The paradox in running a business is that from the very moment you start one, you need to keep its end in mind. In other words, the owners of private companies, whether they’re financial advisories or widget manufacturers, should build a company with the idea of selling it.
It doesn’t matter whether that sale is meant for profit or to pass the business on to family (or employees). This is where financial advisors, consultants and coaches play a crucial role.
The first step is to identify who you’re selling to, says Jeff Brown, president of the newly formed Stratos Private Wealth, a San Diego firm created to help business owners transition out of their companies. But no matter who it is, whether it’s a family member or an employee, that person is going to need time to take over to learn and make mistakes, Brown says.
“A business owner should be thinking ahead five years at a minimum to avoid having to perform triage on the business at the last minute when you are forced to get out,” Brown says. And yet financial firm owners may be the worst at taking their own advice. “Sixty percent of financial firms do not have a succession plan,” he says.
Time is the thing that trips up most sellers, says Jordan Smith, vice president of advanced designs at Schechter Wealth, a wealth management firm based in Birmingham, Mich. “Most business owners are focused on tomorrow and the short term, not the long term. They think they have more time to make these decisions than they actually do,” Smith says.
Business owners basically have three options, Smith says: They can transfer their ownership to a family member, usually a child; they can transfer to a key employee or group of employees; or they can sell to an outsider. Each choice poses different problems, but in any case the founder still needs to envision what happens to the company after he or she leaves.
If the plan is that a child will take over, the company founder needs to decide how to treat other children in the family fairly. If a key employee or group of employees are taking over, the founder must make sure the successors have the financial resources to buy him or her out or that arrangements are made to make it happen over time. This type of arrangement can also be used to provide the founder with ongoing funds during retirement, Smith says.
A key consideration for those selling to outsiders is who can add the most value to the company by bringing in capital or new skills, he adds.
“It’s important in each instance to ask a lot of questions to determine the mindset of the new owner or owners,” Smith says.
Some firms have come up with innovative ways to help advisories in particular make the transition out of the business. AmeriFlex, a hybrid registered investment advisor, has developed a program called SuccessionFlex that aids firm owners in selling part of their businesses, 30% to 40%, to AmeriFlex over a period of time. That allows the sellers to take some money off the table without having to make a clean break, which might be difficult. No equity changes hands at the time of the agreement, and the only requirement is that the advisor remains affiliated with AmeriFlex. Thomas Goodson, the firm’s president, developed the program with Larry Roth, managing partner of RLR Strategic Partners, a boutique M&A and strategic advisory firm. (Roth is also the former CEO of both Cetera and the Advisor Group.)
“What happens is that without advance planning an advisor is subject to the whims of the world where there might be no one to take over when they are ready to exit,” Goodson says.
Some business owners create their firms with the idea of selling in the first place, hoping to make a large profit before moving on to another venture. It’s a typical mindset in the high-tech space.
Adam Katz, a partner and private wealth advisor at the New York City-based Corient, is used to dealing with these types of entrepreneurs, who have different problems than owners who just want to live on their company’s revenue after retiring.
“Our typical client is 34 years old and plans to create a business and get out in five to seven years,” Katz says. “This is not your traditional family-owned business with an attachment to a brand, and it is not someone who wants to take a company public. It is someone who wants to go out and start another company, which he can then sell in five to seven years.”
On the other hand, this type of entrepreneur then has to think of a second or third act, Katz says.
Joshua T. Lieberman, a partner at Lenox Advisors, a national wealth advisory firm, says that sales become more complex when there are multiple owners. He was recently working with a company that had four owners, two of whom were ready to retire, while the other two wanted to remain in business.
Insurance products may be the answer in such cases. An insurance policy allowed the two retiring partners at Lieberman’s client firm to exit the business with buyout money while the other two partners remained whole.
Solo practitioners, meanwhile, might want to leave a family-owned business to their children, but the kids likely have different levels of interest in taking over.
Again, preplanning is a key to success. “It’s easy to find stories about families whose members are now estranged because of the dissolution of a business,” Lieberman says. “Our job as financial advisors is to get the family members to have these difficult conversations before it is too late. The same considerations apply to financial advisory firms as other types of businesses.”
A family can use legal agreements to keep a business going through the second generation, under either family members or employees; that’s why it’s important for an exiting owner to assemble the right team of experts that includes, but is not limited to, a financial coach, says Andrew James Lom, global head of private wealth at Norton Rose Fulbright, a law firm in New York City.
Various agreements can be crafted to ensure that key employees remain with a firm when it is passed to a new owner, and also make sure that a percentage of key customers remain with the company.
“As much as an owner is trying to build a business, when he or she is ready to leave, the person has to have designed a structure that a buyer will want to buy,” Lom says. “For instance, a buyer may want key employees to stay with the firm for a certain amount of time.” That can be part of the buy-sell agreement.
A business might otherwise be sold to a trust to limit capital gains taxes, particularly when it is a family situation, with payout provisions to the owners.
“People talk about mindfulness and intentionality, and if you have the legal agreements in place ahead of time, the exiting owner can consider both the psychological implications and tax implications of a sale,” Lom says. “If situations change, the agreements can be changed. A successful sale needs a lot of thought from the financial advisor, the lawyer and the accountant.”
If preplanning is not at the top of a business owner’s to-do list, the government is liable to take a bigger bite out of the company profits than necessary, says Robin Patin, wealth manager at Choreo Advisors, a national financial services firm based in Chicago with $14.8 billion in AUM. There needs to be a five- to seven-year run-up to any sale.
More companies fail than succeed at getting the best structure, Patin says. “It sometimes takes years to set up the right tax structure, but it is often difficult for an owner to envision a company without him or her at the helm. I see companies sold all the time where excess taxes are paid because plans were not started soon enough. There is no time machine to turn back the clock to do it right.
“Business owners are used to being masters of their own destinies, and this is a time when they have to rely on the right team of experts instead,” she says.
These issues can be overwhelming or paralyzing to someone ready to leave a lifetime of work behind, says Anne Marie Stonich, chief wealth officer with Coldstream Wealth Management, an advisor-owned firm based in the Pacific Northwest.
“This is the owner’s chance to translate a lifetime of built-up value” into a legacy," Stonich says, “but the owner has to decide what her ‘number’ is. The business owner is fortunate if someone in the family wants to take over, but it is more likely key employees will be ready. The other question that has to be decided is what role the original owner will play in the transition process. These decisions are the things that keep the owner up at night.”
That is why it is important to start thinking of the details years, and not months, ahead of time, Stonich says.