Follow the Money in Succession Planning

At first I thought my projections just had to be wrong. How could a succession expert propose such a deal? But sadly, after checking with a different expert, I had made no mistake. My client and I met with the expert, who pitched the plan this way: "You'll make the same total amount of money that you would have made over the 10-year transition; you'll have collected $2.3 million in payments for a firm that is currently worth $2.5 million; and you'll have two new partners who can buy you out when you decide to fully retire. Sound good?"

In all honesty, I can't tell you what my client's answer would have been because we reviewed the spreadsheets in advance, and I prepped him on why this was a bad deal. (Tip for future consultants: Part of your job is keeping your clients from embarrassing themselves.) What I can tell you is that the expert didn't take it very well when I pointed out the flaws in the plan (the rule against causing embarrassment doesn't always extend to other consultants). In fact, after questioning my credentials and experience—he should have just called me a dumb blonde—he continued to defend the plan.

The big takeaway, though, is that advisors need to be very careful about implementing any plans proposed by so-called experts. (As much as I would like to believe I am perfect, I also encourage my clients to question me.) Whether it's a new organizational structure, a compensation plan, buying new technology, or buying or selling an advisory firm, take a step back and look at the big picture. Ask yourself: "What's the end result going to be, and how much am I going to pay or get paid for it?" "Does that seem reasonable?" And: "Is it reasonable from the other side, as well?"

More specifically, the key to making succession plans work (without having the firm owner underwrite the purchase of his or her own firm) is to let the firm's growth pay for its acquisition. Typically, the reason owner-advisors hire junior advisors is to leverage themselves in order to grow their firms. Let that growth pay for those junior advisors to buy you out. It's really that simple.

To do this, I restructured that succession plan several ways. My client decided to hold the owner-advisor's total compensation at his current level of $400,000 a year. (We thought it was unfair for him to take a pay cut, but by keeping his compensation constant, we let the growth of the firm pay for the succession). We also kept the junior advisors at their current base salaries with revenue bonuses and increased their profit participation as their equity grew. Half of those profits go to pay off the owner-advisor.

The employees are happy because they get steady raises every year (doubling their current compensation by the sixth year), and when the equity is paid for, get a big jump to some $300,000 a year. The owner is happy because he actually gets paid for his 75% equity of his firm and takes no hit to his lifestyle.

Of course, both of these plans are projections based on an assumption of the future growth rate of the firm. Currently, it's growing at 17% a year. When we ran the succession plan using a 10% growth rate, the junior advisors are able to pay for their equity in seven years and everybody still makes a lot more money.

This creates exactly the kind of incentives that are the foundation of our entire advisory firm management philosophy, which we call P4: Pay your key employees a fair wage, add junior partners, and a lot more if the firm grows. Maybe it's just coincidence, but our firms tend to grow—a lot. We expect the same from the firm above: Those junior advisors have a huge financial incentive to grow the firm as quickly as possible because if they do, they pay off the loan faster. The owner-advisor has an incentive too: His remaining equity will be valued by the size of the firm at the time he's bought out. That could easily be another $1 million. Once again, that should easily be covered by the growth of an even more successful firm.