Succeed At Succession Planning: A 4-Step Playbook For Firm Ownership Transition

In a charming village, 2 bakers, Alice and Bob, ran neighboring bakeries renowned for their exceptional pastries. Both started their ventures with equal enthusiasm and skill, delivering delicious baked goods that delighted their customers. While their approaches to baking were similar, their approach to their businesses were starkly different.

Alice, with a disciplined, forward-thinking mindset, crafted a plan for her bakery's future. She not only perfected her recipes, but she also trained her staff, documented every process, and secured, groomed, and mentored a capable successor to ensure her bakery's continued success. When Alice retired, her successor seamlessly took over, preserving the bakery's quality and the value Alice had worked so hard to build.

With a more in-the-moment approach, Bob focused all his energy on baking, neglecting to invest in the business or make long-term plans. He hoped that his bakery's charm would naturally carry forward and that he'd be able to find someone to take over when the time was right. As Bob aged, he grew tired of the long hours and going it alone. He felt less and less enthusiasm for his work but was tied to the bakery for his income. When an unexpected event forced Bob to step away, the lack of a successor created real struggles. The bakery's quality declined, customer loyalty waned, and the business struggled to produce the cash flow needed to survive.

Not unlike Bob, many founding advisors across the industry are short-term focused, more preoccupied with creating their beloved baked goods than with succeeding at succession.

As demonstrated by Alice's foresight, a business must plan for its future leadership needs to ensure stability, growth, and lasting success. Succession planning is not about filling a vacancy – it's about ensuring the seamless transition of knowledge, skills, and culture to ensure continuity of care for clients and the realization of value for owners.

The Importance Of Succession Planning

Why do most ownership transitions fail at financial advisory firms? The primary reason stems from a lack of alignment and agreements about the why (goals), what to expect (transition plan), when (timeline), who will do what (roles & responsibilities), and how business will be conducted and issues addressed along the way (expectations) between the founding generation (Generation 1, or "G1") and the next generation (Generation 2, or "G2"). However, there are practical steps that advisors can follow to effectively implement a succession plan that sets them, their successor, and their firm up for long-term success.

To help bring structure to the succession planning process, advisors can follow a framework focusing on the 4 agreements that can help create a smooth succession:

1. Shared Vision – Creating Alignment
2. Transition Strategy – Structured Process
3. Transaction Terms – The Economics
4. Transition Plan – Defined Path

This framework is simple. Simple does not mean easy, but time and energy invested early on is what sets the firm and owners up for success in transition.

The Shared Vision – Creating Alignment

Creating a clear vision of what the firm does, why it exists, what its goals are, and how to measure them allows both Generation 1 (G1) and Generation 2 (G2) to create a shared language for the future and a clear path forward.

When consulting on succession, Jarrod and I often find that a lack of shared vision creates added complexity and confusion. Many of the tension points between G1 and G2 can be attributed to a lack of clarity, resulting in differing views on how to best move the firm forward.

Is the firm built to serve the unique needs of a target client or niche? How will the firm stay competitive in a constantly evolving landscape? Does the firm have a growth engine in place that isn't founder-dependent? How will the firm continue to grow while requiring less time from the owner? How will the team and operations grow? Who will take on the wide range of responsibilities the owner fulfills?

These questions and many more are best answered with a shared vision that aims to align thinking and guide the practical steps taken. When establishing the shared vision, it should include context beyond a single line statement for it to be most useful. A good vision includes the following elements:

• The overriding statement: A concise summary of the firm's core purpose.
• Specific components: Elements that help clarify the overriding statement (e.g., how we define a deeper level of service).
• Measurable elements: Metrics like revenue, profit, impact, clients, or team size.
• A timeline: When the goals should be achieved (e.g., serving 300 families by 2030).

