For many entrepreneurs, allowing a key staff member to acquire ownership simply isn’t a consideration.   As retirement looms, this is probably one of the worst decisions you could make.    

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We just completed our 1,600^th formal valuation last week.  The average value of these independent financial practices was just over $1 million.  76% of these business models, whether a corporation, LLC or sole proprietorship, had just one owner.  With an average age of 53, this is the perfect time, and opportunity, for advisory owners to consider setting up an internal ownership track.  

The primary concern for most advisors, that of losing some control over the business, or sharing the company’s Profit & Loss Statement, really are non-starters, when the process is handled correctly and fully understood.  And this process really isn’t about creating a successor – that might or might not be the outcome 15 to 20 years later – the issue is practice continuity and stability.

Here’s an actual case we recently observed that explains why setting up an internal ownership track should be a consideration of every financial advisor – in this case, the failure to do so cost one practice owner about $700,000 in lost value:     

Richard engaged us to help him value and transfer the fee-based business he’d spent 30 years building and running.  Using his CPA firm as a base, he added financial services to his business model earlier than most of his peers.  Aided by a small, but skilled staff, he grew the practice as a sole practitioner until he began to think seriously about retirement in his late 60’s.  The value of his practice at that time was about $3.5 million, and, like most advisors, became his largest, most valuable asset. 

Richard’s second in command, David, had worked for Richard for almost 20 years and was the heir apparent.  Promises of ownership, like Richard’s retirement plans, came and went until Richard’s health prompted more serious steps.  At this point, Richard was still the 100% owner of the business.

In the later years of his career, Richard spent only about 20 hours a week in the office, leaving most of the client servicing responsibilities to David, as well as most of the day to day operations.   Richard enjoyed traveling and spent more and more time away.  David worked hard, and he earned the trust and loyalty of most of the clients.

At the moment where Richard should have been realizing the value of his years of hard work, things started coming apart.  When offered the opportunity to purchase the firm, David, like many buyers/successors in this situation, considered his practical options.  Should he buy the firm, taking on a seven-figure debt that would require more than a decade to pay off, or build his own business?  What David did was hire an attorney. 

David and his counsel knew that many, if not most, of the clients would follow him, as well as the key employees, and this put him in a powerful bargaining situation – one he expertly leveraged.  Without his cooperation, a third-party sale, at least for any significant value, was almost impossible.  In the end, he was able to force  a significant discount (about $700,000), and generous, long-term, low interest seller financing, with only a nominal down payment and only the stock in the business as collateral. 

What should have happened in this case, at least 10 years earlier, preferably 20, is the creation of an internal ownership track that would have placed David in a position of protecting his value, too, as well as having the benefit of watching his ownership interest appreciate over time.   Richard could have taken this route, maintained full control of the business, and extracted some of his growing equity earlier in his career.  The next couple of blog postings will drill down on this concept and present it in more detail. 

Perhaps the ultimate balancing act in business succession is transitioning an advisory practice to a family member.

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Not only does this strategy require advance succession planning (i.e., 10 years or more), it also must integrate retirement planning, estate planning, tax planning and sometimes, conflict management into the solutions as non-owner family members also tend to expect to receive some value from the transition, as the advisory business is often one of the family’s largest, most valuable assets.

1. Cash (including down payments and earnest-money deposits)
2. Promissory Notes (basic notes and performance-based notes)
3. Earn-Out Arrangements

These payment methods, present in one form or another in almost every deal, are used regardless of practice size; we see them in acquisitions valued at $250,000 and at $25 million. Knowing how to finance a transaction impacts the implementation of almost every equity transfer, whether for just 5% of the business at a time or a complete sale or acquisition of 100% of the assets or stock. In other words, financing options determine how a practice owner is going to actually realize his or her value, and put it in the bank.