In the late 1930s Henry Ford’s son, Edsel, commissioned a one-off convertible version of the Lincoln Zephyr to drive while he vacationed in Florida for the winter. While the initial design is said to have been penned in about an hour, legend has it that Edsel Ford kept tweaking the details and wearing out the engineers such that they finally locked him out of the shop to finish the car. Edsel Ford took his Lincoln, dubbed the “Continental,” to Florida, and came back with 200 orders. Ford suddenly had a halo car, and Lincoln became a durable brand for decades.
The Continental story is significant for many reasons, one of them being that it was a big success for second-generation leadership at Ford Motor Company. Many businesses start and grow by force of the personality of the founder, and wither and die when there is no successor leadership to take over when the founder is no longer at the helm. Ford succeeded where many other automakers failed, which is why this blog post is starting with that company instead of Pierce-Arrow, Packard, or Duesenberg.
Succession is as often discussed as it is misunderstood.
If succession is difficult to achieve in a “products” company like an automaker, it is mind-numbing to engineer in a “services” business-like investment management. Riffing off the over-repeated metaphor to describe the substance of an RIA, if the assets get on the elevator and go home every night…does a change in assets mean a different company altogether?
Succession is as often discussed as it is misunderstood. While many practice management issues revolve around industry expectations, regulations, client expectations, and basic economics, succession involves all of those things plus personality, culture, and skill sets. And while much has been written about succession in the RIA industry, we’ve seen plenty of topics get little, if any attention. This post is dedicated to some of the latter.
Internal Succession is the Default Plan for Most RIAs
Despite the headlines suggesting that there is a wave of strategic takeovers that will ultimately consolidate the investment management profession into a few large firms, the reality we’ve encountered suggests that most RIAs will transition ownership and leadership from one generation to the next internally. The reasons for this are fairly obvious.
Even though there are on the order of 15,000 RIAs in the U.S. which are all generally in the same business (providing investment management consulting services in exchange for fees priced relative to the dollar amount of client assets), there are also about 15,000 business models. Investment management firms are idiosyncratic, with practices and cultures unique to the individuals involved in the practice and the market niche served by the practice.
Staff who grow up, or whose careers develop, at a given firm understand, inherently, the values and expectations of their workplace, and are in the best position to perpetuate the business after the prior generation of leadership retires.
Strategic Transactions Rarely Obviate the Need for Succession Planning
Leadership transition issues can loom large even in strategic transactions. We worked on a dispute situation a few years ago in which a strategic acquirer bought a substantial wealth management practice without even meeting the next generation of leadership. The ink was hardly dry on the purchase agreement when generation two started looking for the exit, knowing many of their clients would follow them. Litigation eventually resolved this in one respect, but most arms’ length observers would conclude that all parties (buyer, seller, and the second generation) were worse off as a result.
RIAs often pride themselves on having a team-oriented atmosphere, which is great for serving clients, but not so great for negotiating succession issues. When team members become buyers and sellers, temperaments that were heretofore aligned become opposed. Arguments can easily break out between members of buyer and seller groups when goals diverge or perspectives on the future of the firm conflict.
Some see strategic transactions as a way to avoid the uncomfortable conversations that accompany internal ownership transition. Not so. If the strategic transaction does not align with the priorities of the group responsible for leading the firm after the deal closes, then the likely outcome will be suboptimal.
Continuity Planning is the Dog that Wags the Succession Tail
The client doesn’t really care who owns your firm. The client cares about the firm serving their needs. It’s easy to forget this because…
Succession is a Strategic Issue Often Mistreated as a Tactical Issue
When managers at RIAs start thinking about succession, they immediately jump into who buys out whom at what price and terms. We would suggest, instead, that the starting point is strategic planning for the business.
Ownership should be a consequence of the business strategy, not the other way around.
Ownership is the single biggest distraction for most closely held businesses. But ownership should be a consequence of the business strategy, not the other way around. Think of the strategic priorities of an investment management firm in the same order they appear on the P&L.
Revenue comes first. So, at a basic level, strategic planning for an RIA starts with growing client relationships and value provided to the clients to maximize revenue opportunities.
Next comes operating expenses, which for an investment management firm consists mostly of employee compensation. Spending on talent and tools to achieve the strategic revenue goals form the organization to be owned.
Profits are at the bottom of your P&L for a reason. They matter, of course, but returns to equity are the residual of client interaction and the organization formed to serve them. Ownership is a by-product of strategy, and, at best, can be structured to support strategic initiatives.
Timing is Everything, and so is Time
Another famous Lincoln, whose first name was Abraham, famously said that if he was given seven hours to chop down a tree, he’d spend six hours sharpening his axe. We would say this ratio of planning to implementation is about right for dealing with the issue of succession as well.