Here's how two advisors made an internal succession plan work.

    It's not that buying and selling practices don't serve a worthwhile purpose. Buyers are exercising an excellent option to rapidly grow their businesses. And sellers are implementing a practical option for creating a succession plan. But that's just it ... it's one of many succession planning options.
    In fact, in his Succession Planning Strategies for the Financial Planner: A Complete Resource Guide (Financial Planning Association, 2005), David Goad, ChIC, lists six possible succession planning options: 1) Selling or transferring your business to a family member; 2) Selling your business internally to employees; 3) Selling your ownership internally to partners; 4) Selling your ownership or assets to an outside third party; 5) Merging your business for succession; and 6) Utilizing the unique succession strategies of consolidator firms.   
    This article is the first in a series on succession plans that fall into the categories other than number four above. The option John Henry McDonald, founding owner of Austin Asset Management in Austin, Texas, chose was to transfer his ownership to an employee.
    McDonald went through financial services boot camp with IQS, eventually leaving to start his own comprehensive planning firm in 1986. Although he started Austin by himself, McDonald hired his first intern soon after opening his doors. Of that experience, he says, "I always intended to build a large practice, so I started with succession planning in mind." To which Goad would say that it's imperative an advisor do succession planning at all stages in his practice development; how else can one create a business without knowing what his or her end-game is going to look like?
    McDonald knew that his end-game would eventually mean transferring ownership to an insider-he just didn't know at that time who it would be. "My first hire was Matthew Reading. Matthew was still in his senior year of college. I needed someone who had a computer, so I told him, 'I have a business.' Matthew said, 'I have a computer.' We both lied."
    Reading went through the COP program while interning with Austin. "His intern program here was just a kid hanging around," McDonald explains. "We have a more formal internship program now." Ten years later, in 1997, Reading owned 10% of Austin's shares, while McDonald retained the other 90%. But Reading ultimately sold his shares and McDonald parted ways with him.
    "What went wrong is we became a business. In the beginning, we were just a bunch of guys doing our thing. I'd often leave early to go bike racing or play blues guitar while the guys would run the portfolios. Some days we'd all take off early. When we finally moved away from that work style, Matthew didn't come along."
    Eric Herman, Austin's current minority shareholder, came on board in 1997. Says Herman, "Around that time, we began doubling our revenue every year or two. In 1997, it was $200,000; by 2001, it was $1 million, and we were up to seven or eight employees." Austin will gross $2 million this year.
    Herman reiterates McDonald's assessment of Reading: "Matthew still wanted lots of free time, but hard work was beginning to occur. We had to have procedures and policies."
    Says McDonald, "Matthew helped build this firm, and anybody who does that has a right to the value they've produced. So he exercised his [option to sell his] shares."
    Austin's brisk growth during this period stemmed from McDonald having dropped his securities licenses in 1994, which positioned him for recognition by several national publications. "We got picked up [on the 'best advisor' lists] by Medical Economics and Worth magazines, and things really took off," says McDonald. To keep up with this growth, Austin has since grown to 14 employees-nine professionals and the rest administrative.
Reading left Austin in 2002 after working 14 years side by side with McDonald. Having been through the experience of selling and then having to repurchase shares from an employee, would McDonald create a different game plan for Herman? Herman says, "I didn't have a path in sight when I was hired. Matthew was investing money. John Henry was quoting fees to people and doing their financial plans. I just came to learn how to do that."
    Austin's revenue had been flat for the three years before 1997. Although Herman initially did some financial planning, a more natural groove for him seemed to be that of finding ways to boost the firm's productivity. He ultimately settled into taking responsibility for the financial operations of the business. "I was running QuickBooks, doing case management, and overseeing quarterly reporting to clients. That freed up John Henry to do more marketing. After just a year, we were supporting two financial planners and we'd hired another employee."
    "In those years," says McDonald, "I asked Eric to keep track of his experience and make it repeatable, so we could create an intern program. I gave him all the rope he could handle to see what he could do. That's what you do with bright people-give them more responsibility, then more money, then more responsibility, then more money. ... By then, he was starting to be very important to the operation of our firm, for which Eric has a real genius."
