Why succession planning is harder than it looks

While the lure of succession is very attractive, the reality is that it is a lot harder than it looks

Statistics from Forte Asset Solutions reveal that there are around 5,500 financial planning businesses in Australia and 50 per cent of these will change hands in the next three to five years.

While half will go to trade sales, the other half will be successions. Worryingly, only 12 per cent of practices have succession or exit plans.

This is a concern because, as Forte Asset Solutions director Steve Prendeville says, undertaking a succession is fraught with difficulty, even at the best of times. But the challenges of the current market – in which we may see movement from its being a sellers' market to a buyers' market – are compounding this.

"Succession is intellectually and philosophically really attractive and can look good on paper; the reality is it rarely works," he says.

"As an industry, we are very aware that succession is one of the single largest challenges, aside from the current economic and market environment we currently face."

The transfer downside

Despite the potential for failure, many practice owners continue to investigate succession.

"I've come in many times as a consultant on succession strategy and, unfortunately, I'm the guy that's wearing the black hat," Mr Prendeville says. "I've killed more deals than I've made deals and it's simply because you start shining a light on the risk factors and the capital requirements [then] all of a sudden it doesn't become so attractive."

There are a number of factors that can make succession a difficult proposition.

One is proving that your business has a strong revenue stream.

Peter Malekas, managing director of Moneysoft, says principals may need to create new revenue lines to protect and grow the value of their practices and, ultimately, secure a top price.

"In an increasingly volatile market environment, and at a time when more and more Australians are retiring and drawing down on their retirement savings, buyers are looking for evidence of growing revenue and upside potential," he says.

Another challenge is the time it takes to prepare for a successful succession.

"To do a succession well can take five years, versus a trade sale, where it takes 12 months," says Mr Prendeville.

"As soon as you have an element of time coming, you are increasing your associated risks. Anything can happen within a five-year timeframe versus a one-year one, which is more certain."

Mr Malekas agrees, and says that principals who plan to retire and sell their business in the next five to seven years must start their succession planning now.

"We know that buyers are getting fussier, so principals can't sit back and wait for a buyer to write them a big cheque," he says.

A final challenge when it comes to completing a succession is the possibility that the new owners might have shortcomings in their skill set.

"There is often a skill gap in that it has been an entrepreneur that's actually created the business and managed it – they've gained clients, retained clients and employees and managed the business and cash flows effectively," Mr Prendeville says.

"The young people coming into our industry might be highly educated, but may be less entrepreneurial."

The case for trying

Despite the challenges inherent in undertaking a succession, for many practice owners, their businesses are both emotional and financial assets.

"Not only are [practice owners] financially tied to their practice, they're emotionally tied because it represents decades of hard work and they want to make sure they're able to sell for a fair price and take care of key staff," says Charles Smith, business growth manager, strategic alliances and growth, at MLC.

For many, this is reason enough to attempt the completion of a succession, but there was consensus among all interviewees for this story that planning business owners should seek assistance when setting up and executing their plan.

Setting yourself up for success

If you are interested in undertaking a succession, here are some key ways in which to lay some solid groundwork.

  • Start planning early

Mr Prendeville says the most successful succession strategies are generally structured over five to seven years and equity is rolled back progressively – for example, 20 per cent over five years.

In its Succession Reset report, consultancy group Pitcher Partners says the incumbent team and the next generation team must "get ready" for the succession process.

"Establish a process, formalise it, timetable it, monitor it and commit the necessary resources. Discuss the process openly, identify possible limitations and barriers before commencement and remove as many as you can," Pitcher Partners suggests.

  • Re-engineer your service offering

Mr Prendeville suggests that business owners should consider re-looking at the types of services they offer or perhaps even consider how they structure their current advice fees.

"Perhaps moving from retail to wholesale, client segmentation, introduction of a new technology to enhance productivity and profitability, or a combination of all of the above," he says.

  • Maintain your profitability

Pitcher Partners says that a key aspect of planning for a successful succession is understanding the financial needs of the business, the exiting generation and the entering generation.

"For effective succession, the business has to be able to meet these combined needs, or expectations will need to be managed to a level which can be met by the business," Pitcher Partner says.

"The process of building the financial capacity of the business to cater for the growing needs of additional generations of the family takes time and must be understood, planned for and acted on, well in advance of these needs materialising."

Mr Prendeville adds that planning businesses must protect the clients and staff that they have.

"We will see many businesses cut back on marketing, but caution needs to be exercised as you need to differentiate expenses from investment," he says.

"An eye still needs to be on future growth but survival in its truest sense means cutting back to the minimum."

  • Be innovative

Mr Malekas suggests embracing new trends to stay competitive and also exposing the business to a raft of new client options. For example, take advantage of cloud-based money management tools that focus on saving, budgeting and cash flow management.

"By doing so, they could build a robust, diversified revenue stream, completely unaffected by market performance," Mr Malekas says.

"Advisers who have introduced a simple, scalable goals-based savings, budgeting and cash flow management coaching service, have found they've been able to start a relationship with previously disengaged clients, and over time move them to a comprehensive, full-service advice offering."

Mr Prendeville agrees: "Don't only look to the expense line but also to revenue and, in particular, revenue generation," he says. "Revenue generation could lie in the introduction or promotion of new or existing services lines – risk, cash flow management, family budgeting, debt consolidation and estate planning."

  • Hire a consultant

Due to the complex and often emotionally fraught nature of successions, an independent professional can often help you wade through the process. Mr Smith says succession planning specialists can help advisers develop and follow a pathway to exit.

"To give advisers confidence, they need to have a comprehensive succession plan and they need to see a clear pathway from where they are now to where they want to be, and when and how they'll exit the business," he says.

"They also need to be held accountable for their decisions to ensure they stay on the right path, which is why an objective, third party can add a lot of value."

Pitcher Partners suggests seeking advice early and retaining that support throughout the process, while Mr Prendeville says industry specialists could provide important insights and knowledge.

"Businesses perform better when they have plans and principles, are kept accountable and responsible for the delivery of the agreed plans," Mr Prendeville says.

"Survival and succession can be achieved irrespective of current market conditions. The focus must be on profitability, risk assessment and management."

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