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Passing the baton, step by step

A guide to ensuring your successor succeeds

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Jack McGrath is turning 65 in August, and he's looking forward to spending more time in Florida. In fact, he's been there for the last four months, far from the Norwell, Mass.-based advisory practice he started 21 years ago.

Just over a year ago, McGrath sold 49 percent of his business, Strategic Financial Services, to Regina Quirk, a certified financial planner who had been working with him since 2002. Thanks to financing help from his broker-dealer, Cambridge Investment Research, McGrath got paid in cash for the first half of the transaction. At the end of next year, he and Quirk will discuss payment terms for the rest of his stake in the business.


McGrath plans to work another two years—only part-time in winter—but has given up the corner office to his younger partner and is happy with the decision.

"The clients don't even ask for me anymore when they call," said McGrath without a trace of sadness. "It's been a huge adjustment, but I've become more and more comfortable with it over the past five years."

Jack McGrath is one of the lucky ones. Of the more than 30,000 independent investment advisors in the country, fewer than a quarter have a succession plan in place, according to numerous studies, and most solo practitioners haven't even identified a potential successor.

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"Full-fledged succession plans are pretty rare in our industry," said Eric Schwartz, founder, chairman and CEO of Cambridge Investment Research, which has formed a subsidiary to help its more than 2,500 independent advisors draft succession plans. "About 80 percent of our people don't have a written agreement or a plan to fund it."

While some advisors may be able to sell their businesses, the truth is, most will not. And lacking a plan for internal succession, thousands may see their practices dissipate without getting a dime for all the blood, sweat and tears they invested in it.

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"A lot of advisory practices will just peter out at some point if they haven't brought in a successor to the owner, and a lot of clients will have to find other advisors," said Steve Levitt, co-founder and managing director of investment bank Park Sutton Advisors. His firm specializes in deals involving advisory firms with at least $300 million in assets.

Levitt advises only the largest firms—mostly those with a focus on high-net-worth clients—but he says one thing is key to making any advisory practice more valuable to potential buyers: growth. "If a firm has bench strength and can demonstrate new asset growth, it really adds value to the business," he said.

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In other words, a practice with a succession plan and the ability to sustain itself and grow, without its founding advisor, is a valuable business.

Succession planning isn't easy. It takes a long time—five to 10 years, according to most experts—and it's emotional and messy. But it's also critical. Here are four steps to drafting a succession plan that can turn an advisory practice into a sustainable business.

Step 1: Soul-search

Succession planning is a lot like financial planning. "It starts with an advisor thinking about what their personal goals in life are," said Rick Schwartz, managing director of business consulting at Schwab Advisor Services, which serves as custodian for more than 7,000 independent advisory firms. "What do they want financially, and what do they want to continue doing professionally?"

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Unless those questions are answered, any succession plan is likely to remain on precarious footing. Most advisors approaching retirement want to continue working, and doing so is likely crucial to making the transition—and succession—successful. Be clear about what you want.

Step 2: Know what your successor wants

Buying an advisory practice represents a major investment and a huge risk for a junior partner. Many will require long payment terms and continued mentorship to prepare for taking over the business.

The more important factor, however, is whether your successor shares the same vision of the business. "Advisors have to find out what [a potential successor's] vision and dream are for themselves and the company," Cambridge's Schwartz said. "Most advisors want to take care of their staff and clients and keep their legacy going."


Step 3: Value the business

Once there is a meeting of the minds between an owner and a potential successor, the details of the transaction can be addressed. It begins with a realistic valuation of the business. While many firm's choose to do their own valuation, most experts recommend getting a third party capable of objectively analyzing client profiles, recurring revenues and profitability to do it.

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A valuation is only the beginning of a long process, and the terms of an agreement are usually more important and can change as it progresses, so don't get hung up on the number. A good succession plan increases the value of the business. "Solo advisors need to realize that when they give up a piece of the pie, the value of the pie grows," Cambridge's Schwartz said.

Step 4: Draft a buy/sell agreement

Get professional help drafting a buy/sell agreement that both parties can honor. In most cases, junior partners are going to require extended terms to pay for their equity in the business, and circumstances at the firm and in the markets can change the picture dramatically.

"What happens if you expected the business to grow by 30 percent and it shrinks?" asked Cambridge's Schwartz. "Will the junior partner be able to pay if the markets drop 30 percent?" He suggested that agreements have flexibility so the parties can come back and change them if they need to.

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So far, Jack McGrath is happy with his agreement and is flexible about payment for the other half of his business. "I understand that it's coming out of cash flow," he said. "Five years ago I realized that my business was my biggest asset, so I put things in place to make this happen."

The rest of the industry needs to do the same.

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