Chapter 24
Ensuring Business Continuity and Planning for Succession
IN THIS CHAPTER
Keeping your business running when you can’t
Making sure your heirs don’t get stiffed when you die
Choosing the right person to run the business after you
Whether you’re a solo practitioner or owner of a several-member advisory firm, you need to plan for your succession to ensure business continuity and provide for your family (and perhaps for yourself) in the event that you can no longer practice (or you no longer want to practice) temporarily or permanently. If you die or are disabled without a plan in place for taking care of you, your family, and your clients, you may be destitute, your family members may suffer serious financial stress, and your clients may be left without the guidance they need to access their accounts or to transition to a new advisor.
A sure sign you’re at the pinnacle of your career is that your clients have tremendous confidence in you and are tremendously loyal to you. If you unexpectedly leave the business (due to a debilitating illness or accident, death, or family crisis; to pursue an incredible new opportunity; or to retire) without conscientiously transitioning your clients to a competent and trustworthy advisor, that accumulated confidence and loyalty dissipates. In addition, an untimely and sudden departure does a disservice to the industry, adding to its challenge of building credibility and trust.
You owe your family, your clients, and the industry the duty of loyalty and care. Should something unexpectedly happen to you, having all the requisite insurance policies to protect your family’s financial plan is easy enough. But, protecting your clients’ futures is more complicated.
In this chapter, I explain how to plan ahead for your planned or unplanned departure from the business to ensure that your family is taken care of financially and that your clients have a smoother transition from you to their next financial advisor.
Failure to plan for your succession is irresponsible, placing both your family members and clients at risk. In addition, failure to plan contradicts the sage advice you give your clients. It’s the equivalent of being the cobbler whose children have no shoes; your clients have contingency plans and products in place to protect against unforeseen risks, but when you don’t plan for your succession, you have no plans and products in place for you or for your family and clients.
Creating a Hit-by-the-Bus Business Continuity Plan
Business continuity involves having a plan in place to prevent any temporary or permanent disruption in income to you or your family and disruption in service to your clients. Think of your business continuity plan as a back-up plan. If anything were to happen to you, where would your family obtain the income you’re pulling in, and who would ensure that your clients’ assets and liabilities were properly managed? As they say in show business, the show must go on, but how? Your answer to that question helps you to ensure business continuity.
Unfortunately, most financial advisors don’t have such a plan in place, which puts their family in jeopardy, creates potential uncertainty among clients, and places their broker/dealer firm into the unenviable position of having to reassign all of that advisor’s clients to someone else.
I strongly encourage you to create your own business continuity plan. In your plan, be sure to do the following:
- Identify the conditions that trigger the execution of the continuity plan:
- If you become disabled (mentally or physically) to the point at which you can no longer fulfill your duties as financial advisor
- If you die
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State the commitments being made between the two advisors:
- Former advisor: the one who is no longer able to serve the client base
- Continuity advisor: The other who is going to be stepping into the role
You may want to include something to the effect of, “I promise, as the continuity advisor, to uphold the standard of care and due diligence executed by the former advisor.”
- Specify the compensation to the continuity advisor for the commitment to the former advisor’s practice. For example, providing a life insurance policy with the continuity advisor as the beneficiary would provide a lump-sum payment for his continued services.
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Specify the compensation to the former advisor’s family, for replacing lost income and/or business value. This clause is especially important, because unexpected events (such as death and disability) usually mean that the former advisor’s family is left only with personal life insurance or disability income policies and nothing from the practice.
Add a promise to pay the former advisor’s family a lump-sum payment or an income stream for a specified period of time. Think about this carefully, and involve your spouses, so that everyone understands the liability being managed. You want to be sure that your family is protected when they’re at their most vulnerable, dealing with extraordinary loss and suffering.
A great way to compensate the survivors and ensure business continuity is to use a fully funded cross-purchase, buy-sell agreement. With this arrangement, all owners agree to buy the interests of the departing owner when the trigger event occurs. The owners take out insurance policies on one another that provide them with the money to pay the survivors for the departing owner’s interests. See Chapter 10 for details.
Create a one-page document to mail to clients after a triggering event. This document should include the signatures of the former and continuity advisors and simple language reassuring clients that their financial matters will henceforth be entrusted to a partner who is dedicated to continuing the ongoing relationship. I recommend that you have the document notarized to convey the formality of the event. Also, share it with your broker/dealer’s compliance department, so they have a chance to review it and are aware of the agreement.
Here’s a sample draft of the one-page document:
- We the undersigned have entered into a Business Continuity Agreement, which becomes effective as a result of a triggering life event. In such an event, ____________ (herein referred to as, Continuity Advisor) commits to the continuation of clients’ care and stewardship of ___________ (herein referred to as, Former Advisor).
