Journal of Financial Planning: January 2016
Most entrepreneurs dream of building a profitable business, enjoying autonomy and financial rewards, and cashing out untold wealth upon retirement. Financial advisers are no different, although they face a series of unique challenges before riding off into the sunset.
Advisers focus on developing lasting, profitable client relationships, and may not think much about their firm’s future without them. Will the business eventually be sold to a third party? How will a successor be selected? Will new leadership come from within the founder’s family or the firm’s management team? Financial professionals often don’t consider these questions and fail to position their businesses properly for succession.
While researching the new book Success and Succession: Unlocking Value, Power, and Potential in the Professional Services and Advisory Space, my co-authors and I discovered several key items to address in order to ensure a smooth succession between business founders and successors. Many strategies incorporate elements from both perspectives, avoiding common pitfalls and acknowledging the operational, financial, and emotional factors involved in the process.
Characteristics of Founders and Successors
First, it’s important to understand certain characteristics of founders and successors. Founders are often self-motivated risk-takers whose need to succeed is in their DNA. Successors, on the other hand—particularly those from the employee realm—have different attributes: they can be good managers, excellent long-term planners, and focused keenly on accountability and performance.
Founders and successors have the capacity to work well together because they may complement one another. When contemplating succession, each must understand the choices presented, maintain respect for one another, and cultivate a level of humility (not always easy for founders, but mission critical for successors).
Founder-Centric or Client-Centric?
Just like advisers analyze client assets and liabilities, they should also examine their own businesses ahead of succession. If the firm is founder-centric, these advisers are the force around which the business revolves—managing clients, making decisions, developing products and services, etc. If that resonates, it’s because most firms develop that way.
The founder probably started out within a larger organization, became increasingly frustrated with direction, and made the decision to strike out independently. In short, the founder has been used to doing it “my way.” It worked for years, but that structure makes it difficult to step back and prepare the company for a successful transition.
Conversely, a client-centric firm means decision making is focused on client experience, and whatever a client needs is of utmost importance. This model goes against what a founder may be seeking—maximum financial gain upon relinquishing the reins.
Risk-Taker or Conservative?
Founders likely see themselves as entrepreneurs, risk-takers who had the vision to start a firm, invest the necessary capital, and create the company that exists today. Honoring the founder, they would argue, is a prerequisite for a successful transition.
On the other hand, the successor may have an entirely different risk profile. Perhaps more conservative by nature, he or she joined an already thriving company and brought a complementary skillset comprising management ability and accountability. The successor’s long-term goal is ensuring the business has the right processes, people, and resources to grow—and the structure in place to accomplish it.
And therein lies the great risk divide: charting a clear path for the future, given that founders and successors view the succession differently. Just as the founder wants and deserves the reward for conceiving the business, the successor may be reluctant to take on debt to satisfy the founder’s liquidity demands without having commensurate control. At the very least, the successor wants decision-making authority; the founder may be reluctant to grant it.
Another example is the successor seeing the role that new technologies can play in enhancing client communications, such as delivering web-based functionality. But the founder, aware that such an investment may tap current cash flow and affect monetization at a time when stepping down is a greater priority, is reluctant to part with the capital to fund it.
Paying for Performance
What about the founder’s future role? How involved do they want to be in the ongoing business? Successful transitions recognize the founder’s primary contribution: the business would not exist today had the founder not taken inordinate risk to build it. The successor, therefore, should understand how his or her future is tied to that fact. Striking the right balance involves a formula of paying for performance—similar to acquiring the founder’s skills in the marketplace.
A Collaborative Approach
In a perfect transition, both founder and successor avoid extremes and adopt a collaborative approach based on empathy—an understanding of the personalities that each embodies and appreciation for what each contributes. Both should also keep clients in mind and how to best enrich the client experience with a stellar service model.
Successful transitions share commonalities. Both founders and successors share a vision for a “brand ideal”—why the business exists and how to best serve its clients. They agree on what constitutes the right service menu. A founder can serve as mentor to the successor, who in turn appreciates the value and benefit of the founder’s experience and judgement.
Non-Negotiables
A format should be put in place to settle disagreements—with both acknowledging and respecting each other’s “non-negotiables,” and adapting to one another’s communication styles. They must also agree on clear priorities to move the business forward. Only when this framework is in place can financial aspects be addressed.
Third-Party Valuations
Valuing the business can also cause conflict, and both founders and successors need to understand what characterizes a market. Contrary to what the founder may think the business is worth, a market is the price at which there is a buyer willing to purchase it. Founders dream of selling for multiples of free cash flow, but reality often dictates otherwise. Securing the services of a third-party valuation expert can help diffuse some of the tension.
Ownership vs. Management
Determining the proper balance between ownership and management may also come into play. A successor is essentially buying what the founder built—stable cash flow—and a successor who didn’t help build the business may be unrealistic in demanding a large equity stake.
Successors will participate in the future value of the business, so they have a greater upside, but also must bear in mind that future value will be built on the back of what the founder put in place. Founders must realize that successors are not likely to take on debt to purchase an entity which they may not control. Nor may a successor be comfortable with a founder commanding an equity share equal to what was in place prior to stepping away from the business.
Any business transition will inevitably have complications that need resolution. The best successions, though, are done in the best interests of clients. And keeping that principle in mind should be the overarching theme for any transition.
Jay Hummel is senior vice president of advisory services at Envestnet Inc. and co-author of Success and Succession: Unlocking Value, Power, and Potential in the Professional Services and Advisory Space.