WASHINGTON, D.C. - For Quest Capital Management, an internal buyout turned out to be the best way to solve a succession planning dilemma.

When a founding partner wanted to step down, Dallas-based Quest initially planned to use an external sale to give him a way to cash out, said Kalita Blessing, one of the firm's second-generation partners. But after a three-year dance with banks, RIAs and investment bankers that lasted from 2007 to 2010, Quest's shareholders changed their mind.

The hefty monthly retainers the firm was paying its New York-based investment bank "felt very rich," Blessing said at a breakout session on "Transitioning an Ensemble Practice" at the annual Raymond James Financial Services national conference here.

A local firm of Quest's size -- it now has about $1 billion in assets under management -- "didn't need that level of expertise," Blessing said. And negotiating with regional banks and advisory firms didn't go much better, she added: "They were trying to buy us with our own profits."

INTERNAL OPTION

Quest then began to pursue an internal strategy, tapping three attorneys, a corporate CPA, external financing and a Raymond James valuation team for assistance.

The firm's existing shareholders -- the one remaining founder along with Blessing and three other new partners -- settled on a valuation of two times top-line revenue (with a clause to protect the sellers if there was a market downturn); an upfront payout using external financing and a private note, and a five-year consulting agreement with the departing partner.

"It turned out to be the best thing for everybody," said Mary Durie, another newer partner in the firm.

Since the transaction closed three years ago, Quest's AUM has increased by 37% and revenue has risen 66%, Durie said. Morale in the firm has improved and client and employee retention has also risen, she added.

SUCCESS TIPS & PITFALLS

Having the founding partner maintain a role in the firm and giving him the "appropriate" title of chairman emeritus helped make the transaction go smoothly, Blessing said. Having his family members involved in the negotiations was also helpful, she added.

But there were things that didn't work, Blessing said. Attorney fees were not specified or capped, she said. The founder wanted the shareholders to personally guarantee his payment -- but the other partners refused, insisting the corporation be responsible. And spending so much time on the transaction took focus away from the business, Blessing said.

Goodwill valuation was also problematic, Durie said. The departing founder had not been involved with many clients for the past five years, making a valuation "difficult to support," she said. "It's a subjective number, and the company doesn't want to pay it as capital gains because it's not tax deductible."

NEW FORMULA

Going forward, Quest has put a new shareholders agreement in place, reducing the valuation formula to a multiple of one-and-a-half times the average top-line revenue over the last three years.

The partners also agreed to cap attorney fees in future negotiations and are "moving toward" equalizing ownership, Blessing said. They are also considering holding corporate retreats, having annual valuations done to benchmark the firm's progress, adding non-voting stock, instituting a sinking fund for the next buyout and a mandatory age for stock buybacks, and having staged shareholder exits.

"The Quest partners are being very proactive by stepping back  and taking time to analyze their overall practice," said Andrea Schlapia, chief executive of Ironstone, an industry valuation and consulting firm working with Quest. "They're already thinking about what the business will be like in 2019."

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