence to both parties that it’s the best transaction.”

The principal’s path

While principals may be tempted to look at succession planning as a way to sell their business and ride off into the sunset, the actual value of their practice can form a critical aspect of the terms of sale.

As that value resides in its client base, it is common for the retiring principal to remain involved during a succession transaction to ensure client retention and secure the value of the business.

“There are many succession contracts where they have a staged purchase, so they might pay a percentage on the day of settlement and the balance is paid 12 months later, depending on the retention of clients,” Ms Viskovic says.

“The principal hangs around for a few months and does a handover to the owners, introduces them to the clients and makes sure they get that retention. This way the incoming adviser doesn’t find they’ve paid for something that disappears in a short space of time.”

Mr Arnold adds that the involvement of the departing principal over a long period of time tends to be in ‘staged successions’ to key staff or family, especially in cases where the owner sells down over a period of time.

“We tend to find that when you’re doing the full sale of a business, quite often the acquirer will look for the old owners to maintain some kind of involvement for a very short period.

“That might only be months, to provide a warm handover, but beyond that they want a clean break so they can start changing the business and move on.”

A business with a ‘key person dependency’ on the principal might not be as valuable as one where the clients are instead loyal to the practice.

“What you can find is an increasing number of clients may choose to opt out or not move across to the new owners and that therefore affects the value to the selling adviser,” Mr Arnold says.

An increasingly common trend is for the departing owner to continue on in a smaller capacity as an adviser in the business they have recently sold.

According to Mr Nolan, in the process of building up their business, former owners can sometimes lose sight of their adviser role and selling is a chance to resume that role.

“Advisers on the older end of the spectrum are saying that they just want to work with clients, and if new principals can find a way for them to do just that, they can hang onto that older adviser for another five or so years,” he says.

“I wouldn’t say it’s the most popular option, but its there for savvy young entrepreneurs who are on the look out to hire mature advisers who just want to do the right thing by their clients.”

However, according to Ms Viskovic, keeping the departing principal in the business can frequently be a source of conflict.

“On paper, it’s a really good plan and it can work very effectively, but in practice quite often you have a whole heap of difficulties around that because the exiting adviser hasn’t changed their mindset,” she says.

“[It’s] because their head is saying, ‘I want to retire, I want to get out of this and play more golf’ but their heart is saying, ‘This is the business that I built and we’ve always done it this way’.”

Passing on the baton
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