Financial planners work night and day to help realise their client’s financial goals, yet so many fail to invest in their own nest eggs — their practice — to ensure they get the full value out of their businesses on retirement.
Commenting on this lack of focus on their own retirement interests, AXA’s head of acquisitions and succession Steven Davison said: “I’m still trying to understand it myself.”
“When times are good and you’ve got plenty of clients knocking on the door, you tend to focus on bringing them in and growing the business, and perhaps you’re not too focussed on your own planning,” said Davison.
“The classic example is that most financial planners own their business through a company structure, they’re paying tax at 30 per cent, and the average age of a principal is about 55. In reality, for many of them taking some of the capital out of the business, putting it into superannuation, taking advantage of the small business CGT exemptions, and combining that with a transition to retirement strategy, will leave them in a much stronger after-tax position than it would if they had 100 per cent of their capital tied up in the business. But not enough are focusing on that type of planning for themselves.”
A number of industry experts have attributed a loss of profitability to a lack of succession planning.
Associate director of Macquarie Business Investment Services, John Collins, said that despite the current economic downturn, the market for financial planning practices is still strong. But now it is ever more likely that it is only those who have implemented a good succession plan that will see the fruits of their long labour, and realise the real value of their practices on selling.
Collins referred to research conducted by practice management group Business Health that suggests that businesses with a documented business plan in place see between 100 and 120 per cent more profitability than businesses without a business plan.
“For somebody with a business that has an effective succession plan, it can be over 200 per cent more profitable than one that doesn’t,” said Collins.
According to Collins, the obvious reason for this is that when you implement business and succession plans, you undertake many business improvements along the way that are reflected in the end result.
“But they also mean that the profitability for the business every year is also higher,” he added.
Planning ahead improves profitability
Suggestions that financial planners should plan up to five, even 10 years in advance before opting out have been doing the rounds through the industry press. For smaller practices, is this level of planning realistic, or is implementing a good succession plan far in advance just part of good business practice?
“The preparation for the sale of a business is critical to the price that you end up getting when you do sell the business,” said Collins.
“The preparation will allow you to put in place some of the business measures that you need to create a very profitable and efficient business.
“You can plan five years out in order to exit, but it’s not necessary. We recommend to all of our clients always to keep their eye on an exit strategy, not only because it enables them to facilitate an easier exit when they do decide to sell, but the strategy that you put in place during that period will also increase profitability throughout the life of your business.”
And, Collins adds, it will lead to higher returns on selling.
Theory versus practicality
Although ideally it is a good thing to plan far ahead, director of financial services consulting firm Kenyon Prendeville, Alan Kenyon, said for smaller practices the day-to-day running of the business can force succession planning to the side.
“The theory of what you should do, and the practicality of running a small business are poles apart,” said Kenyon.
“But somebody could be thinking about what they want to do today, put their hand up and get some advice. It may take between 12 and 18 months to implement, and the program of someone acquiring the business through internal succession could unfold over the next three to five years.”
Chris Wrightson, director of Centurion Market Makers, agreed that the idea a business should be run as though it is about to be sold is not always realistic for smaller businesses. But those thinking about their retirement should start looking at the way they run their business.
“You can start improving the quality of the data you have on your business, managing your profit line, ensuring that all your systems and processes are well documented, structured and running smoothly, and that your staff know how it all works,” said Wrightson.
“A buyer is going to look at all these things. If it’s a well-oiled machine, it’s profitable.”
Macquarie’s Collins maintains that having a succession plan in place is part of good business practice.
“The reality is that many business owners are busy running and growing their business, and dealing with the daily issues that arise,” said Collins.
“But there is a base level of succession planning if you are looking to sell that you should have in place, and many of those things are just good business practice. You need to identify and prioritise those issues that are critical to your business success.”
Ensuring continuity
While some would maintain that implementing a succession plan in advance is essential, simply having an effective continuity plan in case of emergencies can go a long way in smoothing the road ahead.
AXA’s Davison said financial planners often opt out of a business because of issues or situations beyond their control, such as a death (of a business partner or even their own), disability, divorce, debt, developing government regulation, and disillusionment.
AXA, together with subsidiary ipac, have been helping principals through the succession process for the last six years. The 2008 AXA Succession Report, written by Davison, looked at key issues that have emerged during this time.
