Leaving the industry can be hard

Can financial planners sell their businesses for substantial capital sums and yet preserve independence of advice and ensure their clients are well looked after following the planner’s retirement? This should be possible, but the most common succession planning models fail to achieve it.

The three main models for adviser exit are: institutional buyer of last resort, aggregation and in-house succession. Each of these have strengths and weaknesses.

Institutions have been the main acquirers of financial planners in recent years. Many offer a buyer of last resort (BOLR) facility to their planners. Typically this could be, say, four-times last year’s trail, subject to 75 per cent of assets being placed in the institution’s products/master trust, and having a minimum number of years within the organisation.

Naturally this offer values the business from the point of view of the buyer. It values funds under management in a product. The offer is the same whether the clients are well or badly serviced, which is not relevant to the profitability of the fund/master trust manager.

It also does not take into account whether the planner’s business is profitable. The price is the same for a planner’s practice that generates $100,000 of trail commission from 100 or 1,000 clients. Yet the former would be a far more profitable business.

BOLR enables an unprofitable business to be sold for the same price as a profitable business, which will be very attractive to those with low average recurrent earnings per client.

It is less likely to be appealing to a profitable business, which ought to command a premium.

Some express surprise that planners’ businesses should be valued at up to four-times their gross recurrent revenue. It is important to understand the economics for the buying institution.

The fund/master trust manager may be collecting recurrent revenue of two per cent per annum, of which 0.5 per cent is paid in trail. If they offer to buy the adviser’s business at four-times trail, they are really only paying one-times their earnings.

If the offer is conditional on, say, five years of previous service, the economics for the buyer become even better. The institution will have investors from which it earned two per cent per annum for at least five years, at the end of which it makes a payment of two per cent (that is, four by 0.5 per cent). This can be a profitable acquisition.

The future profitability will be affected by any cost for a new adviser to service the clients. Which adviser is assigned will be at the discretion of the institution that now owns the client.

Those advisers who are concerned about quality of service to their clients following their personal retirement will need to assess their confidence in the institution’s commitment to high quality financial planning services. Will it hand clients to an adviser of the same quality as the old one, or will it try to cut costs?

It is a truism that if a corporate culture espouses certain values, but rewards other values, the latter will prevail. The BOLR facility does not reward superior quality service by paying a higher price. The challenge for the institution is that using a methodology that does not reward the provision of quality service raises challenges for the long-term positioning of a business, the satisfaction of its client base and the impact this will have on referrals.

The other great weakness of most BOLR models is that they guarantee four-times an amount that is less than a top class planner should charge. Planners providing excellent service frequently command ongoing fees of around one per cent per annum. If the buy-out only guarantees four-times trail it will not reward those whose clients have demonstrated a willingness to pay more than this.

Another widespread alternative is an aggregation strategy — drawing together a number of small businesses into a bigger block, that might be attractive for an institutional acquisition or listing.

Often these use a common master trust, with planners entitled to some proportionate share of the ultimate sale value — a common usage model.

The capital that a planner achieves under these arrangements is usually dependent upon two factors: whether the planner is able to deliver substantial funds into the master trust and whether the promoters of the arrangement are successful in their business strategy, only one of which is under his or her control.

If the means to access capital is listing, the planner will only make any money if the master trust manager succeeds in building a profitable business. Stockford highlighted that this involves some risks.

If the means to access capital is via sale to an institution (without a guaranteed buy-out), the planner will be dependent on the promoters attracting enough support for the master trust to be able to offer an institution a large and growing funds under administration.

In both of these scenarios, individual planners could do an outstanding job personally but not be rewarded because of weaknesses in the larger entity.

The irony of both aggregation and the BOLR is that the payment is solely for funds under management. There is no payment for the financial planning activity! Why should a planner who gives quality advice profitably, and also delivers funds under administration into a platform, not be paid for both?

The price at which any listed entity trades will depend on its profitability. The best advisers in the group may have strongly profitable practices, while others may not. The share price will be determined by the aggregate of the group. This will be extremely beneficial to the inferior adviser, whose reward will be greater than his or her own efforts deserve, but will be unattractive to the superior adviser.

Planners under these sorts of arrangements may be more impacted by the success or otherwise of their colleagues than by their own efforts. This is a strange way to be rewarded.

Unlike a BOLR guarantee, common usage and listing offer a share of a future pie-in-the-sky where the adviser has limited control over the baking process.

The other common succession model is for planners to develop their own successors within their business, akin to the legal and accounting professions where partners develop others through the ranks who buy them out.

This is a model that can deliver future high quality service to clients. However, it will rarely produce as high a valuation as, say, the BOLR.

Few successor advisers would pay four times revenue, nor would they have the capital capacity to. They may pay four or five times profit, but this will clearly be a lesser number. This profit should only be earnings over and above the owner’s market salary (no employable person should buy a salary).

If you are a top class planner, running a profitable business with a loyal high-net-worth client base, who will buy your business for an appropriate premium price and deliver your clients into good hands? Especially if your client base might view an affiliation with a product-providing institution as compromising their independence?

Our industry has succeeded in developing a range of exit models that could be attractive to the average adviser, but has not succeeded in meeting the needs of the cream of planners. This is a ridiculous position that will not endure indefinitely.