Consider the following example of a good vision statement:

Awesome Advisors provides national expertise on equity-based compensation to highly compensated tech executives. We demonstrate deep value in our work, helping clients achieve financial freedom with personalized financial planning. By 2030, we will serve 500 households who value our relationship and generate $6 million of revenue annually, empowering us to build a happy, healthy business for all stakeholders.

A shared vision is the "why" that governs the owner's efforts, making it far easier to get agreement and take action on the "how" pieces that follow.

Transition Strategy – A Structured Process

The transition strategy needs to incorporate the pursuit of the shared vision and the needs of each generation. It will include the timeline for the transition of operational responsibility and financial ownership.

The shorter the timeline, the more aggressive the strategy needs to be to involve, delegate, and transfer operational responsibility. Conversely, if the timeline spans 10 years before the transition, owners have a much longer time horizon over which to enact their plan and the resulting changes.

The key components of operational transition include the following:

• Client Service Oversight: Delivery of core services
• Sales Oversight: Execution of generating new revenue
• Strategy Leadership: Strategic planning and decision-making for the firm
• Financial Management: Direction of financial management of the firm

Each area should have an individual roadmap and customized plan to develop skills and transition responsibilities over time based on the abilities of the next generation, the transition timeline, and the founding generation's needs.

These topics and conversations can be emotionally charged, particularly when there are differing views. Open dialogue between G1 and G2 is required to find alignment and create agreements that support an effective transition.

More often than not, a lack of intention isn't what prevents G1 from implementing a defined succession plan. Instead, it's usually a lack of clarity on longer-term plans and uncertainty about how to plan and launch a succession plan that keeps G1 from getting started. This lack of clarity creates uncomfortable uncertainty for G2, resulting in mounting frustration and pressure to implement a plan.

We've received more than a few phone calls over the years from succession plans that have created a struggle between generations. The 3 most common complaints we hear include the following:

• The founder identified a successor to fill their shoes but didn't develop a thoughtful plan to help the successor step into them. The result is uncertainty about what to do, stalled progress, and mounting frustration, putting the succession at risk.
• The founder casually decided on the 'heir apparent' and let the successor know, but had no plans or timelines in place. The successor grew tired of investing time in an uncertain outcome and left the firm, leaving the founder to start over.
• The founder had a successor and a plan in place, but either the founder was not fulfilling their end of the bargain, or the successor was struggling to step up, resulting in a lack of confidence by one or both parties.

Getting clear on the mindset and the methods needed to succeed at succession with a clear transition strategy that creates a structured process to follow can help ensure the transaction terms are aligned and agreed upon.

When deciding on a transition strategy, the questions that need to be examined will change depending on the firm's goals and circumstances, but here is a sampling of common questions to consider:

• How will it feel to pass along leadership of client relationships to G2?
• Are you emotionally prepared to let go? Do you have a sense of worth and purpose beyond work?
• What is your G2 training plan and transition timeline?
• What are your concerns with someone else managing firm financials and overseeing staff careers and compensation?
• When will G2 need to take on key responsibilities, such as rainmaking and leadership responsibility?
• For G2, what if you need to wait another 5 years to direct a change in the firm's operating model, investment process, or other desired shifts?
• How will G1 and G2 responsibilities and compensation change over the transition?
• What gaps need to be filled to ensure continuity of all key functions?
• What role will the founder play through each stage of the succession transition?
• What happens if there is an unexpected acceleration of the transition timeline?

Framing a good set of questions can help lead to a clear set of answers during the creation of a succession strategy, setting both G1 and G2 up to succeed.

Once the founder has a clear view of their deal considerations, the next step is to identify all the firm's key responsibilities and determine a timeline and manner for transferring those responsibilities from G1 to G2.

At Limitless, we begin this process by having both owner and successor complete an intake questionnaire evaluating their competency across the firm's key responsibility areas. Next, we evaluate the perceived gaps in competency and determine who and how these responsibilities will be filled in the future state.

If the firm successor is to have rainmaking responsibility, then training needs to be defined and mentoring provided to help develop this skill set over the succession period.

