Start transitioning early

By Will Wood | September 1, 2010 | Last updated on September 1, 2010
6 min read

That great rush of enthusiastic investors who found 24-hour financial networks, the Internet and their 40th birthday all in the same decade are now retiring. So are the proud, fierce tribes of financial advisors who sprung from that demographic and prospered.

But where do financial advisors go to retire, and more importantly, how do they do it?

Investment firms are aware that there will be a huge movement of assets, internally and externally, over the next ten years. An industry that proudly hunted the new and uninitiated will now turn on itself and retreat into cannibalism, as the decades-old wave of savers dries up. Recruiting, long an expensive addendum to the business plans of the industry’s largest players, is now at the core of everyone’s long-term planning. Recruit the young and growing. Recruit the old and growing. Marry the two.

What’s the future value?

Frankly, it doesn’t really matter whether you’re transitioning your book internally to a trusted colleague, or considering the inevitable recruitment offer that lands on every successful advisor’s desk. The value of the deal will be based on the same principles. It’s a good idea to know the rules of the game. And it’s an even better idea to set up your practice to profit from them, in advance.

One thing’s for sure — the rules apply to all and they aren’t necessarily the ones you were taught as they tossed you a telephone book and told you to smile and dial. First and foremost: the deal will value the past, but will look to the future.

The starting point will be based on the obvious quantitative value associated with your practice. Whether that value moves up or down from there will depend on the future you’re providing. If this sounds like the beginnings of a mutual fund performance disclaimer, it’s entirely intentional. Past performance, unless recent and repeatable, is no indication of future performance or value. Revenue matters

The quantitative values are the ones you’d expect: revenue and assets are obvious.

Revenue on assets is the first level of nuance that needs to be recognized. Inefficiently produced low revenue with a disproportionately high exposure to compliance liability and cost to service will result in a discount to value.

On the other hand, disproportionately high revenue may indicate other issues, particularly if a substantial portion is generated from too few relationships. If you’re looking to the future, revenue concentration represents risk, and risk impacts value.

Average household size pre-sents another interesting issue. On the surface, it appears to be the old issue of whether or not small accounts are profitable, and at what point that happens. More important though is the administrative burden caused by higher numbers of accounts, and the nature of the referrals that can be anticipated.

Common wisdom dictates that clients refer people just like them. Dealing with higher numbers of small referrals will reduce the projected future growth rate and lower the transition value. It generally takes just as long to negotiate, sign and service a $150,000 household as it does a $500,000 household, but you need four of the former to grow at the same rate as the latter.

But perhaps the most important value, and the most controversial, is recurring revenue. Firms love it, because allowing for market fluctuations, it’s a quantifiable thing.

The real issue isn’t just financial, however. The kinds of products that produce high recurring revenue, particularly guided or managed products, are not as dependent on the personality or special knowledge of the transitioning advisor. This isn’t a qualitative assessment of fee-based or managed businesses versus traditional transactional businesses. It’s a conclusion based on the assumption that the more quantifiable and repeatable something is, the more valuable it is to someone looking to the future.

Client retention becomes more a factor of maintaining the service level than duplicating the skill set of a particular key person. That said, only a small percentage of books transitioning over the next ten years will be substantially fee-based. In most cases, there’s a mix of platforms inside books. It’s also unlikely advisors will compromise their belief of how money should be managed, or accounts charged, to facilitate their retirement. What they should do is consider how early they need to choose their successor.

Selecting the next you

Choosing a successor, through internal or external partnership, needs to be something you do well in advance of the event. Waiting until the last minute — let’s say a year before your planned retirement — will reduce retention. All transition agreements contain a retention clause. This is typically a pro-rated affair that kicks in if less than 80% of households are retained, and goes down to 50%.

To maximize retention, and most importantly leave your clients comfortable and well served, you need to give your heir apparent at least a couple of years, preferably more, to establish relationships and be seen as the new you. And the more specialized your knowledge is, the more personal your relationships are, or the more geographically spread out your client base is, the longer this can take and the more important it becomes. This is definitely an area you can’t procrastinate in. Interestingly, it’s the one in which everyone does.

You also need to be honest with yourself about who the next you will be. It might be your associate, but just because he or she knows and gets along with your clients doesn’t mean he or she is qualified to be a stand-alone advisor. Is there a reason they’re not an advisor now?

After working in your team for a time, many will believe they can do your job. In some cases it’s true; in others, advisors inadvertently encourage that belief because they fear losing a valued teammate. But a last-minute partnership, a disillusioned associate and a sophisticated business to be transitioned — that’s a recipe for disaster.

If your associate is the right choice, start grooming him or her early, paying special attention to how you transition his or her capabilities in your clients’ eyes. If he or she isn’t the one, you need to start mapping opportunities clearly in order to maximize the fulfilment of his or her dreams. At the same time, you need to keep looking for the new you.

There’s been a lot of talk about growth, and growing books. Practice-management teams are positioning practices to efficiently compete in the cannibalistic, post-baby boom market. Some firms are now tangibly rewarding growth every month to capture and encourage those who’ll drive market share over the next decade and beyond. Organic growth, combined with the recruitment of retiring and growing advisors, will spell success for firms that do it well.

Really though, why should you care? It won’t have any impact on your business, will it? Think again.

Be cognizant of change

Increased competition for a more static market will result in attrition. An aging population, whose children may not live in your jurisdiction or who may have other advisors, means your clients will die and their money will leave.

There will also be some clients who for years have seen you as an agent of growth and will look for someone else to provide them with income in retirement. Those who stay will withdraw from savings, rather than add new savings.

Recognizing changing needs, repositioning your practice to provide for them, offering new services and products, and delivering against the broader wealth and estate needs of your clients will be critically important to stemming the tide. Choosing a successor who can confidently deliver these things is vital to retention.

That said, unless you’re growing your business through acquisition, referral or marketing, it will diminish, despite the measures you put into place. For any advisor or firm looking to transition a practice, a growing book with a strong brand, centres of influence and growth-oriented staff is more valuable. That’s looking to the future. That’s why you should care about growth.

The decision to transition your book may be the most significant business decision you ever make. There are lots of moving parts, and they aren’t all intuitive or comfortable. Make sure you’re in an environment that encourages and supports the behaviours that’ll allow you to maximize the value of your practice in transition.

Start thinking early, and don’t think alone. Know your value, and be honest about what you need to do to ensure your practice’s value. In the end, your clients’ success and yours will depend on how you move forward with a new partner, another firm or into retirement.

Will Wood