Recent challenges at Och-Ziff and Hightower highlight the struggles RIAs face in transitioning the business to the next generation of management. Size doesn’t alleviate this problem and may actually exacerbate it for some asset managers. In this week’s post, we explore what went wrong in these instances and what you can do to avoid a similar fate.
As one of the few publicly traded hedge funds, it appeared that Och-Ziff figured out its ownership succession issue. Legacy shareholders could liquidate their holdings in the IPO or any time thereafter at the market price. Unfortunately, though, it did not resolve the firm’s management succession question. In December of last year, founder Dan Och informed the firm’s clients that his protégé and current co-CIO Jimmy Levin, age 34, would not be assuming the reins as CEO when Och decided to step down. Many believed Levin was the heir apparent after being promoted and receiving a huge incentive package earlier that year (worth nearly $280 million). Levin’s rapid rise reportedly irked other members of management, a few of which left the firm in recent years. OZM’s shares are off nearly 30% since this announcement despite eventually finding Mr. Och’s replacement a few months ago.
Then, just last week, RIA acquisition firm HighTower Advisors announced that co-founder Elliot Weissbluth would be stepping down as CEO and HighTower would be seeking a new president and head of field services. Such turnover at the top means HT will likely have to look outside the firm for new leadership, which can be a long and expensive process when you don’t have a successor lined up.
Certainly, OZM and HighTower are not the only RIAs with succession issues, and this is certainly not an exhaustive list.
- Last year, billionaire Ray Dalio, who started Bridgewater Associates in 1975, announced the second shakeup within a year at the top ranks of his $160 billion firm.
- Israel Englander, CEO of Millennium Management, was caught off guard in January when his potential successor abruptly resigned with plans to start a competing firm.
- George Soros and Seth Klarman have also struggled to prepare the next generation of leadership at their firms.
All of these businesses are industry leaders with tens (or hundreds) of billions under management. The fact that they struggle with management succession shows just how hard it is to actually pull off in practice. Firm size and longevity do not guarantee a smooth transition to the next generation of leadership. In fact, the success of these firms may have fueled complacency and impeded their succession planning – why look for new management when everything’s going so well? The problem is no one lives forever, and (most) people get tired of working.
How to Transition Well
So what can you do now to avert succession issues down the road? It may sound like a cliché, but it’s never too early to think about the next generation of leadership. Most RIA principals are baby boomers that are approaching retirement age, and we suspect (mostly from firsthand experience) a fairly high percentage of them don’t have a formal (or even informal) succession plan. If you intend to evolve your practice into a sustainable enterprise and have something to sell when you retire, you need to be thinking about your likely successors and how to retain them.
A logical starting point for accomplishing this goal is tying management succession to ownership succession. Many of our clients’ principals sell a portion of their ownership to junior partners every year (or two) at fair market value. This process ensures that selling shareholders are incentivized to continue operating the business at peak levels while allowing rising partners to accrue ownership over time. Many buy-sell agreements also call for departing partners to sell their shares at a discount to FMV if they are terminated or leave within a pre-specified period to ensure they stick around after the initial buy-in. Basically, you want your interests aligned with the next generation of management, and gradually transitioning ownership to them at a reasonable price is one way of accomplishing this goal.
It’s also important to relinquish your day-to-day responsibilities with ownership. This can’t (and shouldn’t) happen overnight. After you’ve identified a capable successor(s), make sure he or she is assuming more of your responsibilities and not just your share count. Your work hours should go down over this transition period. When advising clients on management and ownership succession, we often tell principals that are approaching retirement to ask themselves where they want to be in five or ten years (depending on their age and other factors) and work towards that goal. We rarely hear that they want to maintain their current work levels for the rest of their career. Have a goal in mind and steadily work towards it as others assume your responsibilities and ownership. It should pay off in retirement.