Succession and continuity best practices

I'm Shauna Mace, Head of Practice Management at SEI, and I'm here with Scott Leak, who is a senior consultant at FP Transitions. FP Transitions provides valuation and consulting services for advisory firms that are looking to evolve through M&A, succession and continuity, which we're gonna talk about today, and other key business transitions. So today we're gonna talk about key considerations when you're looking to protect your firm and your client's future. And we're gonna talk about what that looks like through continuity and succession planning. We're gonna focus in four key areas, how to design your ideal future, how to define your succession, how to build a plan to protect that vision, and how to make the transition.

So Scott, thank you so much for being here. I'm excited to hear your expertise and what you have to say around these really important topics. I know you're passionate about these topics, it's gonna be a great conversation. So let's start with design. How is continuity planning and succession planning similar and different? 'Cause I know there is certainly some important overlap, but distinction as well.

Yeah, and to be fair, I think different people in the industry define them differently. What the important thing is that we just have a common language and are saying the same thing, the concept's really what matters. So we define continuity planning as creating a death and disability policy, like as succinctly as I can say, that's what it is. It is making sure that the service that your clients are receiving continues in the event of your death or disability. So one of the things that's really important about continuity planning is that, and this is a bit of a macabre subject, but we have to deal with it, just like talking to your clients about life insurance or whatever you need to in those discussions. But with a continuity plan, one of the unique things about it is you are not there to negotiate the deal terms after the triggering event happens.

So if you've been disabled or if you have passed away, you can't obviously negotiate for yourself. So it's really important with the continuity plan to put those terms and conditions in place ahead of time with the person that is going to be your continuity partner. Succession planning on the other hand, and a lot of times people think about it's winding down and walking away, it's not even about that or selling what you've built. Succession planning is a professional written plan, both of these need to be written plans, I can't stress that enough too. But it's a written plan designed to build on top of an existing business or practice, and it's about seamlessly and gradually transitioning ownership and leadership internally to your next generation of advisors. Again, both of these need to be written and they both need to be executable.

Yeah, I'm excited to get in the weeds up of this, 'cause we get asked questions all the time around how do I do this well? But you said one time when we were talking previously, you said this is the number one transition plan that firms need to have. Can you just talk a little bit, maybe there's a story or something to kind of nail this home, because I know on the flip side, advisors understand the importance of doing that future protective planning, that estate planning for their clients, and yet this is kind of the same thing for them. Can you just speak to why, in your opinion, this is the number one transition to plan for as a advisor?

Yeah, well, first of all it's the easiest one to plan for. So I would say you don't have a great excuse for not doing it. It's not that hard to put together a continuity plan. I can usually get one drafted and implemented in a couple of days for an advisor. So the important thing here is, again, it's protecting the clients. And certainly, you're looking out for your staff, you're looking out for your family as well. But I just think that in our industry, as an independent advisor, whether you're technically a fiduciary or not, you need to be putting your clients first, and I think this is an important way to do that. You know, and then for the staff, this is important too. If you are a sole owner and you get hit by the proverbial bus, literally no one else is authorized to write paychecks for people. So what's gonna happen to the business? What's gonna happen to those jobs for those people that are relying on you? So there's a lot of things going into this that are just beyond having a documented, you know, plan in place.

There's the implications of not having the plan in place. So we've got a service at FP Transitions we call our EMS essentials, I'm not gonna go into it, but we call it the essentials program because I feel this is the most essential thing all advisors need to do, get evaluation done so you know what your business is worth and then put in a plan to protect it. - Yeah, that's great, great perspective. So related to valuation, what role does evaluation play in the designing of a solid continuity or succession plan?

Yeah, good question. And again, it comes back to that notion of this is the one case where you can't negotiate for yourself afterwards. And so we need a starting point of what's this business worth today? So we'll do evaluation for a firm and then help them draft the terms and conditions, almost as if they were selling it to a third party right now. So we'll figure out, what's the down payment gonna be, how much is gonna be paid out on a note, and if so, is that a three year note, five year note, seven year note? Is life insurance gonna be involved? And that's something that's unique about these types of situations, particularly if that person on the buy/sell side is an employee or a second generation potential owner, it makes sense to use life insurance to handle this very large transaction. And for that G2, or even a third party, this is gonna be the cheapest acquisition they ever did, 'cause all they had to do was make some life insurance payments. So figuring all those things out, how much life insurance do you get? Well, you don't know unless you know how much the business is worth. So it's vital just for the very starting point of this to know, based on an accurate valuation, where to get started.

