Stay for the 'sunset' or leave for a sale: What to consider

An advisor's choice between a "sunset" deal for a succession plan or dropping their brokerage firm to sell an independent advisory business involves one option that is easier and one that pays better.

With more than 100,000 advisors managing nearly $15 trillion in client assets expected to retire over the next decade, many teams will be selecting their exit lanes soon. They will likely weigh many factors, but three experts said it often boils down to picking between the logistically simpler internal deal within an employee brokerage or the more burdensome independent path with a likely higher return. 

When advisors ask Jeff Nash, the CEO and co-founder of recruiting firm Bridgemark Strategies, whether they can "get a better deal" by leaving their employer to sell an independent advisory business, he answers "most certainly" — with some caveats, Nash said. The higher price tag alone doesn't necessarily dictate advisors' actions, and the sunset deals that hand off the client base to other advisors at a brokerage firm have "gotten a lot more lucrative" in recent years, he noted. But so have the independent advisory practice sales, amid record valuations.       

"Staying inside the firm and doing the sunset is the easy button," Nash said. "The ideal seller is one who's doing 100% fee-based business and the assets are movable, but that may not be the case."

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A shifting marketplace

With so much variation across the tens of thousands of founders who will be retiring in coming years, Nash's team released a report last month pointing out that each possible exit route brings "complexities and benefits." Only the decisions "done hastily without proper research" will bring the worst results for advisors, their staff and their clients, according to the report.  

"Most advisors choose the sunset path for two reasons: It's easier and at this final stage in their career they are focused on simplicity. The second reason is that advisors never ask about their options and don't understand how significant the difference may actually be," the report said. "The best decision is rarely the one with the bigger headline number, or the one that's the easiest. It's the one modeled honestly enough with all of the pros and cons considered to come to the right decision."

Some of those considerations are shifting, though. 

For instance, custodians who identified a need to reduce potential headaches in the migration of client accounts have developed technology that will "will seamlessly switch everyone over to their platforms," according to Mitchell "Mitch" Fenimore, a senior vice president and the Lancaster, Pennsylvania, market leader for Camp Hill, Pennsylvania-based registered investment advisory firm River Wealth Advisors. 

Independent firms seeking an edge in recruiting teams ahead of their founders' eventual retirement can also provide more flexibility in the exit timing and other structural terms in their offers. By the same token, the employee brokerages are trying harder to retain those teams, too.

"The wirehouses have recognized that they need to do a little bit more than they have in the past," Fenimore said. "The valuation of these independent firms is really skyrocketing right now, and if you're an independent advisor you have the potential to really create some wealth for your family."  

Without any "uniform answer" for every advisor reaching this fork in the road of their career, successors may move in an entirely different direction as well. They could take over a client base at the brokerage firm now but still launch their own independent practice someday, according to Jason Diamond, president of recruiting firm Diamond Consultants. So avoiding transitional headaches for staff and clients may be a moot point after a sunset deal.

"They're almost never the optimal economic solution," Diamond said. "They've been around, but every firm is kind of leaning into them and emphasizing them now." 

Noting that "every W-2 advisor who reaches the end of their career" will face the decision, the report by Nash's firm lays out the most common difficulties with the choice.

"Both are legitimate paths," the report said. "They are not, however, comparable using a single number, which is exactly the mistake advisors make comparing a sunset package to leaving and selling your business. A sunset program and an outright sale operate on different timelines, different tax treatment, different risk and different assumptions about who ends up owning the value of the practice you built."

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Adding up the pros and cons

A sunset deal obviates any trouble with client moves, a bidding process and, in some cases, anything left on an advisor's previous recruiting loan. But the departing founders will likely get a lower multiple in their valuation, receive the payout over a longer term as ordinary income that is taxed at higher rates than capital gains from a sale and leave their clients to successors that came from a much more limited pool.

On the other hand, leaving the employee brokerage to sell an independent advisory practice usually enables a founder to negotiate more aspects of the deal structure, take the proceeds as capital gains and secure "double or more the amount someone receives in a sunset alternative," according to the report. This route could bring complexity from trying to retain as many clients as possible, finding the right buyer and losing infrastructure that the employee brokerage previously provided.

As an illustration, the report presented the hypothetical example of a team that is generating $4 million in trailing 12-month revenue. A sunset agreement would come from a set formula and pay about 250% of the revenue ($10 million) in ordinary income over five to 12 years, with the deal execution risk and eventual successor in the brokerage's hands. An independent sale would result from a negotiated price that could fall somewhere between $16 million and $24 million with a faster payment of, in many cases, capital gains, with the execution risk and successor choice taken on by the buyer and seller.

Given the differing outcomes, the report suggested that advisors approach their decision deliberately, with reliable numbers. After getting "an honest practice valuation" and considering how many clients would follow them to an independent firm, advisors should get the sunset offer's formula, schedule, tax treatment and source of financing in writing and go through their due diligence process for either option, the report said.

"A sunset program and an outright sale are not two versions of the same decision," it said. "The trade-off is control and increased financial opportunity for certainty and ease."