Many financial advisors drag their feet when it comes to finding a successor, especially if there's no internal candidate to fill their shoes. With each passing year, this becomes a bigger problem for procrastinating baby boomer advisors (at least those who don't work in wirehouses). And that makes it a problem for the industry in general.

Although many advisors would rather "die with their boots on" than transition their practices, the welfare of their clients depends on finding a worthy successor well in advance.

In Part I of this article, we outlined the pros and cons of finding someone already working inside the firm to take over your business. Now let's look at the major pluses and minuses of looking outside.

The Pros
Getting top dollar for your firm. Over the last decade, as the industry has begun to recognize the intrinsic value of a book of business, the valuations of financial advisory practices have increased. Five years ago, advisors were clamoring to purchase practices so they could grow. That mania has subsided somewhat, but there are still plenty of interested buyers out there, especially for certain kinds of firms. With listing services such as the ones offered by FP Transitions, sellers can advertise an available practice to a wide pool of potential buyers. They will have many suitors from which to choose-and might even set off a bidding war. An external search typically yields a bigger group of qualified candidates and increases a seller's chances of getting the best price for the firm. That's a big advantage over grooming an internal successor.

Top dollar or top candidate? Of course, many advisors would prefer to find the best replacement rather than sell to the highest bidder. And it's not just because they want to do right by their clients but it also serves their own financial interest: Many deals have an earn-out component, in which the buyer of the practice makes ongoing payments to the seller based on the firm's revenue. That means the new advisor must fit well with the clients to retain them, otherwise the selling advisor won't get paid.

Let's say the retiring advisor receives a third of the value of the practice as a down payment, and two-thirds is structured as an earn-out over a period of five years. That means it's important for the new owner to get along with the clientele. Even if the buyer offered 50% down, the seller could end up with much less than the practice is worth if that buyer can't retain the clients.

In an extreme case, all the firm's clients might leave the new advisor, which means the seller earns nothing beyond the down payment. Thus, because of the way most deals are structured, sellers have a vested interest in finding a qualified replacement.

The Cons
A big investment of time and energy. While choosing an external successor may help you get top dollar for your firm, narrowing down the field of candidates often requires a significant investment of time and energy. Imagine this scenario: You decide it's time to transition your practice, which is located in South Dakota, so you bite the bullet and announce that you're looking for a successor. By using a listing service and networking with colleagues, you receive far more inquiries than you'd expected. Although you specified that only those willing to move to South Dakota need inquire, you still get responses from dozens of interested advisors, including:

A 40-year-old independent advisor (affiliated with a different broker-dealer) who lives just across the state border and has 15 years of experience;

An advisor with a small practice whom you don't know but who's affiliated with your broker-dealer;

A career changer with a Series 7 registration and two years of entry-level experience who grew up in the region; and

A California-based enterprise that's expanding across the country and says it will find a local advisor to operate the firm on its behalf.

Although it's exciting to see so much interest in your firm, sorting through a pile of prospects can be a chore. And your work doesn't stop there. Once you've narrowed the field somewhat, you'll need to use the "six C's" to evaluate buyers:

Compliance/legal review. Early in the process, it's prudent to check the compliance history of potential buyers. A quick review of FINRA's BrokerCheck is a good place to start. Also important but often overlooked are the buyer's ADV, credentials, licenses and insurance appointments by state. It's also wise to ensure that a buyer isn't subject to noncompete agreements or involved in any legal disputes.

Capacity to purchase. You don't want to wait until the last minute to find out whether a buyer has the capital necessary to buy. If the buyer can show you that he is preapproved for a loan-for example, from his broker-dealer-that will give you peace of mind early in the process.

Chemistry with the buyer. The relationship between buyer and seller is key to the success of the deal. Often, buyers want the seller to exit once all the client introductions have been made. But this might not be what the seller had in mind. Instead, she might have imagined keeping a foot in the door of the business indefinitely. The potential buyer's intent is also critical.

Increasingly, large firms are accumulating assets by buying smaller practices and assigning a staff advisor to manage the client relationships. The buyer's intent always comes out eventually, but sellers should clarify what that is early on.

Chemistry with clients. Most advisors exiting the business have strong, long-term relationships with their clients and are eager to ensure their continued financial well-being. But the bigger the deal's earn-out component, the more the seller needs to be concerned about the buyer's chemistry with clients; otherwise, his or her own retirement finances may be in jeopardy.

Continuity of investment philosophy. Most sellers seek a buyer with investment philosophies similar to their own. For example, if the seller has never advocated variable annuities or alternative investments and the potential buyer's clients have portfolios full of these products, that buyer probably isn't the best match for the firm. Just as a potential buyer looks at the makeup of a seller's book of business, the seller should assess the potential buyer's book for insight on how he or she actually practices.

Common factors. The buyer's geographic location and current broker-dealer are critical aspects to consider. During a transition, clients may think about going elsewhere, so the less change they experience, the better. That's why sellers typically seek buyers in the same geographic area and those associated with the same broker-dealer. The buyer's age may also be a factor. Clients who are worried about their 69-year-old advisor's longevity may not be comforted if he sells the practice to a 60-year-old advisor.
On the other hand, a deep-pocketed young buyer may be able to make a down payment on the practice, but clients might equate his youth with inexperience.

Of course, no matter how much time and effort you put into conducting your due diligence and negotiating a deal, sometimes things don't work out. Roadblocks go up, as they do during internal sales, so you may need to change course. Just another reason to start the successor search well before you plan to retire or need to exit the business.

Using an outside broker. An alternative to doing it all yourself is to engage an outside firm, such as one of the listing agencies or your broker-dealer, to negotiate the deal. Some broker-dealers bend over backward to support transitions that will keep assets with the firm, offering succession planning services or making loans to advisors for the purchase of a book of business. If you choose to hire an external listing service or business broker-and there are some excellent options available-expect to pay 3% to 8% of the firm's valuation price for the service. Keep in mind, however, that this fee may balance out the premium price you might get from selling to an external buyer.

Time To Get A Move On
When evaluating external successors, advisors often look for an exact replica of themselves. Remember, while it's critical to select the right person to take over your practice, you'll never find a carbon copy of yourself. Sometimes, the unending quest for the perfect candidate simply becomes another way to put off succession planning.

I've said it before, but it bears repeating: Whether you choose an internal candidate or search externally, succession planning takes time, so it's best to start early. This certainly isn't the last article you'll see nudging you to get serious about succession. Indeed, as early boomers in the advisory business turn 65, the topic is just beginning to heat up.

Joni Youngwirth is the managing principal of practice management at Commonwealth Financial Network, a registered investment advisor, in Waltham, Mass. She can be reached at [email protected].