The single biggest threat to an independent financial advisory practice with one owner or one primary advisor is not the lack of a succession plan; rather, it is the lack of a plan to ensure the practice’s support for its clients as well as the owner’s cash flow and value in the event of his or her sudden death or disability, whether temporary or permanent.
A continuity plan is not to be confused with a succession plan, two concepts that are often mistakenly conflated within the independent financial advice industry. A true succession plan is designed to seamlessly and gradually transition ownership and leadership to the next generation, while creating transferrable value for the outgoing owners in the process. The succession plan obviously assumes that the founder and all the advisors who are part of that plan will live long, healthy, productive lives and that each will remain a part of the same business for the duration.
But what if that doesn’t happen? That’s where a continuity plan comes into play. Put simply, a continuity plan is an emergency plan that assures a seamless transfer of control and responsibility in the event of a sudden departure from the practice or business of any of its owners, young or old, and whether by choice, through termination of employment, death or disability, or even partnership disputes.
While the continuity plan should ideally derive from the succession plan, for many independent advisors, it works the other way around -- continuity is the first planning problem to solve for because it poses the most immediate and serious threat to a lifetime of work and value, as well as to the clients’ well-being. For this reason, continuity planning can sometimes be thought of as a dress-rehearsal for the succession planning process.
It’s therefore vital that a successful independent advisor who wants to build a truly multigenerational wealth management firm create a continuity plan that avoids some of the worst potential pitfalls for either the advisor individually, or for the broader business that he or she wants to see endure for many years to come.
With that in mind, the following are six guiding tactics for building the strongest possible continuity plan for independent advisory firms:
1) Avoid valuation traps that lock the business into paying out a potentially unsustainable (or artificially depressed) level of value to a deceased or disabled owner and the owner’s heirs. Specifically, this means avoiding the use of a multiple of revenue or any static formula or a fixed-dollar amount (stated value) to determine the value of the business or any owner’s share of the business in a continuity plan.
When advisory firms fall into this valuation trap, they are in effect locking in a number that they must pay to the owners or their heirs in the years to come based on the trailing 12 months' revenue (or earnings) at the time of the triggering event. But what if there were one-time, non-recurring revenue spikes, such as a large, one-time annuity sale in the last 12 months? If you use the trailing 12 months to determine value in the future, then you capture that one-time revenue spike, even though it may not be sustainable moving forward.
To further underscore this point, remember what happened in October 2008? Using the trailing 12 months as the determinant of value under a continuity plan that was triggered at that time meant that the surviving owners of an advisory practice would have had to tackle a locked-in number without the revenue streams that supported its calculation. The same thing can happen when a partner who is subject to a regulatory event suffers a health issue that causes him or her to be disabled, causes harm to the company, and then has his or her value locked in place just before the revenues take a severe hit. Conversely, a negative one-time event in the 12 months prior to an owner’s sudden withdrawal from the business may artificially constrain value, as well.