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Acquisitions through Incentive-Based Exit Strategies

In this paper we will discuss the benefits and drawbacks of the advisor establishing non-qualified incentive-growth plans that interlink with ownership transfer strategies. These plans are without a doubt the hottest trend today among owners of financial services firms who are planning their successions well in advance of the event. Although a good percentage of ownership positions, their growing popularity is most evident among solo practitioners who must soon formulate exit strategies, incentive-based ownership transfer plans solve many problems that are difficult for them to resolve by other methods.

These benefits of incentive-based exit strategies include advisors being able to grow their firms with the help of junior associates at a pace they could not do alone, and creating more free time for leisure or to focus on more enjoyable areas of their business. In addition, under these plans, ownership is not transferred unless pre-established growth targets have been met. IN the process of meeting those targets, the owner has created a built-in mechanism for increasing their income and their overall business transfer value when ownership transfers strategies so enticing.

Most late-career solo advisors could not achieve the same exponential growth in income and practice value solely through their own efforts. In many cases, advisors can design a plan that ultimately will bring a total of three to five times over what they could sell their solo practice for to an unknown outside buyer at the end of the very same period. Figure 1 below depicts a sample model for advancing ownership with a Junior Associate in a firm:

diagram-figure1

The point of these strategies as succession plans is to retain or attract skilled or trainable personnel to your firm. This enables them to earn some percentage of ownership by achieving targets set in an incentive plan to grow the firm, and sometime later, buy out the remaining balance of your shares. Transferring business ownership to your employees is a very productive way to receive long-term value from your business and to reward your employees or key personnel for their loyalty and contribution to the business.

The Benefits of Incentive-Based Ownership Transfer Plans

  1. Using incentive plans to recruit one or more key junior advisors will give your practice the potential for adding revenues, which can increase your total income and profitability.
  2. They can work very well to help facilitate your eventual departure at retirement. Much like the ensemble or partnership, you can design a buy/sell agreement.   
  3. Incentive growth transfer plans can offer a gradual transfer of ownership, which in turn allows for the advisor-owner to continue working and controlling the company.
  4. Incentive-based ownership transfer plans are extremely flexible. They can be accelerated or slowed down to meet your future needs. The owner can create a plan that allows for them to eventually work part-time and maintain their income levels and full benefits.
  5. The owner can design a plan whereby minority stakes of ownership are only sold to a junior partner after the firm has met significant growth and revenue targets.
  6. It is justifiable to use the highest multiples acceptable in the industry when selling ownership internally, because of the “low-risk” client retention proposition to the buyer.
  7. As financial advisors know, non-qualified plans have tremendous plan design flexibility. Unlike the qualified plans, which requires strict adherence to the ERISA (Employee Retirement Income Security Act) rules, non-qualified plans are not subject to such restrictions.
  8. The owner can choose one or several key persons to benefit from such a plan. The plans themselves can be designed virtually any way the current owner chooses (keeping in mind that once an associate becomes even a minority partner they hold ownership rights).

Not everyone believes they are cut out for managing and mentoring an employee or partner into a position of being their eventual successor. A small percentage of solos just may not be cut out for managing people (even though virtually every solo advisor in the business does so with staff). For both the solo practitioner and those in partnerships who already know the power of leveraging, internal succession plans based on incentives are ideal methods of maximizing your life’s work.

 


Growing your business with Leverage
Perhaps the most important reason for the popularity of incentive-based transfer strategies among advisors is what they achieve in growing their incomes and business value as they proceed toward retirement. Much of the success on incentive-based exit strategies is directly related to the motivation and enthusiasm your successor candidate has for becoming an owner of the business. The many other benefits associated with ownership, including increased compensation and benefits, are very often secondary to the esteem created in a junior advisor having ownership.

So how are advisors constructing incentive-based growth plans that take into account the need to protect themselves from  “giving the shop away” while at the same time setting realistic targets for eventually transferring their business value? Below in Figure 2 is a sample model outlining the steps used in the strategy.

