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.

 

2) Your continuity plan should be a living, breathing document that is regularly updated to reflect reality, and should be reviewed in tandem with any buy-sell agreements.  As a first step towards this end, independent advisory firms should have their businesses undergo a professional valuation process.  Based on the results of that valuation, advisory firms should actively review the buy-sell agreements they have with their broker-dealer platforms once each year. 

A routine review of the agreement can help business owners ensure that their document takes into account changes in personal circumstances or changes in the business itself, and provides for evolution of the plan and the business valuation mechanism. That way, the continuity plan will be ready to do the job when you need it most.

3) When it comes to your buy-sell agreement, drive for maximum clarity in understanding the payment terms. Independent advisory firms should never guess at the payment terms contracted for in a buy-sell agreement, or simply plug in a number that seems about right – something that happens far more often than you might believe.

We recommend using a spreadsheet format to calculate the after-tax effects of buying out an exiting partner, and to take into account the business’s overhead structure, growth rates, cost to replace the lost talent, interest rates, etc.   Remember, one of the goals of a buy-sell agreement is to ensure that the company survives the buy-out process. Take the time to do the math from the outset.   

4) Make sure you understand how “disability” is exactly defined within your continuity plan.  Many business owners simply trust the standard attorney boilerplate language to define when an owner is disabled and must be bought out, or must sell. The reality of most disability cases is not the sudden and completely debilitating, near-death single event such as, say, an auto accident.

Instead, it is often something more subtle, some health issue that starts and stops for uneven intervals over many years, or it is the disability or medical condition of an advisor’s spouse or child that significantly alters their involvement and effectiveness on the job. Study the definition in your agreement carefully and make sure it fits the circumstances of your industry, your business, and your life.

 

5) Address what happens in the event of an involuntary departure of an owner in the practice.  In instances like these, the treatment of the departing owner may depend upon the circumstances surrounding the departure. An owner who is asked to leave as a result of a difference in goals and objectives may be viewed very differently than a person who leaves because of performance issues or, even worse, regulatory violations. Draft these considerations as early as possible, while everyone is getting along well and these issues are still merely theoretical.

6) Address the potential “demographic crunch” in instances where there are two or more senior owners of similar age. An internal buyout arrangement can require as many as seven to ten years or more to payoff from operational cash flow, after taxes, and after replacing the exiting advisor owner. This makes the process impractical for a single remaining owner in his or her late 50s or early 60s. One commonly used solution is to set up an internal ownership track that provides an opportunity for the next generation to step in on a continuity basis and purchase the exiting owner’s shares or interest.

When it comes to continuity planning, successful independent advisors should never settle for something that is “better than nothing,” and should treat the formulation of a continuity plan with the seriousness it deserves.  Advisors owe it to themselves, their heirs, their business partners and their clients to have in place a continuity plan that provides maximum fair value to the owners, and balances that with a sustainable financial structure for the firm the owners leave behind.

While none of us wants to believe that our association with our business partners or shareholders may someday come to an end, as it relates to a continuity agreement, it is always good to remember that, one way or another, you will part ways someday with your business, your partners and your clients.

It is important to plan for such events well in advance – especially for those scenarios where the exit may happen in unexpected ways.

David Grau Sr., JD, is the president and founder of FP Transitions (www.fptransitions.com), which partners with independent advisors to build businesses of enduring and transferable value.  The above is adapted and excerpted from his first book, “Succession Planning for Financial Advisors: Building an Enduring Business,” published by John Wiley & Sons.