The question is, how much client relationship management should the senior advisor delegate to the junior? On one hand, the goal is to help the junior develop professionally so that he or she knows the clients and has the confidence to take over the firm. On the other hand, if the junior and senior have a rift, the junior may leave and possibly take the firm's clients along.
Potential for misunderstanding. Without clear succession time frames and expectations, misunderstandings can arise. For example, a junior advisor who has put in sweat equity over the years may well expect that to factor into the valuation of the practice if he or she eventually takes it over. But senior advisors rarely discuss in advance whether sweat equity applies and, if so, what it's worth. After all, there's no need for the conversation until the senior recognizes that the junior advisor might be a worthy successor.
On the other hand, what if the senior advisor addresses the potential for succession too far in advance, and the junior doesn't prove to be a good fit? Or what if one of the advisors changes his or her mind for another reason? The junior may discover that she'd really prefer to work in an institution, or that she dislikes the rainmaking responsibility that goes along with being a business owner. Instead of exiting the industry as planned, the senior may decide that he'd miss his work too much, that he hasn't saved enough money to retire or that he can get a better deal by selling externally. Unless both advisors are on the same page and the same time line, it's all too easy for difficult situations and hurt feelings to develop.
Limited resources. Often, a junior advisor hasn't saved enough money for a down payment on the practice, especially if it's a larger firm. If that's the case, the deal must be done as an earn-out, with the senior taking the risk position. Assuming the senior is very comfortable with the junior, the arrangement may not be much of an issue. Typically, internal transitions are considered less risky than selling to an external successor.
Still, no one can predict the future. What if something happens to the junior shortly after taking over the practice? Or what if, after transitioning the business, the former senior advisor dies? While a nonregistered spouse can be paid for the practice for a certain amount of time, regulatory issues may arise if the agreement involves an exceptionally long payment term (ten or more years, for instance). Often, these concerns prompt discussion of cross-purchase insurance policies.
Hard feelings on the team. In order for the junior advisor to succeed in the new role, the firm's other employees must embrace the transition. Occasionally, this presents challenges. Say, for example, that another staff member was hired at the same time as the junior advisor who's being groomed as the successor. This can cause tension in the ranks, creating a new authority situation between those initially hired as peers.
A Note On Partnerships And Enterprises
While our focus has been on transitions between a senior advisor and a junior, internal transitions can also be made between a retiring advisor and another equity owner in the firm. In a partnership arrangement, a transition from one partner to another often makes sense. In some cases, however, a firm is a partnership in name only. Although they share office space, the partners don't necessarily have similar investment philosophies or internal processes. Often, these firms have no formal arrangement for transfer between partners if an advisor exits the industry. In fact, such situations may require as much negotiation as they would if there were an external buyer.
Enterprises, by contrast, tend to be more formal, with consistent practices and philosophies that extend to all advisors. Their approach to industry exit is often established upon joining the firm.
The Best Advice: Plan Ahead
One key to a smooth transition is to anticipate it well in advance. Unfortunately, industry data shows that advisors put off succession planning as often as clients put off creating a will. With great change expected in our industry in the coming years, planning a succession strategy is more important than ever.
Ten years ago, anyone and everyone wanted to buy a practice. But as the industry grew more experienced, buyers became more selective, seeking practices with fewer clients and more recurring revenue in more populous and favored locations. What will the next decade hold as the baby boomers retire? Will there be buyers for the practices they've created? While it's tempting to put off thinking about succession, procrastinating will only hurt your chances for a successful transition-not to mention your clients.