Incentive Growth Ownership Transfer Plan Example
Subject Firm: $1 million current fee-based annual revenues, $200,000 net annual operating profit (NOP) after owner’s compensation; Current value= $200K NOP x 6 = $1,200,000; owner is 50 years old, plans on retiring in 10 years; would like to more than triple size of NOP during period; associate will buy up to 40 percent of ownership; associate purchases remainder under buy-sell at retirement, death, serious disability, or illness. (see notes after chart)

diagram-figure2

Notes: In the preceding example of a long-term ownership transfer plan using the installment note as the funding mechanism, it must be pointed out that the junior partner is actually paying less in total dollars in the second, third, and fourth purchases. Since he or she, as minority owner, already owns a percentage of the shares, each of these purchases would not be included in those totals. But, to be completely accurate in the example, a spreadsheet would need to be created (which anyone planning such a strategy would want to do) and there isn’t room for that here. This point is somewhat offset by the fact that the example does not account for any growth in the NOP after the fourth purchase of stock ownership.

A second point to make is that a multiple of six times revenue was selected as the multiplier for the buy-sell agreement based on several factors;

  1. Formulas should never include a “rule of thumb” multiple on gross revenues. Those figures are quick and simple to derive (particularly for journalists to understand and write about) but you would never want to create an incentive plan that was not set upon some net profit calculation. Otherwise, you would be encouraging the minority owner to focus on gross rather than net results, which could have devastating effects for the value structure of your ownership transfer.
  2. The adviser market for practice sales currently has a wide multiple range of 2-8 eight times NOP (after owner’s compensation). It is important to note that a distressed seller without a planned buyer is usually receiving the lower end of the multiple spectrums, while those who have planned family or internal succession strategies can plan on using the higher end. This is because internal ownership transfer plans are usually implemented over time and client retention is not an issue or a risk factor. Lastly, those internal transfers with commissioned firms tend to receive the lower middle multiple range (3-5 times NOP) while those with mostly recurring revenues tend to receive the upper end of the middle segment of multiples (5-8 times NOP). When combined with an internal or family succession, a fee-based or fee-only firm tends to bring the highest multiples and in special circumstances have exceeded more than eight times NOP.

Even for the solo practitioner who has never worked with a producing associate or junior partner, it is amazing how quickly the profits, income to partners, and the total business value can grow in such a short time frame. Surely the advisor who feels like his business does not produce enough “extra” profits for him or her to ever ease out through traditional succession approaches must consider leveraging in late career with an internal incentive exit strategy.

On a final note, it is highly encouraged that any ownership transferred in an internal succession strategy be sold and not given to the successor. Rarely in any business (except for possibly family successions where the owner is looking to reduce estate value) does an owner give away ownership. If that were the plan, the successor would not have nearly the motivation needed to help support a growth plan.

The adage that we don’t appreciate what we’re given nearly as much as what we earn goes a long way in teaching us about giving up ownership in a financial planning firm. It also demonstrates to us that a clear, focused plan to attract, retain, and reward a key associates(s) is crucial to smoothing the transition for the advisor headed into his or her golden years.

The Take-Away: Many financial advisors decide late in their careers that the value of their business is not enough to retire on. If you are  a solo practitioner who already is overwhelmed with too much to do and too little time, you will never get that last bit of growth needed without leveraging the efforts of another. If your plan is to depart in the next 2-10 years, consider developing an incentive growth exit strategy that will help you build value, continue to increase your income and that creates extra free time in your life. After all, it isn’t early career anymore, and your independence is no longer as important as it once was.

Acquisitions through Incentive-Based Exit Strategies

 

In this paper we will discuss the benefits and drawbacks of the advisor establishing non-qualified incentive-growth plans that interlink with ownership transfer strategies. These plans are without a doubt the hottest trend today among owners of financial services firms who are planning their successions well in advance of the event. Although a good percentage of ownership positions, their growing popularity is most evident among solo practitioners who must soon formulate exit strategies, incentive-based ownership transfer plans solve many problems that are difficult for them to resolve by other methods.

