How to keep 'unexpected accidents' from derailing a succession plan

October Cover Feature
David Eads, CEO of Vital Investment Management in Loveland, Colorado, has executed two buy-sells in recent years, the first as a buyer as part of a succession plan for a retiring advisor.
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Somewhere in America, a financial planner is having “the talk” with a business-owner client about succession.

For your firm’s sake, your family’s sake and your legacy’s sake, the advisor says, you need to plan for unexpected accidents, illness and divorce, as well as the inevitable — death. Planners typically advise such clients to address these risks via insurance and, for many business owners, with buy-sell agreements.

It seems to follow, then, that advisors should take their own advice and enter into buy-sell agreements when it comes to succession planning for their own firms. To understand why this agreement can be crucial, consider what would happen without one in case of a personal disaster. You (or possibly your heirs) would be sellers, looking for someone to buy your interest in your practice. There would likely be time pressure and a lack of negotiating leverage for the seller.

With this and other downsides in mind, some advisors support buy-sells enthusiastically, reasoning that a well-drafted plan can lock in fair compensation for a reduced or lost career. But others are ambivalent about the instrument, and still others say buy-sells are just not for them.

Basically, a buy-sell agreement is a binding contract that sets terms for the compensation of a departing (or departed) business owner or co-owner. In the pro camp is Rob Siegmann, principal at Total Wealth Planning in Cincinnati.

“All advisors should have buy-sell agreements in place as part of their succession and business continuity plans,” he says.

Siegmann speaks, in part, from experience. He worked at a firm where the founder — a sole owner who didn’t participate in the business any longer — did not have a buy-sell. As a result, he says, advisor-employees “grew restless.”

When Siegmann bought the firm, along with two partners, “we put our buy-sell agreement in place as part of our partnership discussions and purchase negotiations.”

The newly named advisory firm’s buy-sell agreement now calls for the remaining two owners to buy out the third over a 10-year payout.

This buy-sell would apply in “all scenarios” in which one partner leaves the firm, Siegmann says.

One advantage of having a buy-sell is that it can cover many different events — indeed, a comprehensive agreement should go beyond the seller’s death or disability. Siegmann, for instance, groups the “triggers” as voluntary or involuntary, but buy-sells also might be categorized as catastrophe plans or practice continuation agreements.

Retirement, for instance, on Siegmann’s seller’s schedule would qualify as voluntary.

On the involuntary side, he mentions the four D’s, adding divorce and disagreement to the two common buy-sell triggers of death and disability.

Why Include Divorce?

“Buy-sell agreements typically clarify who is eligible to hold a percentage of the enterprise in case of death or divorce of a partner,” says Genevia Fulbright, president of Fulbright & Fulbright, a CPA consulting firm in Durham, North Carolina.

“These provisions can help avoid automatic transitions to uninterested or unqualified family members who might inherit the business. We have seen situations where small business owners have failed to plan and are forced to immediately wind down operations by a partner’s beneficiary who does not understand the business.”

Similarly, advisors would likely want to be able to buy out an ex-spouse who obtained an interest in the practice after a divorce on terms set by a buy-sell or to restrict resale rights.

Fulbright explains that other triggers can be included in a buy-sell, ranging from violation of ethical standards to a partner’s desire to explore opportunities outside of the business.

“A buy-sell also can include details regarding the level of work required to maintain the partnership,” she says.

Flex Plan

Yet even the above list of eventualities covered by a buy-sell isn’t exhaustive.

David Eads, CEO of Vital Investment Management in Loveland, Colorado, has executed two buy-sells in recent years, the first as a buyer as part of a succession plan for a retiring advisor.

The second agreement was created with Eads as a potential future seller, mainly to facilitate merger activity, because the advisory practice in which Eads had acquired a 50% stake joined a much larger firm within a year of his executing the first buy-sell.

Three years later, Eads triggered that second buy-sell with a request to depart the merged firm. He negotiated a modification of the latter agreement, enabling him to solicit his clients, in exchange for relinquishing a payment for his partnership value.