If the firm is shifting to build a growth engine independent of the G2 successor, then additional resources or hires will need to be planned out and integrated during the transition period. In this case, the G2 training responsibility will be driving growth as the firm's leader, but through marketing leadership rather than rainmaking performance.

With a review and assessment of each area of responsibility for G2 to step into, G1 is well poised to define a training and development plan that effectively supports G2's skills that can be used to gauge performance and measure progress over time.

Transaction Terms – The Economics

Determining the value of the practice and its payment structure is crucial. The value should fairly represent the company's worth to an outside buyer while recognizing that the purchase must align with the founder's vision and continuity goals.

Knowing the value the founder needs to fund their retirement is key to ensuring that an effective economic model can be put in place. The value of the practice is independent of the founder's personal needs, yet any transaction is dependent on deal terms meeting the founder's economic needs.

As such, we recommend that founders begin by doing their own financial plan to clarify their financial needs from a transaction. We then recommend an external third-party valuation to provide a fair market value of the practice and to identify any elements driving or hindering business value.

There are 3 important valuation factors to consider:

• Revenue Concentration: A firm with 40% of revenue concentrated in its top 10 clients is riskier and less valuable than one with 18%.
• Recurring Revenue: A firm with 100% recurring revenue is more valuable than one with a mix of 70% recurring and 30% one-time revenue.
• Revenue Growth: A firm with a non-founder-dependent growth strategy is more valuable than a firm whose revenue is 80% dependent on founder rainmaking.

Having an external valuation can help remove emotions from the process, facilitating productive discussions between generations.

Because each transaction will be unique to the business and owners, we can't give a formulaic answer to what the 'right' price, structure, or financing looks like. However, we can discuss the elements that need to be agreed upon in each deal. These elements include the following:

• Purchase Structure: Will this be a single purchase, or will there be multiple purchase tranches over time?

A single purchase is typically used when a seller is exiting the business within a year of the transaction. Multiple purchase tranches are commonly used in transitions longer than 1 year. This allows the seller to maintain control of both ownership and elements of business operations during the earlier phases of the transition. Multiple transactions also allow the owner to continue contributing to the growth of the firm and benefit from the increased value in future tranches.

• Equity Retention: Will the seller retain some equity beyond the transition?

Sellers may choose to retain equity over a longer term if they transition into a different role inside the firm, typically an advisory seat or business-development-only seat. So a G1 owner who wants to transition away from client service or operations but continue to bring new clients into the firm may want to hold a minority equity position. This can work if it serves the overall business strategy but tends to be less common.

• Holdback Period: Will there be any holdback period for a portion of the purchase?

A holdback period is common during a 100% sale and is put in place to protect the buyer. An example of a typical structure would be to hold back 20% of the purchase price and review revenue 1 year after the sale. If the revenue exceeds a certain target, say 95% of revenue at the time of the transaction, then the full 20% would be paid out to the seller. If revenue falls below that target, the 20% would be reduced by some amount. The intention of the holdback is to ensure that the recurring revenue of the sale is retained and to create an incentive for the seller to assist with the transition.

• Financing: Will the buyer pay cash, finance through a third party, use a seller-carried note, or include a combination of these options?

Most transactions will include a combination of these payment methods. For example, a firm valued at $2M might be paid for with a 15% down payment of $300,000 plus a bank loan of $1M and a $700,00 seller-carried note. The larger the firm, the more likely it will be purchased with third-party financing as a larger portion of the deal.

• Discounting: Are there any issues that will limit control and/or marketability?

Most firms will have discounts applied for lack of marketability because, as closely held businesses, they can be difficult to sell. Additionally,  a transaction for less than a controlling interest in the company is likely to offer a lack-of-control discount. The range of these limitations can be reviewed as part of a formal valuation and should be reviewed by tax and legal counsel, as they can be part of the negotiation between the buyer and seller. Discounts for lack of marketability and lack of control can be between 0%–30% for each factor and will be based on the unique elements of the firm and the transaction.