Yeah, that's really helpful. Let's pivot to the define. So where should owners start in defining their ideal succession?

Well, I'd say evaluation is vital here as well. You know, with an IRA application, you know, you have to designate a beneficiary, right? And so what we're doing here is pretty much the same thing. So we're designing who's the beneficiary in this case, and you know, it starts with what do you want? So, you know, we've got a lot of advisors that'll come to us and say, you know, I wanna design my succession plan. And usually that's kind of where we say, where do you want to go? So you wanna plan your trajectory, you want to plan your work week, like how many remaining years do you wanna keep working and what do you want those years to look like? For a lot of advisors, it's not, I wanna work 40, 50, 60 hours a week until one day I'm gonna stop completely. You want this glide path to retirement.

Succession planning offers that in a way a lot of other transactions don't. So again, get that formal certified valuation in place, start benchmarking key operational data, work on those KPIs to improve growth, improve profitability, because part of this transaction is probably going to include you doing some seller financing for your G2 that's gonna come in and buy, they need profits in order to pay you back. So work on improving the profitability of the business and manage to the bottom line, and get those second generation owners thinking about the bottom line. And then just define the goals for the business and the succession plan, establish that timeline, and then put it in place and implement it with the proper documentation.

Yeah, it's interesting, I mean, we hear about this a lot in our consulting engagements. So people talk about the future in this kind of abstract way, and it's interesting, there's a lot of emotions that happen and a lot to work through personally, I think, to get to whatever that clarity of what do I want looks like, certainly for your clients, for the business, but to yourself too. And it's interesting, I don't know, kind of as a third party consultant, if you have any kind of perspective based on your experience on how do people navigate if it is that difficult, emotional journey to kind of gain clarity and kind of maybe accept that the way things were aren't gonna be the way things will be in the future, and that's okay?

Right.

Sometimes it's a shift in mindset. Any advice on how to navigate that emotional process well?

Oh wow. That is probably the most difficult thing with all of these. And it's hard to not try to apply things logically to it. And one of the things I'll point out to an advisor is if you're really passionate about this business, and your clients, and your employees, and you want grow it, the fastest way to grow it is to have multiple owners. So we've done 15,000 valuations in our company's history, we've got tons of data on this, and it's blatantly obvious, single firm owners do not grow as fast as multi firm owners. And so I think for a lot of advisors, they might be hanging on thinking, well, I've built this, I don't wanna share ownership just yet, I wanna get the maximum amount of value I can out of it. It's actually a bit of a fallacy that if they bring in G2s, generally speaking, the company is gonna grow faster. I worked with an advisor recently that's now selling to their G3s, that he's probably 80 years old at this point, so G3s are starting to come in. He has now fallen below 50% ownership and his ownership of that less than 50% is worth more than when he owned 100% of the company.

Wow. Yeah, that's powerful. And we hear that too, or the mentality of like, I wanna have it all perfectly set up for that next generation. And it's like, maybe that's not the approach.

Right.

But yeah, that mindset stuff, I think, is difficult. And one thing I'll say we see is the power of community, of connecting with peers, of listening and hearing stories, of learning from others, whether it's third party experts or peer advisors who've gone through it. I think just hearing stories and kind of talking about that can be helpful versus trying, to your point, rationalize it all out. Sometimes it's not rational, and that's okay.

Well, and another component of this too is, you know, if you're thinking about it from an emotional standpoint, think about what's gonna happen to this business if you keep going as long as you possibly can without selling, and what's gonna happen to those G2s that aren't getting an ownership stake? They're getting phone calls from other organizations. If they haven't yet, they're going to soon. And if you're not offering equity pathways, you're missing an opportunity to retain those employees as well as attract new ones to come into the organization. So you're also limiting your success by not implementing a succession plan.

