Transitioning Your Business to the Next Generation of Leadership

Successful Succession for RIAs

Practice Management

Continuing with our succession series, this week’s focus is on internal transitions.  If you’ve ever wondered why there aren’t more transactions in the RIA space, it’s largely because most of these businesses ultimately transition their ownership internally to younger partners at the firm.  These deals typically don’t get reported, so you probably don’t hear about most of them.  Still, it’s the most common type of transaction for investment management firms and probably something that’s crossed your mind if you’re approaching retirement.

A gradual transition to the next generation is a good way to align your employees’ interests and grow the firm.

These types of transactions are common for a reason.  Most RIA owners like working for themselves and will eschew outside interference at all costs (unless the price is right).  Because many clients enjoy working with a wholly independent advisor, internal transitions are a good way to accomplish this in the long run.  Further, a gradual transition of responsibilities and ownership to the next generation is also usually one of the best ways to align your employees’ interests and grow the firm to everyone’s benefit.

The most obvious roadblock when planning for internal succession is pricing.  We recommend that all firms have a buy-sell agreement that specifies the terms and the price that shares are transacted at as an owner exits to retire.  Because many wealth management firms are highly valuable, successors are often financially stretched to take over the founder’s interest in the firm.  By establishing the price and terms at which the shares will be transacted, a buy-sell agreement mitigates any potential drama.

In their recent book Success and Succession, Eric Hehman, Jay Hummel, and Tim Kochis examine the complexities of the leadership transition process and summarize their findings from their own experience:

  • Both the founder and the successor need to be aware that firm-wide growth often declines in the first year following the change in management, as the founder-centric firm shifts its brand image and the successor takes on responsibility for creating new business. If a successor is unaware of this trend, he or she could feel additional stress regarding the financial burden he undertook when buying out the former owner.  The founder could feel the need to resume full-time involvement in operations, fearing for his ongoing financial benefits from the firm.  The authors advise both founders and successors to take a long-term view and not focus on this short-term pullback.
  • Regardless of the firm’s performance in the first few years following succession, both the founder and the successor need to set definite (as in finite) expectations regarding the founder’s continued involvement or lack thereof. The founder should remain accessible as his or her guidance is crucial when the successor faces major issues early on.  However, it should also be clear to everyone that the successor is now the one charged with minding the store.
  • Though some things do need to change following a succession of management, the successor should avoid creating new positions to retain people who no longer fit into the firm’s long-term goals. One benefit of succession is that the new manager may have a fresh perspective on areas of the firm in which cost cutting measures or other efficiencies are possible.  Although it may be difficult to assess which employees should remain after the transition, allowing those who are poor fits to remain with the firm does significant damage to the firm’s culture and does not set the proper tone for post-transition success.
  • It is crucial to separate compensation for labor from profit share rewards as the exiting owner becomes less involved in the day to day management of the firm. This issue can be resolved through the establishment of a strict reinvestment versus distribution policy going forward.  The authors even suggest that the founder employ an independent financial advisor in order to objectively estimate a fair amount of compensation following the sale.
  • Though it is clear that the founder has taken on a significant amount of financial risk in the creation of the firm, it must be noted that the successor is also taking on risk in the amount of debt that he or she must incur to buy out the owner. Both parties have a lot to gain and a lot to lose in the process of succession, and both bear a significant emotional burden.  The founder may perceive the transition as a loss of a personal identity that is tied to the firm, and the successor must now bear the responsibility of the ongoing success of the firm.
  • Controversy over what is fair or what is “enough” in terms of a sale price can be resolved through a third-party valuation. While it might seem easier to rely on rules-of-thumb metrics or attractive examples, these tactics are purely short term solutions and can result in overly optimistic estimates. The financial terms of the valuation are already emotionally charged. A third party valuation can provide a much needed “reality dose.”

Obviously, there’s a lot to think about, and this is certainly not an exhaustive list.  It’s never too early to start planning for your succession.  The longer you wait, the more likely you are going to fall short or have to make series concessions on pricing.  Unfortunately, we see this more often than not, so don’t become another statistic.  We’re here to help with the valuation and advisory aspects, but it’s up to you to get the ball rolling.

Previous Post


Planning to Succeed