Succession planning: how best to pass the baton

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Given the current climate during COVID-19, we believe this article will be of use for you during this challenging time.

Succession planning strategies come with a unique set of advantages and disadvantages for advisers to consider. However, the most common mistake experts see is business owners starting the process too late.

Very few financial advice firms have a documented succession plan in place and most of those that do, have not yet identified a potential successor. And while people understandably don’t like to think about their own death, or permanent disability it is becoming increasingly important that advice practice principals have a transition strategy.

Rod Bertino, Business Health owner and consultant, says succession planning means different things to different businesses. But factors such as the mandated raising of education standards and, more recently, COVID-19 are having a substantial impact on financial advice practices, employees and clients. This is also happening at a time when the average age of practice owners continues to rise.

“Our most recent research whitepaper, ‘Future Ready VIII - HealthCheck Analysis’ released in January 2020, shows that just 10% (see source below) of businesses have an agreement in place with an identified successor which is supported by a regularly reviewed and documented plan that covers all major trigger events,” he says.

“The remaining owners have inadequate arrangements in place to address the untimely death or serious illness of an equity partner. And, if it is not a forced exit and the current owner is able to retire on their own terms and timeframes, for most it remains unclear who will buy the business and why they would or should pay a premium for it.”

Source: Business Health

Three succession scenarios

According to The Adviser Retirement Wave: Succession Strategies for an Effective Transition, a practice management guide issued by State Street Global Advisors, the first step in the succession planning process is to determine which of three major succession scenarios suits the firm. It defined these as:

  1. An internal succession

  2. A merger with another firm

  3. An outright sale of the business.

Each of these strategies comes with a unique set of advantages and disadvantages for advisers to consider. However, in each of these cases, Bertino says the most common mistake he sees is business owners starting the process too late. This is especially true with the outright sale of the practice.

“Now, more than ever, buyers are looking to truly understand the asset they are considering purchasing. We are now seeing far deeper and more comprehensive analysis completed as part of the due diligence process,” he says.

“Sellers who cannot provide a detailed analysis of their client base and revenue stream may struggle to convince a buyer to take on an unknown level of business risk. In addition, buyers are now also extremely wary of future remediation.”

Premium sale price

For those principals currently looking to sell their practice on the open market, the COVID-19 pandemic and subsequent share market volatility has seen most sale discussions put on hold. Quite rightly, advisers are focusing all of their immediate attention on their clients and staff while working hard to ensure everyone emerges from this crisis in the best shape possible.

However, in the medium-term, the pandemic is adding extra stress what could be the ‘perfect storm’ for some practice owners.

“Revenue, assets and profits will all be down which, regardless of the valuation methodology, will negatively impact on the capital value of the business,” Bertino says. “Unfortunately, the results for those owners with no choice but to sell their business in this marketplace remain problematic at best.”

“However, as has always been the case, those businesses that can control the timing of their sale and are able to prove to the market they have a quality asset will continue to attract a premium sale price and more favourable terms and conditions.”

Bertino also cautions those looking to merge their business or contemplating an internal buy-out that the transition process generally takes longer than people expect.

“It’s extremely rare that there’s such a thing as a simple, straightforward transaction that goes through without any hitches at all,” he said. “Our advice to clients is if you’re looking at an internal succession solution, then you should be allowing at least three to five years. Generally speaking, a rushed solution does not deliver optimal outcomes for any of the parties: the buyer, the seller or the clients.”  

Important: This article has been prepared without taking account of the objectives, financial or taxation situation or needs of any particular individual. Before acting on the information, you should consider its appropriateness to your circumstances and if necessary, seek appropriate professional advice. Any information used in this article is for illustrative purposes only. Rod Bertino is external and not a member of the Commonwealth Bank of Australia Group of Companies (the Group) and the content or any view expressed by Bertino does not represent an endorsement, recommendation, guarantee or advice in regard to any matter. CBA, nor members of the Group accept any liability for losses or damage arising from any reliance on external parties, their products, services and materials. Past performance is no guarantee of future performance.