I told you in my May column that my firm was readying for a transition. Soon after I finished writing, the deal was done. Here's how it happened and what it could mean for a firm like yours. Most firms have several transition choices for a succession plan, ranging from the good to the bad to the ugly. Let's start with the ways not to go (and let's also be open to a new approach).



You can sell to a roll-up firm, also known as an aggregator. Say you have $1 million in EBITDA. For a firm that size, you'll likely get a P/E of 6 or so. You sell 80% of the firm to the aggregator and 20% to your key employees at a 20% discount to keep them on board.

Assuming you have zero basis in your firm and a P/E of 6, your capital gain is $5.76 million (0.8 x $6,000,000) + (0.2 x $6,000,000 x 0.8) = $5.76 million). This results in federal and state taxes of about 20% (or more), and rates could rise in the future. After the tax dust settles, you'll have about $4.6 million in your pocket ($5,760,000 x 0.8 = $4.6 million).

Given current investment returns, assume you can draw 4% forever or 6% for the next 20 years. That amount ranges from $184,000 to $276,000 annually, a pretty good chunk of change, but only 19% to 28% of what you were making previously.



The second choice? Take the $1 million in profits again. Assume you give 20% to your key employees and keep $800,000 for yourself, until you drop dead at your desk. Based on surveys I've done, that annuity stream scenario is what roughly 25% of all small business owners expect.

Most financial planners, though, would see the poor planning in this tactic and a tremendous lack of concern for all the stakeholders, including clients and staff. You can call this outcome the train wreck scenario. If you decide to do this, your staff - the folks who own 20% of the firm - will figure it out and likely defect with clients before the company implodes.



Consider a third scenario: Sell the entire firm to your valued, loyal employees. They may already own a piece, but that stock is not likely bankable. In the current lending environment, private stock has little value as a security. Banks require you to personally guarantee their loans.

Thinking you can strike a better deal, you offer the employees a 20-year note at 7% with nothing down, which means they have to come up with about $152,000 each quarter, or $608,000 a year. If they give up about two-thirds of the cash flow for 20 years, that's a good deal for you, right?

Other than the impractical nature of this transaction, who would be willing to put former employees in charge of a firm and watch from the sidelines, shouldering the financial risk for 20 years or more? Most sellers, including the individual who offered me the Monitor Group 13 years ago, would not do that. That man demanded two-thirds of the total sales price in cash and took back a seven-year note on the last third. I paid the note off in five years, but a significant down payment isn't something most employees can make.

Still, selling to employees seems easiest for many owners because it retains clients and gives founders a sense of continuity but, to work, it has to be a windfall for employees. Why?

For employees to pull it off, there must be: A minimal down payment coupled with a very low interest rate; a very low price; or a payback period that looks like a 30-year home loan. If these conditions aren't present, the company won't have sufficient cash flow to pay the seller and grow. Nice for employees, but not so good for you.



As I mentioned in my previous column, I talked to Mark Tibergien, CEO of Pershing Advisor Solutions, about business succession. He recommended merging with a firm that has a solid management structure run by folks younger than I.

Fortunately, seven years ago I joined a business consortium of like-minded wealth management firms spread across the country and Australia: the Zero Alpha Group. The organization shares intellectual capital, including best practices and financial data for benchmarking. Over the years I've come to know all the firms and their founders well. These are among the best-managed firms in the country and the combined intellectual base of ideas, experience and strategic thinking is unparalleled in our industry.

At a ZAG meeting in 2007 in Australia, with Brent Brodeski, CEO of Savant Capital Management in Rockford, Ill., I first explored the idea of combining our businesses. A year ago, I re-engaged in the conversation with Tom Muldowney, the chairman. I thought I had a good idea of what I wanted, but came to realize that what was possible was very different.

You'd be right if you thought that I wanted out. I did, at least at first. When all four principals first met, one of my "must-haves" was a liquidity event in seven years.

When I presented my case at our meeting, Muldowney looked around and said, "If Kautt is getting a liquidity event, I want a liquidity event too!" That was a significant chunk of the firm's value, so buying back all that stock was a non-starter.

I was stuck in the mind-set that I had to get out because I didn't know what was going to happen to the company. With no buyout, our potential combination was dead on arrival.

Luckily, I knew all these guys well. I talked with Brodeski about what we both desired. He said he could live with an ongoing dividend rather than a buyout if it was protected. That serendipitous discussion provided the spark that caused us to create a rare business organization for the RIA industry.



As I struggled with how to make the combination work, it occurred to me that we should look to the long-standing model of business continuity: the public corporation. There, the responsibility of continuity rests with a board of directors representing the owners - the "permanent component." The responsibility to run the corporation rests internally with the chief operating officer and other managers - the "flexible component."

As I thought about the organizational design of the new company, it became clear we needed a board that was empowered legally to provide financial and strategic oversight to operating managers to protect the dividend the way public companies do. It is the synthesis of public and private corporate organization that is so powerful. (The Savant-Monitor Group partnership, by the way, has created a firm with 90 employees at 10 offices in four states (Florida, Illinois, Virginia and Wisconsin), managing more than $2.7 billion in assets.

As we developed the organizational design, we became painfully aware of the emotional difficulty for successful entrepreneurs who are benevolent dictators. We report to no one, and decide the fate of our firms independent of outside influence to seal the transition. But the desire to make the merger happen outweighed any negative feelings. I discovered that, in any transition, you will struggle emotionally.

To succeed, you've got to really want whatever's on the other side. I look forward to telling you more about our transition as it unfolds and why this organizational model is so attractive, but difficult to put in place.



Glenn G. Kautt, CFP, EA, AIFA, is a Financial Planning columnist and vice chairman of Rockford, Ill.-based Savant Capital Management.

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