How are these elements put together in a transaction? Let's dive into a few examples.

First, let's consider a 100% sale based on a seller-carried note.

Example #1: Jake is a single 100% owner who is ready to retire and wants to sell 100% of the business to Jennifer, a single-employee advisor. They have worked together for the past 5 years, and all the clients know and like working with Jennifer. The business generates about $1.2M of revenue and $400,000 of profit. There is very little transition risk as the succession has been well-messaged to clients and the rest of the internal team. The firm gets a valuation that indicates its value is $3M.

Jake and Jennifer both feel good about this price, but Jennifer does not have $3M available to purchase. They agree on a 5% down payment of $150,000, with Jake carrying the rest of the purchase price on a promissory note with a 6% fixed rate amortized over 10 years. Because there is a full transfer of control with the down payment, there is no lack of control discount. The parties agree that the cost savings to Jennifer with a seller-carried note providing flexibility is appropriately valued to exclude a lack-of-marketability discount.

The result is that Jake gets an immediate capital infusion of $150,000 plus an ongoing payment of about $31,000 per month for the next 10 years, and Jennifer purchases a business with very little transition risk, covering the note payments with the existing profit in the business. They have an opportunity to grow the business without being underwater on the payment from the closing day.

This would be considered a simple transaction that makes sense where there is low transition risk between G1 and G2.

Nerd Note:

In many cases, a deal for less than a controlling interest in the business would receive a lack-of-control discount. Closely held businesses typically also carry a lack-of-marketability discount. Each of these could be in the range of 0% to 30%, so possibly a total discount of up to 60% from the valuation of the business.

The next example examines a slightly more complex transaction that involves a 100% sale from 2 G1 owners to 4 G2 owners.

Example #2: Awesome Advisors is a practice run by 2 partners, Ricardo and Jada, who own the firm and wish to exit and retire. They both want to complete the transition over the next 3 years but execute the transaction now. Combined, they have $4M of revenue, $1M of profit, and a $10M valuation.

As with the first firm, the G2 partners purchasing the firm are involved in client service but have not fully taken over financial control and operations. Ricardo and Jada desire a longer transition time to set themselves up for success and wind down their involvement. However, in this instance, there are 4 G2 partners involved in the purchase.

Ricardo owns 60%, and Jada owns 40% of Awesome Advisors. Each of the 4 G2 partners will purchase 25% of the firm.

As this gives the buyers full equity control of the business, there is no lack-of-control discount; however, they do assign a 25% lack-of-marketability discount, given the size of the business and the input of the professional valuation service used. This results in a final valuation of $7.5M. They negotiate a deal with $5M of cash up front being financed by a third-party lender for 10 years fully amortized at 8% and the remainder financed on a seller-carried note with a 5-year interest-only amortization at 5% and a 5-year balloon payment.

The thinking is that Ricardo and Jada  both have some lifestyle desires now and want an immediate infusion of capital. They will remain involved for the majority of the seller-carried note period and will be able to help ensure a successful transition and monitor the security of their notes.

The 4 G2 partners have personal guarantees for both the bank loan and seller-carried note and are immediately committed to the success of the transition. They have a reasonable note payment from their portion of the bank loan and the flexibility of 5 years of interest-only payments on the seller-carried portion.

The G2 partners are now well-positioned to grow the business over the next 5 years and either refinance the bank loan and balloon payment together or pay off the balloon payment and the bank loan over the remaining period.

This transaction is suited for a more complex transition that balances risk between G1 and G2.

Finally, let's examine a series of 10% annual sales from the G1 owner to the G2 buyer.

Example #3: Whopper Wealth Management is a large firm run by 3 equal G1 owners in their mid-50s who want to start gradually selling their shares to a group of G2 owners in the firm. This firm has $20M of revenue, $6M of profit, and a valuation of $70M.