- Both Continuity and Former Advisors have determined that in the spirit of ensuring both continuity of their clients’ and families’ financial outcomes, this document memorializes their completion and full agreement to terms and conditions outlined in their Business Continuity Agreement dated _______________.
After finalizing the succession agreement, send a simple letter to clients notifying them of the arrangement and assuring them that it’s just a precaution in the event that you can no longer serve as their financial advisor. In your letter, use a more personal and less official (legal) tone. Taking a more casual approach satisfies the requirement of notifying clients while maintaining their peace of mind.
This agreement and the planning associated with it are simple ways to make sure that your clients and family are seen to properly. The agreement between the former and continuity advisor doesn’t need to be a lifelong commitment. If you’re the former advisor, you’re simply naming the person you think is best at this particular point in time. You can choose someone else if conditions change.
See Chapter 10 for additional details about planning for business continuity and succession.
Protecting Your Heirs’ Interests with a Buy-Sell Agreement
If your business has recurring revenue, usually in the form of financial planning/advisory fees or asset-based fees, then you have a business that carries significantly more value than one that earns only transaction revenue (for example, investment or insurance product sales commissions). When your business is generating recurring revenue, include a business valuation within the business continuity agreement.
You can hire a consulting firm to perform a business valuation, but here’s a simple method that produces a close enough estimate for government work:
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Multiply the former advisor’s annual Gross Dealer Concession (GDC) by his grid payout (GP).
GDC is the amount of money generated for the broker/dealer from a sale. For example, if a mutual fund has a front-end load of 5 percent and a client invests $10,000 into the fund, $500 goes to the broker/dealer as GDC and $9,500 is invested in the fund for the client. GP is the percentage of the GDC that the advisor keeps; for example, if the broker/dealer pays the advisor 60 percent of the $500 GDC, then the advisor earns $300 of that $500 GDC, and the broker/dealer keeps the remaining $200.
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Multiply the result from Step 1 by 2.5 (2.5 is an industry standard multiple in the mid-range).
For example, if the former advisor had $100,000 in the past 12 months in GDC, and a grid payout of 60 percent, the total from Step 1 would be $60,000. Multiply that by 2.5 and you get $150,000, which represents the minimum amount the family of the former advisor would receive.
To be fair when valuing a business, use simple industry standard multiples in the mid-range, which assumes the business isn’t the most valuable or least valuable of its kind. -
Multiply the average annual commissions the former advisor earned from any other business lines by 0.5.
For example, if the former advisor also sold personal insurance policies (life, disability, and annuities), take the average of those amounts over at least the past couple of years and multiply the average by 0.5. Because this type of business revenue is typically up front, commissions (for any ongoing insurance trail-based revenues, those could be added into the prior AUM figure), those can be valued at 0.5. For example, if insurance revenue was $50,000 in the first year and $100,000 in the second year, then the average over those two years is $75,000. Multiply that by 0.5 and you get $37,500.
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Add the result of Step 3 to the result of Step 2.
For example, in Step 2, the business valuation came to $150,000 based on recurring revenue. In Step 3, $37,500 was added to account for sales commissions. The total business value then comes to $150,000 + $37,500 = $187,500.
Based on the results from this example, the continuity advisor should buy a life insurance policy on the former advisor with a net death benefit equal to $187,500. This is the amount that the continuity advisor will pay the survivors in exchange for the former advisor’s interest in the practice. In reality, business values increase over time, so I recommend buying a term policy that can be converted into permanent coverage over a ten-year period. This would provide flexibility in your household’s financial planning as your business scales up.
Planning for Succession
Whether you’re preparing to have someone take over your financial advisor business when you retire or you’re being responsible and making sure your clients are well served in the event of your demise, you need to have someone ready to step in without missing a beat. You need a successor. Ideally, you have a strong team in place with developing leadership — personnel you’ve trained and who your clients know and trust. Short of that, you should have a partner, a colleague, or a well-trained family member whom you know and trust and is willing to take over.
If you’ve done the challenging work of building a business with equity, as I explain in Chapter 23, you have an attractive asset to offer to a successor. You just need to find the right person. In this section, I describe the criteria for selecting a successor.
