Plan ahead to put the success in your succession

By Andrew Rickard | February 18 2008 02:38PM

Financial advisors, like the rest of the country, are getting older. They’ve helped thousands of clients plan for their retirements, but are they prepared to make the transition themselves?

Three years from now, in 2011, the first wave of baby boomers will reach the age of 65. According to Statistics Canada, the country is about to enter a period during which the number of seniors is expected to nearly double.

This shift of demographics has had obvious implications for advisors and the types of services they offer. The trend away from traditional mutual funds and towards more complex products that offer both income and capital protection is just one example. But it remains to be seen how advisors will turn what may be their biggest assets, namely the books of businesses they’ve developed over their careers, into steady retirement revenue.

Paul Brown, the chairman and CEO of Worldsource Insurance Network, says that one of the first questions that needs to be answered is how the deal will be funded. "One of the difficult things for younger advisors is to finance the purchase," says Mr.?Brown. "The buyer wants to buy it over time for as little as possible, and the seller wants cash up front."

Unfamiliar with the insurance and investment industries, many bankers may have difficulty valuing a financial advisor’s practice. They might be reluctant to consider renewal commissions when underwriting a loan. As a result, Mr.?Brown says that dealers and MGAs can help advisors a great deal by either providing or helping to arrange financing for a buyout.

Build your strategy

Arranging for an orderly business succession is not the kind of thing that advisors should leave until just before they retire. "My sense is that it’s a fairly drawn out process," says Mr.?Brown. In some cases, he says it could take as long as ten years to transfer a book of business from one advisor to another. "Don’t wait until you need to do it to plan it," he says. He points out that advisors would never allow their clients to wait until one year before retirement to start planning, and that their practices are worthy of the same attention. "When you’re starting to get to the middle of your career, you should be building it into your strategy," he says.

To encourage advisors to start thinking about the process, Worldsource hosted a succession planning school late last year. This wasn’t a purely philanthropic endeavor on the part of Worldsource, but rather part of the firm’s business retention strategy. "Your advisors and their assets are very important to you," notes Mr.?Brown. "What you don’t want to happen is to have a good advisor who looks elsewhere for their succession plan. It’s very important to us to try to retain assets."

The program, which included sessions on valuation and taxation issues, was well received. Mr.?Brown says that the attendance at the seller breakout session was quite a bit higher than at the one meant for buyers. But simply because older advisors are attending conferences about selling their books, doesn’t mean they’re actually following through.

Kevin Vaughan is a 38-year-old advisor with Money Managers Inc. in Peterborough, Ontario. He says his firm has been trying to buy up books of business for the last five years, but without success. They contacted several advisors who they believed might be ready to discuss a succession plan, but to their surprise these advisors were not even prepared to consider a deal in the future, let alone a current sale.

Not for sale

Mr. Vaughan attributes the lack of sellers to the fact that successful advisors have few incentives to retire. They enjoy their jobs, and they’re paid well to do them.

"An advisor can slow down a bit if he feels like taking more time off. He can continue to service his clients, collect renewals, trailers, and maybe complete the odd new sale if it jumps in his lap. Why should he give up this pension-like income?" he asks. "I’m sure that many advisors built their businesses on the assumption that they could sell when they wanted to retire, but now that they are approaching that age they think ‘Why sell? Nobody is going to pay me what it’s worth anyway.’"

The prospect of entering a prolonged semi retirement – one in which the advisor writes little in the way of new business and simply rests on his or her laurels – may appeal to older advisors, but the problem with that kind of retirement plan is that it fails to take human morbidity and mortality into consideration.

"But what about health? What if you’re the aging advisor with no succession plan and you suffer a critical illness? What if you need to go to a long-term care facility?" asks Mr.?Vaughan. He points out that the value of an advisor’s business will almost certainly decline if he or she is unable to serve clients and keep business in force. "We all know these dangers," he says. "We advise our clients to protect against these risks but are we heeding our own advice? It appears not."

Steven Ross, executive vice-president of individual insurance and annuities at La Capitale Financial Group, says the last thing he wants to do is push older, experienced advisors out the door. "We’d like to keep these people as long as possible," he says. Instead of implementing a model in which advisors are encouraged to leave and to sell their blocks of businesses outright, La Capitale is currently working on a system of incentives and benefits so that members of its career sales force will keep working longer, but part time. Mr.?Ross says he’d rather see advisors working three days a week, than have them out of the business entirely.