    It seemed natural, then, that Eric should become an owner, which he did in 2000. He also formally became Austin's CFO/COO. "The way we explain it to ourselves," says Herman, "is John Henry catches the fishes and I fillet them. That is, I build the structure to support growth and service."
    And so, Austin's succession plan evolved. In 2000, Herman bought 10% of Austin's shares from Reading who, by that time, had acquired 30% of Austin; therefore, Herman owned 10%, Reading 20% and McDonald 70%. It was time for the shareholders to decide if their desired future paths were parallel or perpendicular. Explains Herman, "Matthew's intention was to have a comfortable lifestyle, John Henry wanted to work till he ran out of breath, and I wanted to grow the firm indefinitely."
    After Reading departed, Austin's succession plan acquired another layer of sophistication. "I've set personal goals for transferring this firm to the next generation," says McDonald. "We now have voting and nonvoting classes of stock. Of my 70% ownership, half is voting and half is nonvoting. Eric, who later picked up Reading's other 20%, owns strictly voting stock. In about ten years, when I'm 67, I still want to have a majority of the voting shares, but I want to have sold my nonvoting shares."
    McDonald sees employees growing into their jobs and into new levels of management who will earn the right to buy these shares. However, Herman is now the heir apparent to Austin's ultimate ownership.
    So where does Herman go from here? Says McDonald, "We had a conversation about Eric getting more than his 30% ownership, and I'm not opposed to that. I've always said that when Eric turns 45, just as I turn 70, I'll be at the crossroads," an apt metaphor for a blues musician.
What will that mean? For starters, Herman will need to figure out how Austin will be marketed if McDonald is no longer involved with the firm. How will Herman replace the firm's chief rainmaker?
    "We now have a marketing committee," says McDonald, "but there's no one individual who could replace me right now. Maybe we'll hire a public relations firm. This is the first time we've had a budget for public relations. We're not sure if there needs to be one 'star' in the company in order to get P.R. done. We're looking at lots of ways to do it." Adds Herman, "One of the marketing committee's roles is to figure out how to use of our resources to expose Austin to the right markets, not how to get me or John Henry in front of people, per se. We've worked very hard at branding this firm."
    And what will happen with Hehman's stock ownership and ultimate control of Austin? "I figure a big company may come in and offer to buy us, and there will be a decision to be made-probably more Eric's and the younger shareholders' decision than mine," says McDonald. "If Eric wants to sell and go be a golf pro, that may happen. Or maybe he'll sell but continue to be employed by the firm. I may sit on the board or continue marketing for the firm."
    If the white knight doesn't come along with a purchase offer, Herman and McDonald will face the decision of whether or not to have Herman buy voting control away from McDonald. "My intent is to take over a majority of this business when John Henry's ready to let go," says Herman, "perhaps with three or four strong owners behind me. I know I would prefer to have a majority [of the voting control] when he lets go of it."
    "Which is why we developed two types of shares," adds McDonald. "We can sell 35% of the business without adjusting control. A decade from now, the voting-class share ownership could be the same as now, with the non-voting shares owned by many people." McDonald and Herman could also maintain control and still sell small pieces of their voting shares, if they wanted to.
    Their plans may seem haphazard but, says McDonald, "We've talked about this topic a lot, and we've had coaches and consultants helping us along the way." Adds Herman, "When Matthew left, John Henry and I decided to turn a firm built on his back into a business that would be here throughout my life, so we've spent the last four years being very serious and methodical about that."
    Perhaps the best evidence of the value they've created and the motivation Herman feels is Austin's climbing stock price. "Matthew bought his 10% share in 1998 for $16,000," says Herman. "I bought that share from him in 2000 for $38,000. When I bought my other 20% just two-and-a-half years ago, it cost me $170,000, and now the value's even higher. Today, a 10% ownership would cost $200,000 using a one-times-gross-revenue multiplier."
    "And now we use a higher multiplier," says McDonald.

David J. Drucker, M.B.A., COP, an independent financial advisor since 1981, now writes, speaks and consults with other advisors as president of Drucker Knowledge Systems. Check out his new, indispensable practice management portal-Practice Lifecycle at Virtual Office News, the only monthly practice management/technology newsletter for financial advisors, at