Practice Management is a key area that broker-dealers have identified as a way that they can provide value to their affiliated advisors, and one of the main areas encompassed by practice management is clearly the area of succession planning.

The reason that B/D's, and outside consultants as well, can provide a lot of value in helping with succession planning is because it is so misunderstood in the field.  You get the feeling that it is one of those areas that a lot of financial professionals really think will take care of itself when the time comes - like planning your own funeral (undoubtedly in a subconscious way). It is something that when the time comes, it will get taken care of, somehow. But, once delved into, the ugly realities surface, and near panic can ensue. To understand this, we must go back in time to discover what has lead us to this point.

In the early days, before financial planning and financial advice ascended to the place it now occupies, the few people who engaged in it probably worked in the trust department at a bank. As for the vast majority of Americans, they bought their investments, stocks and bonds mainly, sold to them by their broker - a salesman. Same with insurance. In fact, insurance professionals in those days, the days before "agents," were actually called insurance salesman (I use the male tense, since in the early days it was an industry pretty much dominated by men). Being a salesman wasn't a derogatory term back then.

The broker sold a stock to the client and received a commission for having done so. Likewise with the insurance salesman. The very best went on to become top producers at brokerage firms or to have their very own insurance agencies. But still, every morning, they would have to get up and sell something since, in jungle parlance, you could eat only what you killed. You didn't sell, you didn't make
any money.

Closing a client and getting good referrals from them were the ways that you were taught to survive in the business.  Keep going back to clients who already said 'Yes' and then talk to their friends, family members and co-workers to keep making money and stay in business.

You could annuitize your business, slightly, by getting annual renewals on insurance policies you sold and, as a broker, if you kept buying and selling stocks to the same client (churning, in essence) you could get the commissions on both sides of the trade. So, that at least took some of the pressure off since these existing clients could be counted on for future business, and as you built your book, the more future business you could possibly count on. End of the year bonuses to top sales people helped as well. The better the producer, of course, the larger the bonus. Top, top producers were certainly in 'Fat City'. Cash, cars, trips, a Rolex, all went to top salesmen.

Still, through all of this, a producer had to keep on selling. The thing that set them apart from 99% of the general public was one thing - their ability to close. They could close sales and keep the money coming in - and they didn't get tired of it. Each day, day-in and day-out, they could get up in the morning, go back out there and keep closing. Not an easy thing to do, at all. And this is where all of the trouble with succession planning begins. Who knew, with certainty, what would happen tomorrow?

Oh sure, as long as the top-producer and major rainmaker was still out there, still breaking his back going after sale after sale, producing as he had been for decades, an accountant could, more or less, sort-of annuitize that. You could take years of production and average it out over, say, five years and come up with a reasonable estimate - or a reasonable valuation.

But, my friends, succession planning and the sale or transfer of a practice isn't about that. It's about the transference of that practice from that producer to a new one. And, as we all know, even if the new producer is pretty good in their own right, this is a relationship business. Clients are very much like juries. Who knows what they are going to do? Will they like the new producer taking over? Will they decide that now is the time to listen to new pitches from new financial planners wanting to work with them? Who knows. And that is very hard to evaluate; after all, in this situation, just what can you count on?

So, the time has come. The lifelong, successful, producer decides it is time to retire and wants to sell their practice. They have done well. They have earned six figures a year, for years now. Their clients love them.  They invite them to their homes for barbeques, invite them to weddings and christenings, they play golf with them and yes, even attend their funerals, unfortunately. The producer has dabbled somewhat with fee-based accounts, but its probably less than 10% of the assets invested by their clients. The veteran producer, however, feels very good about their book, their clients and the fact that they've taken, maybe millions out of the place, all told, over all of the years. It's got to be worth a lot.

They call someone like a Moss Adams to come in and tell them what the place is worth, or find one of the firms that matches sellers with buyers. The accountants descend upon them, pull out their microscope, delve-in and look at the practice and, suddenly, it is worth a fraction of what the producer thought it was worth.

Turns out that the accountants are having a hard time finding the one thing they want to see: recurring revenue streams or income streams. The problem is that there basically aren't any. Some trails off of mutual funds, some fee-based revenue thrown off of a few TAMP programs they sold and some insurance renewals. And that's it. The producer finds out that the practice is worth maybe one-times trailing 12 month gross dealer concessions, or something not far away from that.

It is at this point that the selling producer either comes close to having a heart attack, goes into shock or nearly explodes. After all, this has been a successful business for decades. The practice generates a million-plus in annual GDC. So, how can this be?

It is explained to them that, sure, it generated a million plus in GDC, but that was with them at the helm. No telling what could happen once they are gone. And, second (and most important), they didn't annuitize the thing. Their generation of recurring revenue is a fraction of that annual GDC. There is basically no income stream, upon which, can be counted.

I call the situation the producer now finds themselves one of "reverse sticker-shock." The price is so low that they find themselves in a near catatonic state, and so, do nothing.

The moral of the story is two things. First, when you are valuing your practice, look at the income stream that has been created. How much recurring revenue can be counted on, with you or without you? Have you sufficiently annuitized the thing? Fees, trails, renewals. That's about it. What are they bringing in each year? That is really what the lace is worth in a strictly monetary sense.

Next, if you are going to transfer this practice to a junior partner, or an existing full partner, or a colleague or another firm entirely, you had better start the process early, and allow your clients sufficient time to get to know them and to get comfortable with them - or they could easily jump ship once you are gone.

Any practice consolidator or roll-up or any firm that specializes in acquiring financial services practices is going to be seriously  concerned about not just number one above, but number two as well. After all, what reasonable assurances can be given that once you are gone that those clients won't disappear also? And don't think they won't think of that - believe me, they will. Both things must be in place.

You must annuitize your practice, and create a good strong income stream of recurring revenue - and you must have your successor firmly in place and already on sound footing, with a good relationship with the clients. In short, they must go from your clients to clients of the firm.

In the end, this is still firmly a relationship based business, and that will never change. Clients want to deal with someone that they can trust, and that trust is not earned over night. You can't pack-up and jump-ship and expect them to stay on board.

There are lots of other contractual and legal matters that need to be settled as well, like how you are going to be paid (I wouldn't expect it to be all-cash and all up-front, honestly, or you'll be selling at a significant discount), but this article was simply written to outline some of the most obvious problems with succession planning, and I find that they are the two things discussed above: Annuitization of the practice and the succession, or transfer, of the book of clients to the new financial professional from the old.

And one last thing - get yourself a good lawyer. The buyer is going to have one and probably one that just works in this area all day long. You need a good one too, one who is a specialist or, trust me, down the road, you are going to realize that you did not make the deal you could have, or that you should have. Your family lawyer, with all due respect, is not the attorney you are going to need in this
matter.

James Manouse is founder of todaysadvisor.com.