There are 40 employees, and 12 are identified as potential G2 owners to whom the G1 owners would like to extend partnership offers to. In this case, the G1 owners elect to approach the 12 G2 team members with the proposal and expect that 10 of them will accept. These 10 will execute an initial purchase with a 30% discount from the valuation. The 30% discount includes 20% for lack of control due to the incremental minority sale structure, and 10% for lack of marketability due to the closely held nature of the business.

The 30% discount will result in an internal valuation of $70M × 70% = $49M and an initial sale tranche of $4.9M, with each of the 10 G2 buyers purchasing a 1% ownership stake for $490,000. The ownership group selects a bank that will finance these minority transactions and that offers a 7% interest rate, fully amortizing over 10 years.

They will repeat this process annually based on a new valuation each year, with each of the G2 buyers purchasing an additional 1% interest for a total of 10%, allowing the G1 owners to maintain control of the firm for the first 5 years of the transition and participate in the continued growth of the firm.

The 10 G2 owners will be able to utilize 100% financing and receive an appropriate discount on their shares. As the firm grows and new G2 partner candidates join the firm, the G2 owners will be able to expand the ownership group with these annual purchases.

In this example, this type of transaction works well because the current G1 owners are working on a longer time scale and want to remain involved in the growth of the firm. It also requires that the G2 owners be interested in taking on ownership in a gradual fashion.

As these examples show, deal structures should be as individual and nuanced as the firm and its owners. The best transactions will meet the financial needs of the business, the seller, and the buyer. Internal successions can be especially attractive options as they often have the great benefit of lowering transition risk, and both generations can work together to get creative in designing a financial transaction that fits each of their needs.

Transition Plan – A Defined Path

This final element combines the founder's Vision, Strategy, and Economics into a unified structure. It should also outline their succession check-in cadence and decision-making process. Key questions to consider when developing a transition plan include the following:

• How often will you meet specifically about the succession?
• How will you make decisions along the way?
• How will you resolve problems or disagreements?

It is best to answer these questions in a written transition plan at the beginning of the process and when both G1 and G2 are in a positive headspace with no issues on the table. Without the benefit of a clear transition plan, it's easy to get out of sync at critical times, complicate the resolution of issues, and throw the transition off track.

Creating a structured approach for succession check-ins is important to foster open, honest, and consistent communication between the parties throughout the entire succession process. This allows any concerns or issues to be addressed and resolved in a timely manner, preventing potential conflicts or small setbacks from ballooning into a breakdown.

Additionally, seeking an external valuation of the firm can provide an objective perspective on its current value and identify areas for improvement that may increase its economic value. Bringing in outside consultants or coaches can help create alignment, facilitate agreements, and foster improved communication and accountability before, during, and after the deal has been struck.

The purchase structure, equity retention, holdback period, and financing options must all be agreed upon by both parties in order to facilitate a smooth transition. A transition plan should also be established at the beginning of the process to outline meeting frequency, decision-making processes, and problem-resolution methods.

It is then important to regularly revisit and update the succession plan to reflect any changes or updates in goals, strategies, or economic factors. By continuously evaluating and adjusting as needed, owners can ensure that their firm's succession plan remains relevant and effective, setting the stage for a successful transition for years to come.

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Succession planning is about more than monetizing value and passing on ownership control. At its worst, it's a race against the clock to cash out one's capital before kicking the can. At its best, it's a disciplined process of recognizing, monetizing, and transferring the value owners have created in ways that serve all the stakeholders in the process.

In short, owners who want to succeed at succession shouldn't be like Bob. Instead, they can take Alice's disciplined approach and apply our 4-step playbook to set themselves up for success in succession.

Ready to build your Succession Planning Playbook? Join Stephanie & Jarrod live for a 2-day workshop in Denver, CO, on Sept. 9-10 to build your personalized playbook here.