“The most surprising thing I have learned from my buy-sell agreements is their flexibility,” Eads says. “They provide a great roadmap to where you’re headed, but the actual execution of the buy-sell usually needs to be tweaked to the current situation of both the buyer and seller.”

Eads, 36, reports that he’s in the process of creating a buy-sell agreement with another local fee-only RIA. Although some years from retiring, he intends to protect his clients and his family in case of catastrophe.

In addition to their ability to cover many contingencies, buy-sells deserve advisors’ consideration because they’re well established as a means of delivering satisfaction.

They’re Done Because They Work

Damon Dyas, an advisor at Cornerstone Financial Group, a private practice of Ameriprise Financial Services, in Southfield, Michigan, had entered into a buy-sell with another Cornerstone advisor, as required by Ameriprise. Dyas faced a cash need and used “practice equity” instead of taking out a loan by selling his practice to the advisor who had signed the buy-sell with him.

Now, Dyas’ buy-sell agreement is no longer active, and he is considered an employee of the practice.

“Nothing else has changed about my day-to-day duties,” Dyas says, adding, “I do receive more back-office support and benefits, being an employee. Overall, I’m pleased with the transition, and there was no effect on client service.”

Accentuate the Negative

Despite the advantages of buy-sells, some advisors aren’t completely sold.

“I’ve been a one-man operation since 1982,” says Bob Maloney, founder of Squam Lakes Financial Advisors in Holderness, New Hampshire, “and buy-sell agreements have no place in this type of an operation.”

Yet Maloney is hardly a never buy-seller — in fact, he estimates that 20% of his business over the years has been with small business owners, so he has been involved with numerous buy-sells. He says they are “one of the cleanest ways” for such clients to deal with death or disability.

Maloney’s problem with buy-sells for his firm is that, although he offers comprehensive financial planning, portfolio management is farmed out to parties he has recommended. His value as a fee-only planner comes from his holistic advice.

If Maloney were to bring in a junior advisor and work with this prospective successor for several years, he says, “maybe I would have something to transfer.”

But as he sees it, his practice has scant value without his personal expertise.

In Maloney’s succession plan, in case of his death or disability, his wife would reach out to a younger local advisor Maloney has already identified. This other planner would have the opportunity to meet with each of Maloney’s clients to determine if an ongoing engagement is desirable. No compensation to Maloney or his wife would result.

Some advisors have no buy-sell at present simply because they haven’t yet found the right successor.

“I am still working on our firm’s transition plan,” says Carol Schmidlin, president of Franklin Planning in Sewell, New Jersey. “My goal is to find a buyer who has similar values and beliefs as I do.”

Schmidlin plans to decide on the right successor in three to five years, followed by a two-year observation period before deciding whether to go ahead.

“It is very hard for me to even think about this, because I truly love what I do,” Schmidlin says. “However, I know it is the right thing for my clients’ best interests.”

An Alternative Approach

Even without a buy-sell, some advisors have fairly comprehensive disaster protection and succession plans in place. Ryan McKeown, a CFP and senior vice president at Wealth Enhancement Group in Mankato, Minnesota, says he has a successor agreement with the other advisor on his team, who is younger. McKeown or his estate will receive a percentage of the team’s profits for four years following his retirement, disability or death.

“At our firm, all of the financial advisors who are senior vice presidents have similar agreements,” McKeown says. “Therefore, the senior advisors have a strong incentive to pick successors they believe will run the business well.”

Wealth Enhancement Group is partially owned by certain advisors and key employees as well as a private equity investor. Clients are assigned to teams, which may have few advisors, and the senior advisors have succession agreements strictly for the team’s clients.

McKeown has equity in the parent company, as well as an agreement to sell back his shares in case of certain trigger events.

One advantage for the successor advisors is not having to go into debt in order to buy out senior colleagues when they retire, become disabled or die.

Both buyers and sellers may benefit from a formula that sets payment based on the future performance of the business, rather than a present value of estimated future cash flows or a metric of current performance.

“The arrangement I have is technically not a buy-sell,” says McKeown, who also is a CPA. “However, as more RIA firms aggregate and become bigger, arrangements like ours might become more common.”

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