Numerous surveys have shown only about 25% of financial advisors have a written succession plan in place. Which begs the question, why do so few advisors who counsel their clients about the importance of planning not have a plan in place for their own retirement and for the ultimate succession of their own organization?

“I believe part of that is because it’s a stressful subject,” said David DeVoe, managing partner and founder of DeVoe & Co., a San Francisco-based wealth management industry consultant. “It’s something you have to carve out time to do, and it’s not something that’s interesting to do.”

DeVoe addressed the subject during a webinar he hosted last month about valuations and succession planning for financial advisory practices.

DeVoe, who formerly spearheaded Schwab Advisor Services’ mergers and acquisitions and strategic consulting business for registered investment advisors, offered that trying to put a value on a financial advisor’s practice has both business and emotional components. This is, after all, an advisor’s “baby,” and it’s his or her most important economic asset.

The factors that go into a valuation include a firm’s profitability, its business processes, and client satisfaction and retention, among others. But DeVoe said all of these fall into three major categories: the organization’s growth, its cash flow and the risk associated with the company.

He discussed the quantitative measures commonly used to value an advisory practice––the book value, the multiple of revenue, the multiple of cash flow and the discounted cash-flow model.

“Book value is basically irrelevant to the valuation of an RIA,” DeVoe said. “Multiples of cash flow or revenue can be useful in some situations, but overall they have the potential to be dangerous. The best way to value an organization is through the discounted cash-flow model.”

When advisors seek DeVoe’s help with succession planning, some of the common questions include what is the best channel for them to sell to externally and what kind of interest rate should they charge when they finance a junior partner’s buy-in. “Invariably, I ask that person to step back from the action or transaction they’re contemplating and start with a very broad assessment of their business, professional and personal goals to understand what the right answers to their questions might be.”

He noted that an advisory practice’s size often dictates possible succession options. For example, advisor firms with less than $100 million typically don’t have an in-house successor, which makes selling externally a possible exit strategy.

Firms with between $100 million and $250 million will likely have a potential successor in-house, and might be in the strike zone where one or several people are able to buy out the principal of the organization.

But things can get trickier further up the AUM ladder. “When you’re in the $250 million to $750 million zone, the junior folks probably can’t afford to buy the firm, and you need to start thinking creatively,” DeVoe said. “But if you don’t plan to retire for another 20 years, then you have many more options for an internal succession than if you plan to retire in three to six years.”

DeVoe said a common feature among firms larger than $750 million is that they create well-engineered financial and economic exchange programs to sustain the organization that entails setting the right price for the shares internally, or having the right number of partners coming in to take over from those leaving the organization.

“As you move up the chain, the options might become greater, but the engineering becomes more important,” DeVoe said.