Exiting Your Practice, Stage Left

Coming Up with Price

How much might advisors get for the sale of their practice? A general rule of thumb, sources say, is to multiply income by some factor. For recurring revenues, such as fees derived from investment advisory services and trailing commissions on product sales, observers suggests a multiple of 1.5 to three times revenue. For non-recurring revenues (e.g., heaped or front-loaded commissions) the multiple will generally range between 0.75 and 1.25.

When markets are down, the computed figure–the sale price–could be substantially below what the advisor wants. Hence, experts caution against selling a practice in a contracting economy. Especially vulnerable are investment advisory fees charged as a percentage of assets under management, which fluctuate in tandem with prevailing equity values.

"If the market has been down for two to three years straight, then your recurring revenue has likely also been down over the same period," says Randy Miller, an attorney and business consultant at National Planning Corp., Santa Monica, Calif. "So the valuation is affected and your business won't be worth as much in a down economy. Conversely, it's probably a good time to sell when the market is up."

For producers who generate mainly one-time commissions on life sales paid by clients whose loyalty to the firm is tenuous, it may never be a good time to sell. When these agents retire, note experts, the clients are as likely as not to leave the practice.

"The relationship between the life insurance professional and clients is usually personal to that professional and is difficult to transfer to another life insurance advisor," says Brown. "In my experience, it seldom works, unless the exiting producer is transferring the business to a child who, because of the family connection, can inspire loyalty among the clients.

"Whenever possible, I recommend that agents expand the practice beyond life insurance, such as by offering investment advisory or financial planning services," he adds. "These fee-based services are more easily transferable owing to the ongoing stream of income."

Putting it all in Writing

Sources say that that many financial professionals bypass a critical step: putting the succession plan in writing so that the plan's stakeholders know what to expect–and when–during each phase of the transition. Such an oversight can be bad both for the seller and buyer.

All too often, experts note, the parties reach an informal understanding, but then one or the other doesn't follow through on verbal commitments.

Miller recounts the time an advisor sold his practice to another shortly before retiring and didn't notify clients about the transition to the buyer. He also failed to renew licenses. Many of his clients left the practice for another, and because he was no longer licensed, the seller was unable to partake in new commissions generated by the buyer.

"It would have made more sense for him to keep his licenses and to have structured the deal differently," says Miller. "Basically, he was cost-conscious. And he was very checked out of the business before he sold it."

Another pitfall of exit planning is the failure to indentify a suitable buyer. The ideal candidate, says Miller, should share the seller's high ethical standards, presentation style, investment philosophy, product mix and technology.

Gillespie agrees, but observes there is room for differences. A senior advisor can also learn things from a junior associate being groomed to take over the practice, particularly in respect to productivity-enhancing technologies.

"An articling advisor may have new ideas or technology skills that would benefit a practice in transition," says Gillespie. "Yes, a successor should share the departing advisor's outlook and business processes. But the junior associate should also push the outgoing advisor to try new things."

AXA Equitable's Van Zandt also cautions that advisors should be open and flexible when choosing a successor.

"Sometimes advisors may not consider a potential successor because he or she isn't exactly like them, or doesn't do something exactly the way they do it," she says. "Advisors should be open and look for someone who has strong skills, who knows the business and will service the clients properly, even if they might do it in a different way."

If the successor is one of several adult children of the retiring advisor, then pressure may be brought to bear to equalize the value of the estate for siblings by purchasing life insurance. Miller, however, thinks that's not necessarily a good idea.

"Buying life insurance to equalize an estate may not be fair to the child inheriting the practice," says Miller. "That child has to maintain a business that, if things go awry, could be worth a lot less in later years. The other kids will get a lump sum of cash that they can dispense with as they please.

"If the advisor wants to be fair, it may better to separate the business from the rest of the estate, then divvy up the non-business assets among all children equally," he adds. "In any event, the advisor should make clear in a will, the purchase agreement or other estate planning documents his or her wishes for passing on the estate."