Journal of Financial Planning: November 2023
David DeVoe is founder and CEO of DeVoe & Company (www.devoeand company.com), a leading consulting firm and investment bank to wealth management firms. He has been a sought-after thought leader on RIA M&A for 19 years.
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The tango has become synonymous with an action that requires two essential elements to achieve a certain outcome. For some, hearing the word “tango” might elicit negative reactions—as in “it takes two to tango”—while others appreciate the elegance and power of the Argentinian dance.
Similarly, the “succession dance” requires two key elements to achieve a goal. The transitions of both management and economics are required for a next-generation leader to succeed the founder or CEO. As in the tango, these two components need to move in relation to each other, one complementing and enhancing the other.
Setting the Stage
Just like many people retreat from the dance floor when the bass kicks in, founders often recoil after they start the succession planning process. Despite the best intentions, they soon absorb the complexity of the initiative, become overwhelmed, and shift their focus to something else.
Succession planning may at first seem to be simply a decision to sell internally or externally. However, it quickly extends from a single decision into an increasingly complex decision tree as planning progresses. It involves identifying the people, their development needs across all functional areas of the firm, their leadership skills and potential, and their financial status, including their ability to afford to buy into the firm. Then the questions around valuation arise: Is there a clear valuation or is one needed? Can this be done internally or is an expert needed? Other decisions may include the need for key person insurance, sources of capital, and tax implications. The list goes on but that should give you context of the decisions in play. All in all, there are 20 areas that a given firm might need to assess to develop a comprehensive succession plan.
The good news is that your plan doesn’t require all 20-plus components. Each firm is different, and each will require their own unique mix of components. The challenge is therefore determining which ones you need. To paraphrase Einstein, how do we make it as simple as possible, without making it too simple?
The best way to simplify this task is to start with goals—basic, but critical goals.
- Business: What do you seek to achieve with the business?
- Professional: What roles do you (and potentially your current and future leaders) enjoy and are good at? Which roles should be migrated off your plate?
- Personal: When do you want to retire? And what will that look like? Do you want to stop cold on a given Friday, or dial back little by little?
- Economic: What are your economic goals? Can your next-generation leaders afford to buy out the firm at the valuation you think is appropriate?
Gaining clarity in these four areas will enable you to cut to the heart of the key components that you need in your unique succession plan. This clarity will also help you determine where you need to focus, prioritize the areas that need to be assessed today, and backburner others that can wait. The components of the plan emerge, and you can move forward with conviction and start working through this shorter list.
All the components of the plan will fall into two major categories: management and equity transitions.
(Dance) Step One: Management Transition
Once you have determined the overarching goals and the components that are most important to your firm, it’s important to identify potential successors at your firm. Ask yourself: Who can manage the organization after you retire? Who in the organization has the potential to be the future leader? It may be the case that one person alone isn’t the perfect fit. So, what group of people within the organization can become the future leaders? In this case, you might divide and conquer the broad number of areas that a current leader oversees.
Advisers often think of a successor as “leading” the firm, but perhaps it’s better to focus on them as learning to “manage” the firm. Likely these employees are skilled in one or two aspects of the business—relationship management, business development, investment management—but you will need to help develop them to learn all the areas of running a firm. Even Fred Astaire once said, “All the good dancers I’ve known have been taught or trained.”
As you evaluate your management transition, it can be valuable to assess the potential successor’s capabilities along four dimensions and create coaching and development plans to close outstanding gaps:
- Technical: Does the successor have experience in the core technical areas such as investment management, relationship management, and financial planning?
- Management: Is the successor capable of running the day-to-day business in functional areas like marketing, operations, technology, and accounting?
- Leadership: Does the chosen successor inspire others to maximize their potential? Can they pull the team together to achieve the company goals?
- Economics: Can the potential successors afford to buy out the current owner over time?
Advisory firms that start this process early and commit to the training, coaching, and development will help ensure that their next gen is positioned to run the firm.
This transition of management is quite different from the transition of equity. Being a shareholder does not magically make one capable of running a firm. It’s necessary to think through the management needs and transition in a vacuum before considering the equity piece.
(Dance) Step Two: Equity Transition
Many owners plan to execute internal succession to keep the business in the “family” of employees. Employees who have grown with the firm may become its next leaders, clients feel confident in knowing the staff, and you feel confident in your legacy. Why an internal sale? An internal sale can benefit the founder. Although it may not yield the high price that selling to an external partner might provide, it allows founders to maintain greater degrees of control while moving toward retirement. An internal succession plan lets owners create a path to retire on their own terms. However, many wait too long to understand the economics of internal transition. Many times, the music stops here.
First up in this process is an assessment of whether your next gen can afford to buy out the founders over time. Some owners oversimplify this equation by thinking they will sell 10 percent of their equity each year for 10 years. With that comes the assumption that the incoming owner will want to buy in at the same rate. What happens if they want to stop in year four? Others pencil out that several next-gen leaders will be able to afford the firm together—only to learn later that one is not interested. At that point, the plan is undermined. The future of your organization is not a good place for guess work or assumptions.
Unfortunately, most advisers don’t know if their next gen is willing and able to afford the purchase. In DeVoe & Company’s recent adviser survey, nearly 40 percent of advisers (of firms with over $100 million in AUM) said they don’t know if G2 can afford to buy out the founders. Don’t be part of this pool. Do the math or hire a firm to do so. This is important to do sooner rather than later, as each year your firm becomes more valuable and can unexpectedly exceed the economic buying power of the next generation of successors. Over the last three years, the number of respondents who said next-gen planners can afford to buy the firm has steadily shrunk from 38 percent to 18 percent.
Once you know the economics will work, put the plan in place. Draft a schedule of equity buy-ins and incorporate this into your plan. What are the minimum and maximum amounts a shareholder can and needs to buy each year—and how will those economics be calculated?
Now that you have a growing group of shareholders, you will need to think through governance. What decisions require votes from the owners—and what are the voting mechanisms and triggers for each decision? Governance also helps create clarity about which decisions management doesn’t need to make—and who makes them. Create clarity on which functional heads and which levels within various career paths make decisions. This is an opportunity to ensure that the company is able to move efficiently, and individuals have appropriate authority to drive results.
Although the economic goals that were raised earlier are key drivers of many equity-related decisions, you will find that the other goal areas—business, professional, and personal—also drive the structure and timing of the equity plan.
It Takes Two to Tango
As the frameworks of these two plans emerge, you can begin to explore the intersection points, and you can also seek to harmonize these two transition plans so they complement one another. For instance, career paths can be crafted to ensure that future leaders are developing the skills needed to become a partner or successor before equity is offered. Voting rights can be engineered based on role or level within the company, as well as certain percentages of shares owned by an individual. Even the choice of the title “partner” versus “shareholder” can be an equity-related decision that influences the value and power of one’s standing in the company.
Be thoughtful and creative about how the paths of management and equity transitions can support and complement one another.
Take A Bow
The dance steps outlined above should help you drive your planning forward. Invariably, advisers find relief and confidence and are reenergized once the plan is in place. Importantly, the companies that go through this process universally are stronger and move faster. Your company will be at the next level because of this planning work.
Putting this final plan in place will help bring clarity for the future and peace for the present. Perhaps you will even do a little happy dance to celebrate the succession plan finally being in place.