The group found that only 15 per cent of practice principals actually sell their business, while the vast majority (85 per cent) sell their client base. Davison said the reason for this is that financial planners are often ill prepared and therefore go for the easiest option available.
“Even with the best insurance in place, if a principal does become disabled and/or dies, even though the insurance will come into play and deal with the estate, it won’t necessarily see the business continue thereafter,” said Davison.
“They don’t put enough thought into those things they can change or influence.”
Aside from emergencies, Macquarie’s Collins said simply having a continuity plan in place — such as reducing key-person risk and documenting processes and procedures — can add value and increase profit for the business on an annual basis, as well as having the added benefit of adding value when you do eventually sell.
“Purchasers are really looking for the history of the business,” he said.
“So if you are able to produce documents over the life of the business, and can refer back to that to indicate that you have had growth over the life of the business, it gives the purchaser a lot of comfort in that the business is actually able to achieve the goals and targets it has been set. You have some hard data that can support that track record.”
Buyers’ increasing caution
While there are plenty of buyers out there, the industry is seeing more caution from their side. Centurion’s Wrightson said that buyers are indeed looking more closely at practices’ investment history.
“If you’re selling externally, I think the level of due diligence has increased, because people need to be more sure what’s been offered to clients,” he said.
Wrightson said buyers are looking more closely at the investment history of the planner, and how many clients may be unhappy because their investments have underperformed, or even failed.
“That’s not very attractive to a buyer because you know you may be buying 20 or 30 people who are very unhappy,” said Wrightson.
“They are more and more discerning about what they are going to buy, because they don’t want to buy problems.”
Radar Results is a financial services consultancy firm focussed on buyers. The company has been around for three years, but principal John Birt has been a business coach and planner for 25 years.
“Buyers are a bit more cautious in their due diligence of what they are buying than they were a few years ago,” Birt said, adding this is largely due to client loyalty not being as high as it used to be.
Cultural fit
The importance for sellers to find a ‘cultural fit’ is another issue widely talked about.
“The cultural fit is the key critical thing, and that above everything else,” said Kenyon.
“A vendor will sell to the ‘right’ person. Price will be one of the issues, but not the main issue. These are very personally driven businesses, and it’s all about relationships. So quite a lot of business owners, their best clients are often their best friends, and these relationships have been built up over 15 or 20 years. So they are very conscious of making sure the right person continues the business.”
But while finding the ‘right’ person to buy your business will make the transition process easier, and enable the seller to look his previous clients in the face when they next meet, it is a consideration also rooted in profitability.
“What is the buyer really buying,” asks Kenyon. “They’re buying the relationship and the entitlement to the revenue. So it’s important that those clients are handed over in a proper transition program.
“Most transactions will have a significant amount of the purchase price paid up front, with the balance at the end of 12 or 18 months, based on retention of clients or revenue.
“So there’s a very vested interest in making sure that the clients stay.”
Selling in the current climate
According to Collins, growth in the financial planning industry in recent years has led to an increased number of buyers over sellers.
“There’s definitely been an increased number of buyers looking to acquire practices,” he said.
“Vendors have been sitting with a very good cash flow and very good growth opportunities, so they have been unwilling to sell in the last few years.
“We’re still seeing that same situation in the current climate, although some vendors are now coming to market that probably wouldn’t have if the economic climate was still what it was 12 or 18 months ago.
“They are certainly more open to having conversations about selling their business. However, it’s not that they’re under pressure to sell.”
Could this reluctance to sell have to do with values of practices falling?
“Given that with most businesses their fees are related to the value of their assets, and assets have come down, so the actual quantum of the value of their businesses has come down, but not the multiples that apply,” said Kenyon.
“So if you had $1 million of recurring revenue, and the multiple on that was three times, and you’ve seen a 20 per cent drop in the market so your fees are now $800,000, the multiple is still three, but you’ve got less value simply because your fees have come down.”
It’s great news for buyers, but what of sellers’ interests? For many financial planners, circumstances dictate that they have no choice but to opt out now. But for others who can stick it out a few more years, perhaps now is the best time to implement a sound succession plan, and implement key processes and systems that will improve profitability in the long run - in time for the next upturn in the economy.