Not Ready to Retire? Consider a Partial Business Sale
Are you a financial advisor approaching retirement, but not quite ready to retire and sell your business? With 1/3 of the financial advisors expected to retire in the next 10 years, this is a scenario that we find many advisors in today. They ultimately know they need to implement a succession plan and would like to start to wind down, yet still enjoy what they are doing and want to make sure their clients are taken care of. If this description sounds like you, you may want to explore segmenting your current business and create a succession plan for clients that are no longer an ideal fit for your business.
If you are like most advisors who have been in the business for over 20 years, you have most likely worked with thousands of clients over those years, in all sorts of capacities. However, there are most likely clients that you sold a product to and are not actively engaged with you or, as your business grew and evolved, clients who no longer became an ideal fit for your model. While these clients may not be your top clients now, they still need access to a financial advisor for service, and there is value in those client relationships, as well the revenue they are generating. As you start to think about winding down your business, why not segment your book and create a succession plan with a younger advisor for the portion of clients that you no longer are actively engaged with. This allows you to receive value for that portion of your business today, rather than those clients just slowly leaving your business as years go on as they close or transfer their accounts to another advisor.
So how could this work? What would be the benefit of this approach? And how would it be structured?
How it works:
The first step would be to segment your business. The concept of segmenting your business has been around forever, but generally it is used for different levels of service provided to clients generating different levels of revenue. In this case while revenue is certainly a consideration, I would also encourage you to look at clients based on the amount of service time needed, fit for your current business model or niche, and product type. Once you have segmented your clients, you can determine what percent of your clients you would like to continue to work with, and what percent you would like to transition to another advisor. You can get that portion of the business valued, discuss deal structure (examples below), and work on a client communication and transition strategy. It’s also a best practice to household after you have completed this segmentation so you are not splitting up client households.
What are the benefits:
1) For the Clients: We have found going through this process, with a well thought out communication strategy, is a great way to reengage clients. Introducing the new advisor, explaining that you are starting to wind down and want to make sure they get the service they deserve, provides the clients the opportunity to address some of the planning needs they may have been putting off. The clients also may have been thinking about what would happen to their accounts once you did retire. Now that they know there is a plan in place beyond you, they are more likely to reengage, introduce their next generation, and potentially do additional business.
2) For the New Advisor: This is a great opportunity for a younger advisor who has some capacity and is willing to make an investment in their business to take on a larger number of clients at one time. As we have previously mentioned, these clients may not have been actively engaged with the selling advisor, which can be a negative if they are unable to engage with them. However, for the clients you can engage with and start to actively work with, it becomes a positive. In many cases, these clients not only have other assets, but also have financial planning needs that can be addressed through a fee for service model. This is an opportunity for a new advisor to take a relatively small revenue business and quickly grow the revenue through client engagement and additional services. Finally, this is also a great opportunity for a young advisor to prove to the selling advisor that they may also be a good succession plan for the other percent of their business when they are ready to sell. By providing amazing service to these clients, you can build trust with the selling advisor, so when they are ready to stop working with their top clients and fully retire, you are in position to take over that business as well.
3) For the Selling Advisor: As the selling advisor this allows you to ensure all your clients continue to receive the service they need and deserve, even as you start to wind down your business. It allows you to monetize a percent of your business that you were not actively working with and most likely would become a depreciating asset moving forward. It allows you to stay engaged and focused on your top clients while also starting to plan the next phase of your life. Finally, it is a great way to help support the next generation of advisors and in doing so, possibly vet your future successor for the other part of your business when you decide to fully retire.
How to structure the buyout:
The great part about this scenario is the buyer and the seller are both staying fully licensed and, in the business, so there are multiple different ways you could structure the buyout. While there are multiple variations, the two basic structures are fixed with contingencies or a split of revenue.
1) Fixed with contingencies: The first step is to do a valuation on the portion of the business being sold and use the recurring revenue as the baseline for contingency measurement. If the portion of the business is valued at $250,000 with $100,000 of recurring annual revenue, the buyout could be structured with $100,000 guaranteed paid in year one, with payments in year 2 and 3 of $75,000 plus interest. The guaranteed payment can be paid to the seller as ordinary income, to assist with the transition, while the ongoing payments could be long term capital gains. There can also be contingencies put on the year 2 and 3 payments, such as the revenue from the business acquired does not fall below 90% of the recurring revenue mark of $100,000. If it does, the two ongoing payments can be adjusted proportionately. The benefits to this structure, is it provides the seller with more upfront and guaranteed money. While providing the buyer all the upside on additional revenue generated from the business.
2) Revenue Split: In this example we will use the same business valued at $250,000 with $100,000 in recurring revenue. The buyer pays $50,000 guaranteed upfront to the seller, and then 50% of revenue generated from the portion of the business sold for 4 years. If the revenue continues at the current $100,000 that is being generated, the total amount of the sale is the same as the fixed with contingencies. However, the advantage to the seller in this scenario is they also get to participate in the upside of revenue growth created by the buyer. We have seen with a good transition plan and an actively engaged new advisor working with the clients, revenue from that portion of the business should increase. The advantage to the buyer is there is less of a down payment, and they are only paying the ongoing payments from revenue that is being generated. This can be a particular advantage for a younger advisor with less capitol.
No matter how you structure a partial sale of your business, it ends up being a win for all parties. The clients get access to a qualified advisor who will be able to serve their needs, as well as the needs of their next generation. The new advisor is able to invest the time to serve these clients, while growing their business. Many times, we see the new advisor take a client who may have purchased one product 10 years ago and create a financial advisory relationship with that client as well as engaging with their next generation. As the selling advisor, you are able to monetize a portion of your business that you were not actively engaged with and feel confident you are providing your clients access to the service and financial advice that they need. A side benefit is you are also helping the next generation of advisors grow and build their business and are potentially vetting your future successor when you decide to sell the rest of your business and retire.