"It’s not physically demanding and it keeps your mind in good shape if you have 200 customers to take care of, or maybe 100 of your best customers," he says. La Capitale is still considering its options, but Mr.?Ross says advisors deemed to be in the semi-retirement phase could, for example, have lower production requirements, a different bonus scale, or a separate formula that would still allow them to qualify for clubs and travel incentives. In exchange for these perks, the partially retired advisor would be required to gradually transfer his or her book of business to another individual.

If advisors can’t find someone to whom they can begin transferring their business, La Capitale does promise to buy them out based on a set value that’s outlined in their contract. It’s two times the individual’s renewal commissions on their life and health business, and half a per cent of their assets under management, including mutual funds, segregated funds, and annuities.

They pay 25% of this guaranteed value to the retiring advisor immediately, and the remaining 75% after a twelve month buffer period (put in place to allow for cancellations or transfers). "We think that the current market value is higher than that," says Mr.?Ross, but at least advisors have a contractual minimum value for their books of business upon which they can rely.

Compensation counts

Terry Johnston, an advisor with the J.C. Mitchell Insurance Group in Barrie, Ontario, suggests that independent brokers who want maximum value for their books of business need to think long and hard about their current method of compensation. He believes that the choices advisors make about their fee structure could play a big role in determining the kind of retirement they have.

"Never mind the up front commissions. Try to go to zero front end," he says. He allows that some advisors may need to rely on heaped commissions from deferred sales charges on mutual and segregated funds early in their careers in order to pay the bills. But ultimately he believes advisors will have a larger and more predictable income stream, and therefore a more profitable book to sell, if they focus on maximizing trailer fees on their asset business. "Invest in your client and go long term," recommends Mr.?Johnston.

With such reliable revenues, will Mr.?Johnston, who is in his late fifties, ever retire? "I love it too much," he says, but admits the day will eventually come when he’d prefer to spend some of the colder months in a warmer climate.

Mr. Johnston says his own succession plan involves splitting commissions with other, younger advisors in his office. By putting the name of one of his associates on the initial application, Mr.?Johnston says he’s made sure the client will remain in good hands, not only while he’s on holiday, but also in the event of his death or disability. His associate will have access to any information they might require, and will be familiar with the client’s situation. He, on the other hand, will continue to receive his portion of the trailer fees even when he’s no longer working.

Alternatively, he says established advisors could hire an associate for a kind of apprenticeship period, during which the seller would set aside a portion of the prospective buyer’s earnings to help him purchase the practice. "I’m going to pay you less than you’re worth, but I’m going to take the difference from what you should be earning and put it in an account, say at the rate of $15,000 a year." After a decade or so, the associate would not only have experience and contacts, but also a significant source of funds he could use to buy out his mentor.

Going to market

Apart from membership in and networking through industry associations like Advocis, the Canadian Institute of Financial Planners and the Independent Financial Brokers of Canada, there are few obvious solutions for those in search of a book of business to buy. Mr.?Brown says that one of the ideas that came out of the Worldsource succession planning school was that there might be a need for a bulletin board to bring buyers and sellers within the company together. Nothing concrete is in the works, however. "We’re just considering it at the moment," he said.

The "eBay for advisors" model does exist south of the border, but it has yet to realize its full potential. When doing his own research on buying and selling books, Mr.?Vaughan came across the U.S. web site, which bills itself as the "largest and best known succession, valuation, and acquisition consulting firm for the financial services industry" in the United States. That may sound promising, but he points to an article in the January edition of the American Investment Advisor magazine which reveals there are about 4,000 to 5,000 buyers vying for just 200 firms, with about only 100 deals closing in a year.

Mr. Vaughan is concerned that the relatively few advisors who are looking to sell may not be exploring all of their options. One advisor he knows ended up selling after only having talked to one buyer. "They don’t always go to market," he says.

Take your time

Once they have found each other, what’s the best approach for advisors? Mr.?Brown thinks it would be "a serious mistake" to simply calculate the price according to the size of assets under management. Instead, he believes the value of a business should be based on things like recurring cash flow and profitability. The buying advisor should also consider how easy or difficult it will be to fold clientele, employees and overhead into his or her existing practice.

Besides crunching the numbers, he suggests that both the buyer and the seller should understand each other’s personal idiosyncrasies, and need to make sure the two practices are actually a good fit. If clients are used to one person’s style of doing business, they may want the same thing from his or her successor. And younger advisors have to make sure they have an appropriate level of technical knowledge to service the business they’ve purchased.

"Be patient," he says. "You have to have a long term view of it."