Key Takeaways
Postponing succession often increases risks for founders, employees, and clients, even when the business continues to perform well.
Remaining independent requires investment in future leaders, a workable ownership transition, and a willingness to share authority (and clients).
An outside sale can be the right choice when the financial and personal costs of independence exceed what owners are willing or able to commit.
In late 1959, BMW’s shareholders faced a decision familiar to many RIA owners: sell to a larger competitor or find the means to remain independent. BMW’s circumstances at the time were considerably more desperate than those of most firms we encounter. The company was in acute financial distress, and a proposed takeover by Daimler-Benz appeared both necessary and likely. Small shareholders helped stop the transaction, but rejecting the buyer did nothing to resolve the problems that had made a sale seem inevitable.
Independence required someone willing to pay for it. Herbert Quandt increased his investment, and a restructuring plan followed. BMW leveraged its newfound financial stability to develop new products and a more promising direction for the business. The BMW 1500, unveiled in 1961 as the first of the “Neue Klasse,” became an important part of that future (I got to drive one when I was working at an import car repair shop in high school - great car). The company had secured its independence by committing to substantial change.
Few RIA founders face circumstances as dire as BMW’s in 1959. More often, we meet founders whose firms have enjoyed 25 or 30 years of success. The business is profitable, the clients are loyal, and the founders are comfortable with their status quo. This comfort tends to complicate ownership transitions. An outside sale introduces unfamiliar people and expectations. An internal transition means sharing authority with colleagues they may respect, but still regard as junior. Continuing the current arrangement can feel like the safest choice.
The difficulty is that the arrangement, along with the parties to the arrangement, keeps getting older, even when it otherwise appears to stay the same.
The Familiar Has Risks, Too
Nobody likes change. For founders, selling to an outside firm can mean having a boss for the first time in decades, or at least a partner whose opinion carries weight. Selling to the next generation means giving people you once hired the standing to disagree with (or possibly overrule) you. Neither prospect necessarily improves with familiarity. Gen 2, meanwhile, is accustomed to having a boss and may find an outside buyer less unsettling than the founders do.
But postponing a transition has consequences. The founder’s wealth remains concentrated in a business that depends heavily on him or her (a portfolio allocation few advisors would recommend to their clients). Each passing year shortens the remaining career and the time available to prepare someone else for the job, and lowers what a buyer would pay for a business that still depends on its founder.
Capable employees have their own decisions to make. How long should they wait for responsibility and ownership that remain just out of reach? Clients may be equally patient in conversation and less patient in private. Someone planning for another 25 or 30 years of financial needs has reason to wonder who will be answering the phone.
The founder’s comfort with their success offers limited reassurance to either group. Staying put is a decision about their futures, too. Eventually, employees and clients may make decisions of their own.
What Independence Requires
When founders tell us their next generation isn’t ready to take over, the question is what would make them ready. Some need more experience managing people. Others need responsibility for business development, financial performance, or difficult client situations. Those capabilities develop through practice, with enough authority to make decisions and enough support to learn from them. If every consequential choice still goes through the founder, it’s difficult to know what the successors can or cannot do.
Preparing the next generation also costs money. Hiring ahead of need, giving promising colleagues time to manage, and building an ownership transition may reduce the cash available for current distributions. Internal buyers generally expect to fund their purchases from future earnings, which means the business must support both the retiring owners’ liquidity and the continuing firm’s investment needs. Founders may have to accept a lower price, payment over time, and continued financial exposure to a business they increasingly entrust to others.
Entrusting the firm to others can be the hardest part. Successors will have ideas about staffing, services, technology, and compensation that differ from the founders’ preferences. Giving them responsibility while reserving the right to reverse every uncomfortable decision leaves the transition largely unfinished. As we discussed in Changing Drivers, they need room to build the firm they will lead.
The cost of independence therefore includes money, time, and a willingness to relinquish authority. Owners who want the firm to outlast their careers have to make room for careers other than their own.
Making the Choice
After considering those commitments, some owners may conclude that the cost of independence is simply too high. An outside sale can offer liquidity at closing, resources for the business, continuity for clients, and opportunities for colleagues that the existing owners would struggle to provide. Choosing that path can be a thoughtful decision about the firm’s future.
Others will decide that preserving independence is worth the investment and personal adjustments. That decision should come with named successors, a timetable for transferring responsibility, and a workable plan for ownership. The next generation needs to understand what is expected of them and what they can reasonably expect in return.
BMW’s shareholders rejected Daimler-Benz in an afternoon. Building a viable independent future took considerably longer. RIA owners who choose independence take on a similar obligation. Keeping the firm, like selling it, means preparing it for a time when someone else will be running it. Only waiting requires nothing, which is why it feels safe and why it isn’t.
About Mercer Capital
Mercer Capital is a valuation and advisory firm organized by industry specialization. Our Investment Management Team provides valuation, transaction, litigation, and consulting services to asset managers, wealth managers, independent trust companies, broker-dealers, private equity firms, alternative managers, and related investment consultancies.