Going forward in an unsteady market

Succession planning always creates complications. This is especially so for investment advisers in markets such as this one where investment opportunities are unsteady or trending downward.

Market conditions such as those we face currently often have a negative effect on the level of assets under management, which are part of the formula traditionally used in the calculation of the price of a succession sale. A sale in a down market using an old buy-sell succession planning agreement, therefore, can result in a price that may not necessarily reflect the actual value of the assets being sold.

Accordingly, several steps should be taken to ensure that a succession transaction in today’s environment is equitable.

First and foremost, it is important to periodically review the succession planning buy-sell agreement and make sure that it adequately reflects the value of the assets being sold. If the parties are relying on a formula to determine the purchase price, the formula may have to be adjusted.

If the formula is using a multiplier of the assets under management, the multiplier should be revisited and possibly adjusted to properly reflect the actual worth of the entity. Valuation formulas that are based upon earnings and assets under management can become obsolete quickly in a changing and fluctuating market.

Additionally, changes in a firm’s accounting and compensation practices can affect valuation in a manner not reflected in the formula. Accordingly, it is important to periodically review the formula used to determine the price of the transaction to ensure that it reflects the market for such assets and the actual offering price.

An investigation into the terms of formulas in use at the time of the review can be helpful in evaluating the formula in the agreement. All parties to the agreement should have discussions periodically to ensure that the agreement meets the needs of the buyer as well as the seller and that the ultimate price is appropriate.

A review of the agreement and its terms also should take place periodically to ensure that the agreement is appropriate for the tax environment at the time of the review. As tax laws change, a transaction’s structure may be materially deficient in that it will be taxed in a way that doesn’t reflect the appropriate value of the purchase.

Periodically, an agreement’s tax ramifications should be reviewed. It also makes sense to take a look at how a different structure might provide more equitable tax treatment.

Particularly in a fluid market, Congress and the Treasury will be looking to change the tax treatment of various items to help support continued economic growth. Any changes they make could affect the structure of a transaction, and should be analyzed.

It is important that each succession agreement properly reflect the needs of the parties involved, the underlying economics of the advisory firm and the all-important client relationships.

In a fluctuating market, client relationships can become difficult and strained. An advisory firm even may lose some clients, especially those who think that a different adviser may better manage the choppy waters.

It is important, therefore, that a succession agreement adequately reflect a greater potential for client loss.

When the environment is uncertain, succession transitions can be very unsettling to clients. They want to be certain that their interests are being tended to properly and that they are comfortable with their adviser.

Under such circumstances, succession planning probably should include provisions for the seller to remain at least partially involved with clients and the firm during a transition period. This will ease the transition and give clients comfort that even during unsettled times and turbulent market conditions, their interests are being tended to appropriately.

Successful succession planning during turbulent times, therefore, comes down to a few basics: Avoid problems by periodically reviewing underlying documents to ensure they do not become obsolete, and make sure any agreement includes ways to ensure that clients feel that their interests are being protected — and that they don’t feel abandoned — during the transition.

Those two steps can go a long way to ensure that succession is smooth and beneficial to all parties, regardless of market conditions.

Allen M. Silk is a Lawrenceville, N.J.-based shareholder and chairman of the business law department of Stark & Stark, a law firm with offices in New Jersey, New York and Pennsylvania.

For archived columns, go to investmentnews.com/successionplanning.