Our succession planning crisis

We’re all familiar with the proverb, “The cobbler’s children have no shoes.” For many financial advisers, though, it’s not their children who lack proper planning, but the advisers themselves.

A 2018 study by the Financial Planning Association and Janus Henderson showed 73% of financial advisers lack a formal succession plan and 93% believe there is risk in not having one. These are alarming statistics for a profession tasked with helping people plan for a successful future.

Data from a 2020 Cerulli Associates research paper, “The Impending Succession Cliff,” shows that while marked improvement has been made in recent years, our industry is still facing a succession planning crisis. Cerulli estimates that roughly 103,000 — nearly 40% of the approximately 260,000 financial advisers in the U.S. — are going to retire by 2030, 26% of whom are unsure of their succession plan. These 26,000 advisers represent a whopping $1.8 trillion in assets. Houston, we have a problem.

Not surprisingly, financial services firms and M&A consultants have launched major initiatives aimed at solving the impending succession planning crisis. To demystify the various types of plans that financial advisers should consider, let’s dig into the differences between servicing, continuity, exit and succession planning.

• A servicing plan is triggered when an adviser is disabled for a short period. In this type of plan, another adviser steps in to service clients and is compensated for this activity.  

• A continuity plan is one that is engaged upon a triggering event, such as an adviser becoming permanently incapable of serving clients or unexpectedly passing away. In a continuity plan, an external successor adviser or firm acquires the practice upon the triggering event and pays a percentage of revenue (50%, for example) to the adviser’s estate for a predetermined time, typically four or five years.

The downside risk for both parties is that clients may leave because the transition isn’t handled smoothly, or the acquirer is not an appropriate fit. Advisers are prudent to select a continuity partner who uses the same firm — whether broker-dealer, corporate RIA or custodian — and employs a similar approach to serving clients. Doing so minimizes paperwork, avoids transferring accounts and helps maintain a seamless transition during a disruptive period given the unplanned nature of this event. Sellers should have a continuity plan in place and share it with clients to put their minds at ease and maximize retention and firm value.

• Exit planning is a scheduled merger with or acquisition of a retiring adviser’s practice by a suitor. This is the “succession planning” that comes to mind for most financial advisers who are thinking of retiring. The valuation multiples have never been higher: Fee-based practices that were selling for 2X to 2.5X gross revenue just a few years ago now are going for 2.5X to 4X in many cases. Advisers are smart to implement a plan before the average age of their client base increases to a threshold where the valuation becomes discounted.

• Succession planning is the cultivation of a suitor from within the firm. For solo advisers, this may be a junior or servicing adviser. For larger enterprises, this is often in the form of equity interest. A solid succession plan engages talent, optimizes the client experience and fortifies the firm’s value for decades. Large enterprises are typically valued based on EBITDA or earnings before interest, taxes, depreciation and amortization.

Implementing these plans can be an arduous but necessary task for many advisors. According to Marcus Hagood, director of equity management solutions at FP Transitions, “Bottom line is, at minimum, advisers need to have a continuity plan in place to protect their clients and meet their regulatory obligations. But ideally, they would build something far more sustainable so that their business can serve clients well beyond the advisor’s retirement or demise.”

Roll-up RIAs, private equity firms and wirehouses have become very active in acquisitions as high client retention and free cash flow attracts these buyers, which are often willing to pay higher multiples. Sellers should identify what is most important to them and their clients before choosing a successor, though. For some advisers, having the right fit is far more significant, which may mean receiving a lower price; for others, getting the highest valuation is the driving factor, but their clients may lose personal relationship value and firm culture.

As we transition into 2022, financial advisers who lack one of the above-mentioned plans are strongly encouraged to make this a top priority for the new year. Having the appropriate plans in place will bring peace of mind to themselves, their families, staff members, and ultimately, the clients they serve. After all, they’re why we’re here, and the data show that we should practice what we preach.

D. Vance Barse is an investment adviser representative with and offers advisory services through Commonwealth Financial Network, a registered investment adviser.