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Cerulli Associates found that one-third of financial advisors are expected to retire over the next 10 years.

As the COVID-19 pandemic continues to impact the health, financial systems and economies of countries across the globe, the financial advice industry will not be immune. While tragic, disasters like the novel coronavirus outbreak underscore the need to think about the future and should set off alarm bells for financial advisors who haven’t created a succession plan, particularly as many are nearing retirement age.

Despite these pressing trends, the Financial Planning Association reports that only 28% of advisors feel “very prepared” to transition their business when necessary, while 34% report feeling “somewhat prepared.” The issue is particularly acute among small firms – only 13% of advisors at firms managing less than $50 million in assets report having a succession plan. While a succession plan is not a legal requirement, proactively planning for a firm’s future is in the best interests of the advisor, firm staff and clients.

Key Stakeholders Benefit from a Proactive Succession Plan

Advisors seeking to optimize the return on investment they have made in their firms should prioritize developing and enacting a succession plan. Identifying and training a successor who has the skills and capabilities to propel the firm forward provides added security for the advisor, the firm’s staff and the firm’s clients.

Advisors frequently opt to sell their firms as an exit path to retirement. However, buyers of financial advice firms often pay only a small percentage of the firm’s value in cash at the time of closing. The seller is then entitled to an earnout over time in the form of payments made by the  buyer that represent a percentage of the firm’s yearly revenue. The bottom line is there’s a financial incentive to identify a successor who is poised to grow the business and deliver the best earnout possible.

However, the value of a strong succession plan extends beyond dollars and cents. Advisors who fail to prepare their firms for a time when they are no longer present to advise are doing their clients a great disservice. Clients trust their advisors with critical personal and financial information and rely on them to deliver excellent financial advice. When their advisor is no longer present to give financial advice, clients may be left with questions and concerns. Not only will the firm risk losing the clients’ business as they move on to find a new, better-prepared firm, but the lack of a succession plan can also cause unnecessary stress.

While many advisors feel that they have plenty of time to create a succession plan before their retirement, it is important to establish one regardless of how many years they plan to continue working. Unfortunately, unforeseen health events do occur, and if an advisor is no longer able to service his or her clients due to surprising circumstances, it is in the best interest of their family, staff and clients to have a contingency plan in place. Moreover, clients and staff may seek out firms where advisors have demonstrated the existence of a succession plan for the added security and peace of mind that it provides.

Components of a Successful Succession Plan

According to research conducted by Commonwealth Independent Advisors’ Practice Management team, 70,000 financial advisors, who control approximately $2 trillion in assets, will exit the business within the next eight years – and more than one third of them do not have a succession plan. With all of these assets and client relationships at stake, it’s critical that owners and operators of independent financial advice firms take succession planning seriously. First, it’s important to establish the purpose of a succession plan. According to David Grau Sr., a succession plan for a financial advice practice allows the business to continue and survive intact. Below are some of the key points that Grau highlights in his book, “Succession Planning for Financial Advisors”:

  • Empower the Younger Generation: Because most advisors started at wirehouses where compensation is tied directly to top-line revenue contribution, independent firms often employ the same “Eat What You Kill” structure, which can be detrimental to succession planning. This often disincentivizes advisors from buying into ownership because they have already borne the brunt of the risk in attaining their clients and building their revenue base. In a structure where compensation is flatter with higher compensation tied more closely to firm profits, it will be easier to develop a succession plan that can be executed through proper equity management overtime.
  • Understanding Valuation: Many advisors don’t think about their business from a bottom-line perspective and are unfamiliar with what aspects of their business drive value. Grau suggests receiving an annual valuation to not only see the value of the firm, but also to understand the factors that may be pushing that number up or down any given year.
  • External Sale as a Last Resort: While conventional wisdom often suggests that an external sale will maximize a firm’s value, Grau argues that founders are often better served by an internal succession plan. This allows for a gradual internal transition through which the founder can continue to participate in the growth of the firm, thus leading to more profit-sharing for the founder.

Take the First Step in Developing a Succession Plan

Simply thinking about the future of the firm, rather than putting off planning until a later date, is a great first step. Financial advisors are used to providing advice to others, but when it comes to succession planning, treating their own finances with the same care and attention as their clients’ will go a long way in ensuring the long-term success of their firms.