That's a great point. And that brings me to the question around how do you, and maybe you have some of these people in your firm, maybe you don't, how do you find or identify a successor?

Well, I'm glad you phrased it exactly as you did, because I wanna say you don't look for one, you look for more than one. So a lot of succession plans fail because advisors will try to bring them in one at a time. We generally recommend for every G1, for every founding owner, you have two G2s and three G3s. Now, maybe you're not gonna be around long enough to worry about the G3s, that can be the G2s problem, but you want two G2s at least for every G1. And the reason is about a third of them don't work out.

So if you've only got one, you're putting all your eggs in one basket. If you've got two, the odds are really good that at least one of them is still gonna be there five years from now, 10 years from now when you're starting to do those second and third tranches, and selling ownership, and they're becoming that majority owner. Sometimes you find out that that G2 doesn't like being an owner. Sometimes that G2 spouse is in medical school, and they get residency, and they move across the country. Maybe you don't wanna have a G2 that owns 5% of the company and lives on the other coast. So there's a lot of reasons to have multiple G2s and not just focus on one. How do you actually find one though? You know, I'm not gonna give them any advice that SEI is not already doing a good job of doing, you know, talking to universities, networking locally, and then having those equity pathways ready so that you can recruit and say, if you come into the organization, this is the pathway we would've for you.

Yeah, so it's like you're selling, you're prospecting for clients, but instead of clients, it's for employees.

Exactly.

Really key employees.

Yes.

What about, and we see this a lot too, what about if the successor is a child or a family member? Anything that you would recommend maybe specifically to that situation to build a successful transition plan when it's a family or there's some existing relationship?

Yeah, so we've certainly worked with a lot of those as well, and there's nuances that come in that make those situations a little bit different, for example, when you're selling to a G2, you're oftentimes putting in a minority discount, because you're selling a non-controlling, illiquid position in the company. That's not the same as what the market value is when you're selling the whole thing and someone can control the entire business. So we do put in minority discounts or calculate minority discounts, you don't have to do it. But usually with a family member you're gonna see a discount, otherwise you might have some pretty awkward Thanksgiving dinners. So you do see differences, but then you wanna make sure you definitely have a certified valuation in place, because you're gonna have to justify to the IRS if you go too much on the discount or you're actually outright gifting to the child or the adult child of that founder.

That's great advice. Let's transition to building your plan. So for continuity planning, there are various agreement types. Can you speak a little bit to those types of agreements and how they may impact a firm valuation?

Yeah, so I'll kind of start from least to most protective agreement. So number one would simply be putting a guardian agreement in place. And that's just saying, okay, in the event of my death or disability, this person is going to keep payroll going, keep monitoring the clients, rebalancing portfolios, for probably a period of, let's say six months until a proper buyer can be found. And so a guardian is certainly the minimum I would say to have in place. And sometimes it's temporary, you know, again, that's where the disability could come into play. We've had advisors that come to us and just say, you know what, my spouse just got diagnosed with cancer, it's gonna be a grueling process, and I don't care about anything other than her right now. So they're going to implement the plan, guardian is gonna step in and monitor the business while treatment goes on for the next six to nine months. So having that already ready to go and having that not be something you have to worry about, even if it's something that you've got a little time with, sometimes it could be a car accident and you don't have time to plan for it.

So again, sorry to be macabre on these, but these are important things to talk about. So next would be the buy/sell agreement. And that's where you're actually saying someone's gonna come in and buy the business and you're negotiating those terms ahead of time. If you've got someone in house that can do it and has the will and the skill to be an owner, that's great, that's probably ideal. If not, try to find someone within your network that you trust that can do it. Otherwise, we have a actually continuity matching partner program where we can help people find an appropriate continuity partner if they need to. Third beyond that would be a combination of the buy/sell with a guardian agreement, so putting both of those in place at the same time. And then after that would be just the full blown succession plan. So those are kind of the stages or progression of continuity planning.

