The road to an internal succession plan may be lined with good intentions, but there are common speedbumps that everyone—from the founders through the second and even third generations—need to keep their eyes on, according to a panel of former RIAs who made the transition successfully.

The three veterans of the advisory industry shared their experiences and lessons learned in a webinar this week, “Building the Foundation for Your Internal Succession Plan,” hosted by San Francisco-based DeVoe & Company, an advisory firm strategic consultant.

Jane Williams was a founding partner of Sand Hill Global Advisors, with $3.5 billion in assets under management; Peggy Ruhlin, was a second-generation partner and eventually former chair of the board of directors at Budros, Ruhlin & Roe, with $3.3 billion in AUM; and Tim Kochis was former CEO and chairman at Aspiriant, with $14 billion in AUM. All three of them are now DeVoe succession planning advisors.

Three of the common themes that all firms eyeing internal succession must explore are why they’re doing it, what it is that they’re doing and who they’re going to enlist as the next standard bearers of the firm, the panelists said.

For the most part, the majority of firm founders or original partners will face these issues of internal succession at some point in one guise or another. DeVoe recently surveyed RIA principals, and 49% said they preferred an internal succession, with another 18% wanting a hybrid of internal succession combined with external succession. These statistics were true even in a world where high valuations often presented sellers with offers from the outside that were hard to refuse. Only 33% wanted solely external succession.

Williams said that she, in fact, had done it both ways, and with the same company. Her firm went through a sale to an external buyer in 2000 in order to accommodate two retiring partners. Then she and a group of younger partners bought the firm back in 2009, and she has since retired.

“I really advocate for internal successions if they can be done. They’re really important,” she said. “Everyone needs a turn at the wheel.”

Reasons To Keep It In The Family
The best reasons for internal succession over an external sale are that it’s better for clients and staff, Kochis said.

“The economic activity of the firm should stay as close as possible to the people who are delivering the service to the client,” he said. “It’s the basis for a business that can be very durable, the idea of a permanent firm.”

Twenty-five years ago, there weren’t readily identifiable acquirers with a lot of cash to make RIA acquisitions, so internal succession was for many the only option other than close, Ruhlin said.

“The situation is different now, but that just wasn’t happening back then, so we wanted to try to build an exit strategy for the two of us who were the founding partners even though we were nowhere near ready to retire,” she said. “But we knew we needed to start it sooner rather than later.”

Ruhlin said she wanted to grow her company, and in order to grow she needed help and additional partners. “We couldn’t clone ourselves. We couldn’t meet with every client and manage everything that needed to be managed.” The best partners to do that, she said, would be real partners.

“People who had skin in the game, who actually had an ownership interest in the firm,” she said. “So that’s what made us pursue our internal succession strategy.”

At the core of that decision was the understanding that their clients expected the firm to be a permanent firm.

“If we just decided to turn out the lights one day, what was going to happen to them? If we got hit by a bus one day, what would happen to them?” she said. “They needed to know we were running our business as well as we were trying to help them run their financial lives.”

It also would have been irresponsible to her employees, she said, as they were expecting to have long careers that lasted past the tenure of the founding partners.

Kochis said it doesn’t matter which reason comes first, as both clients and staff are essential. “The motivation behind internal succession is some combination of doing the right thing, of doing the best thing, for clients and staff,” he said.

Ownership And Management Face Transition
At firms where the founder still holds the reins, the line might be blurred between ownership and management, but that is just an illusion.

“A very common conceptual mistake I’ve seen many people make, particularly founders, is to believe that these two transitions are actually the same—which is anybody who becomes an owner has some role and some authority for management,” Kochis said. “And that’s not the case at all.”

The larger the firm, the more owners there are likely to be, he said, but fewer managers. And the two transitions don’t have to happen at the same time, either.

The first thing, Kochis urged, is to expand the ownership. “That’s the easier transition.”

When is the time for that? Whenever the founding partners have enough, he said.

“That’s the time to start transitioning ownership of the firm to other people, to give those people opportunity to build their own wealth, to give them a stake in the long-term success of the business,” he said. “But not necessarily to have a management role.”

That is a separate proposition, he said.

Williams agreed, saying at her firm it became clear that some people confused ownership with management.

“They thought that by virtue of their stock status they had the authority to act like they were running the place. And that was a lesson,” she said. “Everybody has their role, but they can’t cross over and change the rhythm of the firm by throwing their weight around.”

Ownership, she said, should be seen an indication that an employee is ready to earn in a different way, and even have responsibility and risk in a different way. But it’s not an indication that their role is changing.

Kochis said there is a hierarchy of decision making that should stay with management. Owners of course should have an opportunity to weigh in on big business decisions, like whether to open up a new office, but it’s just an opportunity to be heard.

“In the day-to-day management, their being an owner should convey no power,” he said. “It’s just sharing in the economic opportunity the business presents.”

Identifying Future Leaders
Not everyone is cut out for leadership. But very few people naturally have all the talents and skills required to run the show from the day they join a firm, the panelists agreed. It takes time and attention to nurture younger careers so that the older partners can step away.

That way someone on the investment side can morph into a great client manager, or the head of research can transition into being head of wealth management.

“A firm that is dominated by people in their 60s is going to have a hard time with a transition unless they actually change the way they look at themselves and the company. That almost sounds like an outside transaction because you can’t bring somebody in in their 40s and 50s and expect them perform right away necessarily,” Ruhlin said. “They have to learn the process and so on. It’s really important to pay attention to your age demographics and to recognize it takes a long time to make a transition.”

Helping employees add to their credentials and try out different aspects of the business without fear of failure are ways to support them and give them breadth. Of course, the longer there is until the transition has to happen, the easier the going will be.

“Someone in their 60s will have a difficult time with this if they haven’t done any of the development work we’re talking about, but it’s never too late to start,” Kochis said. “People are still involved actively in delivering services well into their 70s in this industry. So someone who’s 62 still has some runway to work with. But people who are younger have no excuse for not making the kinds of investments in the future of their firm that we’ve been talking about.”

One issue that comes up often for younger staffers is finances, and that can be an obstacle, Ruhlin agreed, but not an insurmountable one.

“We had no trouble getting a bank to finance our new shareholders into buying their shares. They worked around making their payment plan dependent on the dividend distribution (we were an S corporation),” she said. “And it was very easy for them. If our multiple had been a lot higher I don’t know whether it would have worked the way it did.”

That all-important multiple will be lower with internal succession plans than with external sales, she said. “The discounts are minority discount and lack of marketability discount, which combined range from 20% to 30%.”

Kochis added that he is not aware of any internal transaction that didn’t involve some kind of discount to what would have been a third-party price.

“For all the reasons why internal is good—the best deal for the client, for the staff—there is going to be a discount,” he said. “But there’s a psychic reward for doing that. It’s not dollars, but it’s real.”