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Know your practice's worth

Matt Pais

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If you’re thinking about retiring and selling your practice, start the transition process sooner rather than later.

First published in the May/June 2017 issue of Round the Table

At some point, you’re going to retire. Whether that’s partially or completely, you’ll need to execute a successful transition for your business, and that doesn’t happen overnight. It’s more like thinking ahead five to 10 years. “Advisors need to do the same thing they’re preaching to their clients,” Ralph Steiner said.

He should know. Steiner has spent about seven years helping financial advisors transition their businesses in his work at Minneapolis, Minnesota-based Transition Brokers Inc. Before then, he had his own independent financial planning practice for about 45 years. Around the 40th year, when clients started to ask him what would happen if he was unable to serve them anymore, he had no answer. Steiner’s successful transition happened after five years and many dead ends, making the following mistakes he now sees frequently in his consulting work:

  1. Considering newer people in the business rather than those with experience running a practice that’s at least the same size. “You need people who have attained about the same level of success you have. They will be able to support it.”
  2. Narrowing eligible buyers to a set geographic area. Steiner began looking for someone within a 25-mile radius but ultimately sold to buyers more than 100 miles away.
  3. Assuming buyers would have the necessary cash to buy the practice. Because few have that amount available, Steiner participated in the financing by having a payout over a period of three years and worked to transfer clients one by one. The result: a 98% retention of his clients. 

“If you start this process too late, the risk is you’re going to limit yourself to one type of succession plan,” said Eric Leeper, vice president of research and analytics for Portland, Oregon-based FP Transitions. The company consults on structural and transactional issues for independent financial advisors and performs about 1,000 business valuations per year.

“You only have one chance to sell your business; advisors should structure these transitions correctly to preserve their legacy and the goodwill they’ve established over a long period of time,” Leeper said. “This is not a time to play fast and loose with your life’s work.”

Many advisors do not take enough time for their transition plans, Leeper said, because most prefer not to pick a date to sell their business. Instead, they seek to transition from, for example, working five or six days per week to four, then down to three, and so on, which does not lend itself to an easily executed adjustment.

Then, of course, there is the multifaceted determination of the practice’s value. A small glimpse of the variables involved:

  1. Age demographics of clients. According to Leeper, the 40-to-60-year-old age group is ideal due to significant assets and long-term potential.
  2. Asset demographics, with high-net-worth clients predictably worth more than lower-net-worth clients.
  3. The nature of the practice’s revenue, with highest demand for fee-based practices. The more predictable, recurring revenue, the better.

For Brendan Clune Walsh, a five-year MDRT member from Birmingham, Michigan, the precision of the valuation was not as large of a factor as he took over the business from his dad, MDRT Past President Clune J. Walsh Jr., CLU. The company focuses largely on estate planning for high-net-worth families, corporate benefit strategies and individual retirement planning. The transition, with help from M Financial, happened very quickly — in just three months.

That involved getting their own attorneys, talking with tax advisors and determining the best course of action for both of them, legally and in terms of taxes. The younger Walsh wound up not continuing the original company but transferring the previous business to a new company, which required new licenses, a new logo and more to get in order. They also segmented clients and advisors and addressed the transition either face to face, via phone or by a letter or email.

“The devil’s in the details,” he said, noting that, in hindsight, they could have slowed the process a bit. “They’re worth getting done right.”

That frequently is not done, Leeper said, when people rush to use transition plans that have worked for others without knowing the other options available. For example, a common approach is revenue splitting — one person sells a book of business and the other pays a percentage of commission for a defined period of time — but this can have very negative tax implications for the seller.

Besides understanding, communication and expectations are also key, Leeper noted. One of his clients worked to transition his practice, but after selling just 20% of his company to key employees, decided to work less and less without selling more stock. Eventually, the employees bought out the president, who was holding on too long before retiring. According to Leeper, this is a common, significant problem.

“There are major emotional hurdles that need to be overcome, and that tends to create a lot of issues,” he said.

From all angles, it comes down to relationships, especially between the buyer and the seller. To make sure both parties are qualified, Steiner has a series of meetings where they get together and talk, taking up to six months to determine if they can work together.

As an attorney told Steiner, “If you and the people you want to get involved with in this deal don’t trust each other and don’t feel you can get along together, there isn’t an agreement I can possibly put together that’s going to work.”

Walsh echoes the importance of having necessary conversations about transitions sooner than later, even if it’s awkward. “Too often we get caught up in the day to day, doing what we do best and seeing clients or helping clients,” he said. “We’re not helping what’s going to happen to the company in the long run.

“It’s what we do every day with our clients, but we procrastinate doing it for ourselves.”

Other questions to ask

Steiner recommends considering these elements when determining a business’ value and the conditions for a transition:

What kind of record-keeping does the seller have? “If you just have a bunch of file cabinets with files in them, that decreases the value substantially as opposed to someone who has everything on a computer and can tell you who the top 10 or 25 clients are, how much is renewal income vs. first-year income and has everything backed up, including tax statements and balance sheets. Unfortunately, many people in the business are good salespeople but terrible business owners.”

Is this person ready to embark on a transition? Steiner recalls a client he regrets taking on because that client hadn’t adequately structured the business or compiled necessary records and thought the business was worth more than it was. After working together for three years, Steiner helped him more than double his revenue and develop his client list and overall business to the point of being ready to be presented to a seller.

What are the business’ expenses, and will these be recurring for the buyer? If the seller’s financial statement includes a spouse’s car (or staff the next owner won’t be retaining), the buyer can eliminate those costs.

Is the owner still working hard? Steiner said the worst time to sell is at “the top of the mountain,” when a successful person has built a good standard of living but slacks off and lowers the revenue coming in. “It’s kind of like a bear on a greased flagpole; you have to keep climbing, and if you stop you just slide down, and the descent is very rapid.”


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