That's really helpful. So we talked a little bit about finding a potential successor or successors. What are some steps that you can take to make sure that you're setting, you know, potential successors up for success?

So you wanna start communicating the plan with them even before you implement it, you've gotta gauge their interest. Again, I kind of use the will and the skill, do they have both of those components to be an owner? It's one thing to have the technical skills of being a good advisor, that is not necessarily the same skills as it's to be an an entrepreneur or an owner of a business. And like I said, in the definition of succession planning, this is about a gradual transition of ownership. You need to be transitioning, not just the ownership and the financial benefits of so, but the responsibilities of ownership. So start letting them hand over those responsibilities.

And I always tell the G1, this is the best part about this, is you get to take the stuff about your job you don't like and hand it off to somebody else. So let the G2 start to do the unfun things first of being an owner and let them learn. Like there's responsibilities that go with this ownership, I'm having to do extra work for those profit distributions. And then just have regular check-ins along the way, have good, open communication. Some successors like the idea of ownership, but turns out they don't like the responsibilities of it. I'm working with a firm, did succession planning with us in 2018, fast forward five years later, everyone's paid off their first round of notes, they're ready to do tranche two. One G2 said, "I don't like being an owner, and frankly I want you to buy back my shares." Another one said, "This is great, I love it, sell me more." And then a third one said, "I wanna buy more, but the G1s are like, you're not cut out for it, we're not selling you anymore." So have those open communications and understand that there's so many different ways that this could go besides how it's perfectly planned.

Yeah, in that case it's good they had those three so that they could navigate

Absolutely. As time told them kind of how it really could work out.

So are there any important elements of compensation design for successful succession? - Number one, don't cut their salaries. I think for a lot of advisors there's kind of this notion of, well, they're getting profit distributions now, it's gonna cost me more money. Yes, it is, but you're gonna get all these other benefits, you're gonna have things you don't have to do anymore, you are probably gonna have growth, and if you think about it, they're getting profit distributions, they're using those profit distributions to pay off a note. That note most likely was seller financed, maybe it was banked finance, we see both, but they're trying to get this paid office fast as they can. One way to do that, increase profits.

So you've got someone who's really motivated to help the bottom line, so let them go out and bring in more revenue or cut expenses if they can to boost those profits. So these are important elements of their new responsibilities, that whatever you're paying them, it's probably worth it. Don't cut their salary because they're now getting profit distributions.

That's a really good point. Let's transition to making the transition. You've built your plan,

Yeah - you've found your successor or successors. So once you have, and specifically a continuity plan, once you have your continuity plan in place, is there anything else you need to do? Is it set it and forget it? Or what do you need to make sure that you're continuing to do? - So you can draft these a number of different ways. And the way we draft our continuity plans is that they expire after two years. So it kind of forces you to go in and review those on a regular basis and make sure that all the terms and conditions are still ones you want to use, that the person that you've designated is the person you still want to be the guardian or be the buyer. We've had instances where someone comes back after two years, they're like, all right, I'm ready to, you know, extend it, so we can quickly and easily extend it without having to rewrite it. But it turns out that the person that they appointed was someone that was in the firm that left and went somewhere else. Well, you don't want that person buying it now.

So we need to redo it, just like an advisor would do with their clients. I make the analogy with this all the time, this is your beneficiary form for your business. So this is something that you wanna review on a regular basis. If that person is no longer with the firm or maybe they've changed the way they do their investment models and they're doing something completely different, and that's not what you want for your clients anymore. All those are good reasons to review those on at least a bi-annual basis.

Okay, so don't set it and forget it. Don't forget it.

Don't set it and forget it.

Don't set it and forget it. For a succession plan, again, you have your successors. How do you determine that glide path, that how much and when to sell or increase ownership to those next generation?

