The RIA industry and CFP movement was born in the 1980s. Investors stopped listening to EF Hutton and other broker-dealers, and started working with fiduciary, fee-only advisors that put their clients’ needs above high commission wages. These industry pioneers are now retiring or building succession plans for their business as they contemplate “what’s next?”

According to recent surveys of RIAs, 64% of RIAs either don’t have a succession plan in place or don’t plan on making one. Further, and according to separate research by Cerulli Associates, around 43% of all RIAs owners are 55 and older, while just 7% are less than 35 years old, meaning succession planning should be a priority but isn’t. It is important for RIA owners with next generation talent to put in place a formal succession plan preparing for that eventuality or paving the way for a successful third-party sale.

Founders underestimate the time, complexity and level of preparation necessary to complete a successful sale of their business whether that be an internal sale to G2, or to a third-party buyer. Indeed, in preparing for an internal succession founders must address many of the same considerations as if it was an external sale. Specifically, is valuation fair, is this right for my clients, does this transaction provide continued employment and career path opportunities for my staff?

G2 – A Succession Path Forward

A. G2 Adds Value, Creates Transition Option

Before you can sell to G2, you first need one. Having next generation talent necessarily means you have reached a level of success in your business that can support multiple advisors (CFPs). Advisors that also possess the skill set and desire to lead and manage are also rare and valuable in either an internal or external sale. With these resources in place, you are well positioned to establish a G2 succession plan.

B. Retaining The Talent

I was involved with a transaction where the founder had strong G2s but they were not equity owners and no internal succession plan was in place. The G2s serviced 50% of the firm’s clientele, they felt they “owned” those client relationships and would take the clients with them unless they were rewarded for their contribution to the firm upon sale. Given ours is a relationship business, and the lion’s share of the client relations were managed by the G2s, I worked with the founder and G2s to put in place a Phantom Equity plan. This enabled the next generation advisors to become equity owners prior to our sale and thus, had “skin in the game” allowing them to profit by the sale, continue serving clients and holding leadership responsibilities as the founder phased out. 

Because the founder had none of this architecture in place prior to our transaction, it extended the length of time it took to close the deal as we restructured the business, and ultimately put less money in the founder’s pocket because he had failed to do the necessary internal planning before listing his company for an external sale. Had he completed his succession plan prior to going to market, that preparation would have suggested to any buyer this business was at least partially institutionalized, G2 was intact and staying with the business on sale, and the roadmap for founder’s transition to “what’s next” was already contemplated. This level of preparation and planning would have commanded a higher valuation for the business.   

C. Valuation Is Required For Both Internal And External Sale     

A G2 succession plan requires valuation of the business so next generation talent knows the value of the whole firm, any minority shareholder discounts, voting rights, profit splits and cash call rights. Understanding that value allows G2 to buy into the business with capital and /or sweat equity. The same valuation methodologies used for sale to third parties, are used in internal succession plans. There are three generally accepted valuation methodologies: (i) discounted cash flow analysis; (ii) multiple of net income or EBITDA; and (iii) multiple of top-line revenue. Finally, while every buyer has a preferred valuation methodology, the most important aspect to any valuation is establishing a GAAP supported EBITDA. Having a fully supported and verified EBITDA is the single most important factor in determining value—not the valuation methodology.   

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