Picking a successor with the right credentials
Clearly, the first qualification your successor must have is competency as a financial advisor. After working with a colleague or protégé, you’ll know whether the individual has the core competencies to fill your shoes. Here are the basic qualifications:
- A bachelor’s degree from an accredited college or university, preferably in a finance or accounting field of study
- Experience in the field, as a financial advisor, accountant, loan officer, or other related position
- Financial Industry Regulatory Authority (FINRA) licenses, including Series 6, 7, 63, 65, and 66
- Additional certifications from financial education institutes that show a commitment to continuing education and improvement in the field
See Chapter 6 for additional details about the education and skills required to become a financial advisor.
Addressing personality and values compatibility
As with any job, the knowledge and experience to do the job are the baseline requirements, and measuring them is fairly easy, especially if you’ve been working with a successor candidate for some time. You can tell whether the person knows how to conduct a thorough client due diligence process and audit an investment portfolio. Those skills are quantifiable.
Personality and values are more subjective but almost equally important. As you observe successor candidates, ask yourself the following questions about them:
- How do does the candidate interact with clients? As a professional, or more as a buddy? A good candidate is personable but turns professional when the time comes to discuss business. Clients aren’t paying you to be their friends; they can get those for free.
- Does the candidate try to explain complicated financial concepts in simple language or try to impress through the use of jargon and acronyms? The candidate you’re looking for wants to be understood, not revered as an enigmatic genius.
- Does the candidate pick up the check at a business lunch or social gathering without being prompted or asked? Your successor needs to be a natural at being a good host, which is reflected in his comfort at picking up the check.
- Does the candidate demonstrate a genuine interest in learning the trade? Does he ask intelligent questions about how you would’ve handled a situation in which he recently struggled? Does he actively seek out learning opportunities? You want a successor who’s eager to learn, not one who thinks he already knows everything.
Try to get to the core of the person. Intelligent people can always develop the skills, knowledge, and experience to do a job, but they’re born with heart and spirit that’s difficult to change. Look for a candidate who “has the right stuff,” not necessarily the one who has the most knowledge and skills. Sometimes the subjective qualities are the most important.
Considering transferable skills
Whenever you’re recruiting someone for a job or to be your successor, consider not only the skills required for the job but also transferrable skills — skills acquired through experience outside of the financial advisory field, such as leadership skills, motivation, the ability to delegate tasks, communication skills, empathy, character, and so on. You probably have transferrable skills that your clients have come to rely on and expect from you, so be sure your successor has the same or comparable skills.
Your successor shouldn’t only replicate what you provide but also be able to take it to the next level. For example, I’ve developed unique protocols and processes for both portfolio management and client due diligence. I want to be sure that these not only continue but also evolve along with the evolution of technology and capital markets. I know that eventually I won’t be in a position to steward that evolution, but my successor certainly can be. I want to be sure that my successor has the same passion and ability to do so.
Be prepared for the possibility of investing time and effort into mentoring a candidate only to discover that the person isn’t the right fit to be your successor. Mentoring requires time and effort, as does discovering whether someone is the right fit for a position. However, keep in mind that time spent mentoring is rarely time wasted. You’re always learning from the experience. More specifically, you may discover that someone isn’t the right choice to be your successor, which can be a valuable lesson. Learning is all part of the journey, for everyone involved.
Sizing up a candidate’s leadership potential
A wallflower isn’t your ideal successor. You want someone with a demonstrated history of contributing to team meetings, someone who frequently visits your office or asks for your time to consult on a matter, and someone who’s proactive. The team member who shows up to a meeting with a whole client solution sketched out and seeks your and other team members’ feedback is a great candidate.
Keep in mind that although you want someone with leadership qualities, you don’t want a control freak. You want someone who has ideas but who is willing and perhaps even eager to have those ideas challenged and to obtain feedback. Be wary of anyone with leadership qualities who is defensive or has a my-way-or-the-highway attitude.
Resist the urge to choose a successor whom you just really like and who reminds you of yourself early in your career. You’ve made a lot of mistakes since then and discovered a lot about how to lead you to the position you hold now. Don’t assume that someone who reminds you of who you were back then will follow the same path.
Accounting for loyalty
Loyalty to you, your clients, and your firm is what you’re trying to assess here. You don’t want blind loyalty, where whatever you say is treated like rule of law. True loyalty is when your successor asks you why you believe what you do. Whether it’s about handling a client anxiety or understanding when a certain product mix may be most appropriate, you want your successor to have a deep understanding as to why you’ve chosen to do things in your practice the way you have. This takes time, of course. Be patient while sharing your wisdom.
Create opportunities to spend time with a successor candidate away from the office. You can meet after work hours, for happy hour or dinner, or during a weekend get-together on a hike or beach day. Time spent with your potential successor can give you better perspective on who he is, what makes him tick, and what motivates him. You’ll want to know that his heart’s in it for all the right reasons.