When to start is yesterday. That's usually my default answer. I've never once had an advisor say, ooh, I started my succession plan too soon. That just never happens. So you gotta think about the fact that if you're gonna sell to somebody, you need to have them in place for two, maybe five years as an employee before you're even willing to know that this is someone that's worthy, and trustworthy, and capable of being an owner. So you've got that ramp up period, then you're gonna sell them their initial tranche of five, 10, maybe 20%. You're gonna wanna have this incubation period, this kind of tryout, if you will, for another two to five years before you sell them their second tranche. They're gonna pay it off, you're gonna see, is this working for both parties? If it doesn't work out, and let's say you went the maximum of five years in both cases, you're now 10 years into a succession plan that didn't work out, and you gotta start all over.

So again, that's why you do multiple G2s instead of just one. But even then, you gotta start this really soon. We tell advisors start at age 50 or when you're 20 years away from retirement is the ideal time to start planning for succession. You don't necessarily have to put things in writing and sell right away, but be thinking about it, be devising a plan, be communicating to those employees that this is a pathway they're going to have so they don't leave.

So specifically around devising that plan and implementing it, are there any best practices that you all have around operationalizing that plan? Like formats, how often you should be checking in on it, anything real tactical that you've seen work well in making sure that you're actually doing the things that you want to be doing?

Right. I've said this before, and I know this is a broken record here, it needs to be in writing. Continuity plans, we even recommend that those get notarized, our forms have a place for them to be notarized. And then you need to communicate those with a number of different people, particularly the continuity plan, 'cause if it's in the event of death or disability, somebody needs to know where to find it. So make sure you're providing it to your custodian, your broker dealer, provide it to SEI, provide it to FP Transitions, whoever drafted the plan, provide it to whoever's the executor of your estate, your spouse.

So make sure that people know how to find this. So share it with others. And with the succession plan, yeah, continue to review it on a regular basis, check-ins with those G2s and make sure that both parties are pleased with how it's going. There is a really high likelihood you're gonna do some course corrections and the plan is not gonna work out as you intended. You know, I go into my annual meeting with my financial advisor every year and they'll say, all right, here's what the retirement plan is, is this still what you wanted? And I'm like, I never said I wanted to buy an RV. And they're like, yeah, you did two years ago, you said you wanted to do that. So know that those goals are gonna change over time.

Yeah, that's a great point. We all evolve, so can't expect to plan it once and it'd be perfect.

Yep. So we've talked about a ton, you've covered and provided a lot of really great tips and advice. Is there one piece of advice or key takeaway that you wanna leave us with related to continuity and succession planning? - Well, again, get it in writing and start now, you know, again, no one's ever told me that they did this too early. If you wait too long on succession, this is another key point a lot of advisors don't realize, you run the risk of your G2s not being able to afford it if the business gets too valuable. So let's say you build this up and it's now worth 10 million, you've got two G2s, are these two G2s capable of coming up with $5 million? Now even if you do seller financed, you want them to put down 20%. Now they gotta put down a million dollars, that's more than their mortgage, that's probably more than their student loans, and they're still paying those off as well, and their spouse might have the same issues. So you can't wait too long until the business gets so valuable that all you're left with is an external sale. If you want this multi-generational, enduring, sustaining business, you want this legacy, you need to start planning for it early so the business isn't so big. Again, I'm begging everyone who's listening to this, have a continuity plan, that is the absolute essential minimum you need to have in place for your business. But for those succession plans, know that the plan's gonna evolve, it's gonna have course corrections you're gonna need to do, but for the most part it's okay to have that plan put in place. You can always implement a plan B. If you don't put it in place, you don't have multiple choices anymore, at some point, plan B is your only option.

Yeah, very, very good points. Scott, thank you so much for joining us and sharing your experience and insights. You, the advisor, you do this work, you plan and protect your client's future, and now it's your turn. Like Scott said, this is probably one of the number one, if not the number one planning piece for yourself, and your business, and your clients that you can do. And I know the work may not be fun in the short term, but it obviously can have a huge impact in a number of different ways over time. So hopefully you are inspired from this conversation to stay focused on that ideal future and the impact that you want to have and do this planning starting now if you haven't already started. At SEI, we see a lot of business transitions and we would love to help, we have a number of resources, including resources like the Growth Lab to help you in partners like FP Transition. So please don't hesitate to reach out to us as you're navigating your transition. Again, thank you so much for joining us. Thank you, Scott.

Thank you.