How to find the right RIA successor

Finding the successor to a financial advisor's practice requires a complicated mix of the right personality, skills, capital, compensation and — most importantly — time, experts said.

The consensus for an adequate number of years to ensure a healthy transition among succession-savvy advisors and M&A experts interviewed by Financial Planning amounted to about five, or even longer when taking into account the difficulties of picking the successor. That's why more registered investment advisory firms and wealth management companies of all types are devoting resources to developing their talent in-house rather than recruiting it.

"This is a big challenge for our industry. The other big challenge for our industry is attracting talent into our industry. So succession planning is key," said Pradeep Jayaraman, president of Bluespring Wealth Partners, the RIA M&A arm of Austin, Texas-based wealth management firm Kestra Holdings. Jayaraman joined the firm in September after prior tenures with Focus Financial Partners and Goldman Sachs.

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New tactics for a familiar problem

Estimates that more than 100,000 advisors comprising more than a third of the industry's ranks will retire over the next decade are prompting more firms to consider how they can find successors or carry out M&A deals that lay out the future of their businesses when they're gone. Besides the structure of the transaction, the thorny and often emotional process for advisors to step down from a business they've built over decades and the necessity of capital financing, the choice of the right successor looms as one of the most important questions for all plans and one with massive stakes for client retention.

"There's a lot of succession that's going to continue to happen across the industry," said Kris Carroll, a managing director in the Carolinas region of Plymouth, Minnesota-based RIA aggregator Wealth Enhancement Group. In addition to being an adjunct professor at Winthrop University and a second-generation advisor, Carroll has led in-house training efforts at the firm through its "Wealth Enhancement Group University" and a current role coaching practice founders on their succession planning.

"The best thing and the thing people need to hear over and over again is, just because you're not ready to retire doesn't mean you shouldn't be thinking about it," he said. "It's so interesting that we help other people retire all the time and yet don't think about the finer points of our own retirements."

To that end, the best time for advisors to begin thinking about their successor isn't right when they launch their firm — but probably "shortly thereafter," according to David Grau, founder and CEO of M&A and succession consulting firm Succession Resource Group. Grau also frequently reminds advisors that "you can't just go recruit it and find a mini-me" to get their successor, he said. In fact, advisory practices that have reached $2 million in revenue or above usually need at least two or even three specialists in particular areas rather than one successor.

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That means that they should think in terms of a career track similar to those of accounting and law firms and seek interns directly from local colleges who can grow into those roles over time. The next generation of advisors and wealth management professionals "want something to believe in, something to buy into literally and figuratively," Grau said. In that vein, equity-based compensation can retain advisors for longer-term careers with the firm.

The last five years have seen "mass adoption of phantom or synthetic equity plans" aiding founders and successors in addressing a key financial challenge: less-tenured advisors don't usually have the capital on hand to buy an advisory practice and their more experienced counterparts are often wary at the thought of handing over their firms, Grau said. Deferred compensation based on the value of the company reduces the obligation to get outside capital.   

"As the firm grows in value they can capture a small portion of that," Grau said. "They've got the ability to buy a little bit of equity or have a down payment without having to pull out of their personal savings."

Lessons from the field

Some founders no longer have enough time to work with to set up a successor in that way, though. About nine months ago, a sole practitioner working with 220 client households and about $80 million in assets under management had agreed to a succession deal with Fairfield, New Jersey-based advisory practice U.S. Financial Services. It's one of 25 advisory practices owned by Bluespring, and the firm has picked two junior partners as its successors while acquiring two other books of business in the past five years, according to U.S. Financial Partner and Managing Director Steven Gallo. Its most recent succession deal presented challenges.

"He had an administrative assistant and no other staff," Gallo continued. "Unfortunately, just as we were getting ready to close the deal, he suddenly passed away. Taking over a practice without the retiring advisor available is an extremely difficult process. Still, we have been able to retain 95% of the clients to date, and we believe that we will continue to grow this practice as we can offer many additional benefits and services to these clients."

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Ideally, the outgoing advisors ought to expect a runway of two to three years after the deal — but not much more than that, according to Jayaraman. On the one hand, they'll want to be introducing the clients to their successor as a way of "being very thoughtful about this on a post-transaction basis and not just saying, 'OK, I sold my business,' and checking out," he said. On the other, founders who wait too long to leave their firms and don't delegate enough on their way out are falling into what Jayaraman views as the two biggest pitfalls in succession.

To smooth the process of going from the first generation to the second (or from "G1" to "G2" as industry experts refer to it), Bluespring has created a "successor academy," which is a two-year program for about eight to 12 advisors from across its firms who learn together through case studies, coaching sessions, webinars and other content. 

"Sitting where we are, we do get a good sense of what's working and what's not and we're able to codify and disseminate it," Jayaraman said. "The main focus is getting out of the shadow of that charismatic G1. … Succession planning is easily the No. 1 value creator or value destroyer, depending on how well you do it."

Doing due diligence

Anecdotally, advisors' chosen successors tend to fit that role in only about 1 out of every 3 cases, according to Carroll of Wealth Enhancement. Time represents one of the most important elements of the selection, since "finding a successor if you have five years is very different from finding a successor if you've got 12 months," he said. And across large RIAs, those questions are popping up a lot: Wealth Enhancement will have 17 successions among its advisors this year.

If there isn't much time for the handover, Carroll recommends a successor who closely resembles the founder as a means of bringing consistency to the client base. With more time to work with, he advises finding successors with complimentary skills that enhance the advisory practice as the founder trains them on any of the weaker parts of their expertise.

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To check whether the potential successor's personality will jibe with that of the founder, Myers-Briggs or Kolbe tests could prove beneficial. Another quiz called "StrengthsFinder" can identify strengths, weaknesses and values to start the conversations that are necessary to establish the right connection between founders and successors, Carroll said.

"If you want to learn somebody's values, you've got to have a deeper conversation. The good thing is that, as financial advisors, we're used to having deeper conversations," he said. "Succession is so much more successful when you have time and when you have a plan."

In that regard, the "open, truthful dialogue from day one of the negotiations is key," because "not every opportunity you come across will be a good one, and you must be willing to accept that fact," according to Gallo. If they have addressed any and all concerns they have up front, the founders and successors can then move to the more technical parts of the transaction.

"The more you know about the practice you are buying or the one you are selling, the better," Gallo said. "A detailed analysis of software packages used by both firms is a must. This will allow an adequate evaluation of potential cost savings, migration needs and the time it will take to make it all happen. Investing styles and products used by both parties need to be evaluated to determine how easily they can be merged, review any selling agreements and overall investment philosophy to ensure the two firms are compatible."

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To complete the transition "comfortably," the generation of founders set to leave the field in the next decade ought to anticipate "five to seven years, minimum, to exit the industry," according to Grau. "If you do it in any less than that, you are taking a ton of intellectual capital out of the industry. That's the scariest thing to me."

In order to avoid that possible "brain drain" scenario, he said that RIAs and the industry at-large must alter their traditional approach to hiring that has made a career in wealth management "almost Plan B for college graduates."

"If I know what I want to build, then every hire becomes a strategic part of my overall plan," Grau said. "The next generation are almost literally millionaires walking if they just sit back, listen and learn."