Multigenerational teams have several options for monetizing and transitioning the book from one generation to the next. So, how do they decide what’s best?
By Allie Brunwasser & Jason Diamond
It’s no secret that the wealth management industry has a major impending crisis: A shortage of quality next gen advisor talent. But there is another wrinkle to this dilemma that’s often overlooked. Namely, even when senior advisors have a rockstar inheriting advisor in place, these “Gen 2” advisors seldom have the capital at hand to facilitate the purchase of the book in a timely and orderly fashion.
As a result, it’s often incumbent upon the retiring advisor to either accept a discounted valuation for the book and/or show a great deal of flexibility in how their next gen ultimately takes the reigns of the business.
But is that fair? After all, shouldn’t the retiring advisors be compensated fairly for their life’s work?
So, what can advisors do to ensure a successful client transition from one generation to the next? And how can advisors solve the “dual mandate” of allowing the Gen 2 advisor to inherit in a timely fashion while also making the retiring advisor economically whole?
Here are four potential paths such advisors might walk:
Option 1: Stay put and accept your current firm’s sunset deal
Many firms offer “sunset” or “retire-in-place” programs that effectively finance the transition of the book from Gen 1 to Gen 2. The firm pays the retiring advisor a multiple of top-line revenue (150-250% on average), and the inheriting advisor “pays for” the book out of the future cash flows of the business.
The Pros: Any time an advisor can get paid to stay put, it’s a compelling proposition. This clearly represents the path of least resistance. Since the advisors need not transition the book, it’s effectively riskless.
The Cons: These agreements are often consummated at less than fair market value because there is no competition driving up the price of the business. Said another way, if an advisor were to move to another firm or sell to a firm in the RIA space, it would create competition and likely drive up the valuation of the business. They also significantly lock up the next gen inheritor for the life of the agreement (typically 5-7 years). Lastly, at the end of the agreement, the firm technically still “owns” the book of business, so what did the inheriting advisor really receive?
Option 2: Sell the business to a strategic buyer
A quality wealth management business is like the holy grail: everyone wants it. This certainly includes existing RIAs, many of which are private equity-backed in their own right. A “strategic buyer” is a buyer, like an RIA or other established wealth management firm, that also runs a wealth management business, meaning they would presumably recognize significant cost and operational synergies from the transaction. Examples include Creative Planning, Mariner Wealth Advisors, and Beacon Pointe.
The Pros: Since the buyer of the business has their own wealth management platform/infrastructure in place, a transaction of this sort allows advisors to offload many of the day-to-day responsibilities associated with running a business. These buyers often pay a premium for a quality book as well (and at capital gains treatment) since they recognize immediate purchase synergies from the transaction. (They can buy a business for X, but as a part of their larger entity, it’s immediately worth X+Y). These buyers are often deep-pocketed and highly experienced at advisor transitions since they are often repeat acquirers. Most importantly for Gen 2, it takes the heavy lift off them in terms of paying Gen 1 for the business themselves.
The Cons: A transaction of this sort requires an advisor to sell the entirety of their business, meaning they lose operating leverage (their incentive to grow is limited because they don’t maintain an equity stake in their own business). Also, it likely means ceding some control in any or all of the following areas: brand, compliance, investment autonomy, marketing, and operations. Lastly, the ongoing payout post-transaction is typically quite low for the “selling” advisor. The downside for the next gen in this scenario is the business is now sold to the larger entity, meaning they won’t own any of the book and will have limited-to-no agency and autonomy over the future of the business.
Option 3: Sell the business to a financial buyer
Not all buyers are interested in exerting control, influence, and leadership over an acquisition target. In some cases, the buyer simply views a seller’s book of business as a sound financial investment. These buyers (sometimes referred to as “aggregators”) might purchase a majority or minority stake in the seller’s business, and they almost always mandate that advisors continue operating their own brand and maintain their own operational integrity. Examples include Focus Financial, Merchant Investment Management, Kestra Bluespring, and Hightower Financial.
The Pros: These firms are a great fit for advisors who want to maintain maximum autonomy while simultaneously unlocking liquidity. Since an advisor can keep some of their own equity, they may keep some operating leverage in the business. Plus, they may get a “second bite of the apple” down the line when the buyer has a liquidity event. But make no mistake: a transaction of this sort is about the seller keeping control while still unlocking some liquidity. In this instance, the aggregator helps to finance/buy out the senior partner by taking some chips off the table and still leaves a minority or a majority of the business left for the next gen to have ownership and control over.
The Cons: For those advisors who want ongoing coaching, support, and resources, these buyers may ring hollow. They do little to free up capacity, and the valuation may be slightly discounted relative to option two above because the buyer has fewer natural synergies to realize. Plus, the buyer provides little, if any, ongoing support. This can be an issue for Gen 2 once Gen 1 retires, should they desire such guardrails.
Option 4: Move once, monetize twice
Even if a sale to a financial or strategic buyer might yield the highest after-tax purchase price for an advisor, not all advisors are attracted to the notion of moving their book to the RIA space. Many advisors (and their clients) are more comfortable in the traditional firm/wirehouse world. And for these advisors, the ability to “move once and monetize twice” can be a game changer. This is the same exercise as outlined in option one above, but the advisor first transitions to a new firm and then enters into that firm’s sunset program.
The Pros: The combination of the recruiting deal (offered as an incentive to change firms) and the new firm’s retire-in-place deal is highly lucrative. This move also gives Gen 2 a voice in the future because, presumably, they had some input into where the team chose to move the book. It also puts money in the pocket of the next gen because they would receive a portion from the recruiting deal.
The Cons: Similar to option one above, these deals always have real teeth to them, particularly for the next gen inheritor. In this instance, the team is even more “stuck” because they are tied down not just by the retire-in-place deal but also by the recruiting deal they took for moving the business.
It’s clear that multi-generational teams have many potential options at hand when it comes to monetizing and transitioning the book from one generation to the next. There is no “right” answer—it simply depends on what each advisor values most and what specifically they are looking to solve for to ensure the right balance between legacy and liquidity.
As seen on ThinkAdvisor.com…