 

These benefits of incentive-based exit strategies include advisors being able to grow their firms with the help of junior associates at a pace they could not do alone, and creating more free time for leisure or to focus on more enjoyable areas of their business. In addition, under these plans, ownership is not transferred unless pre-established growth targets have been met. IN the process of meeting those targets, the owner has created a built-in mechanism for increasing their income and their overall business transfer value when ownership transfers strategies so enticing.

 

Most late-career solo advisors could not achieve the same exponential growth in income and practice value solely through their own efforts. In many cases, advisors can design a plan that ultimately will bring a total of three to five times over what they could sell their solo practice for to an unknown outside buyer at the end of the very same period. Figure 1 below depicts a sample model for advancing ownership with a Junior Associate in a firm:

 

FIGURE 1:

 

 

Partner

 

 

Senior Partner 1 year

 

 

Junior Partner 1-2 years

 

 

Associate 1-3 years

 

 

Junior Associate 1-3 years

 

The point of these strategies as succession plans is to retain or attract skilled or trainable personnel to your firm. This enables them to earn some percentage of ownership by achieving targets set in an incentive plan to grow the firm, and sometime later, buy out the remaining balance of your shares. Transferring business ownership to your employees is a very productive way to receive long-term value from your business and to reward your employees or key personnel for their loyalty and contribution to the business.

 

 

 

 

 

The Benefits of Incentive-Based Ownership Transfer Plans

 

  1. Using incentive plans to recruit one or more key junior advisors will give your practice the potential for adding revenues, which can increase your total income and profitability.

 

  1. They can work very well to help facilitate your eventual departure at retirement. Much like the ensemble or partnership, you can design a buy/sell agreement.

 

  1. Incentive growth transfer plans can offer a gradual transfer of ownership, which in turn allows for the advisor-owner to continue working and controlling the company.

 

  1. Incentive-based ownership transfer plans are extremely flexible. They can be accelerated or slowed down to meet your future needs. The owner can create a plan that allows for them to eventually work part-time and maintain their income levels and full benefits.

 

  1. The owner can design a plan whereby minority stakes of ownership are only sold to a junior partner after the firm has met significant growth and revenue targets.

 

  1. It is justifiable to use the highest multiples acceptable in the industry when selling ownership internally, because of the “low-risk” client retention proposition to the buyer.

 

  1. As financial advisors know, non-qualified plans have tremendous plan design flexibility. Unlike the qualified plans, which requires strict adherence to the ERISA (Employee Retirement Income Security Act) rules, non-qualified plans are not subject to such restrictions.

 

  1. The owner can choose one or several key persons to benefit from such a plan. The plans themselves can be designed virtually any way the current owner chooses (keeping in mind that once an associate becomes even a minority partner they hold ownership rights).

 

Not everyone believes they are cut out for managing and mentoring an employee or partner into a position of being their eventual successor. A small percentage of solos just may not be cut out for managing people (even though virtually every solo advisor in the business does so with staff). For both the solo practitioner and those in partnerships who already know the power of leveraging, internal succession plans based on incentives are ideal methods of maximizing your life’s work.

 

 

 

 

 

 

 

 

 

 

 

Growing your business with Leverage

 

Perhaps the most important reason for the popularity of incentive-based transfer strategies among advisors is what they achieve in growing their incomes and business value as they proceed toward retirement. Much of the success on incentive-based exit strategies is directly related to the motivation and enthusiasm your successor candidate has for becoming an owner of the business. The many other benefits associated with ownership, including increased compensation and benefits, are very often secondary to the esteem created in a junior advisor having ownership.

 

 

 

So how are advisors constructing incentive-based growth plans that take into account the need to protect themselves from “giving the shop away” while at the same time setting realistic targets for eventually transferring their business value? Below in Figure 2 is a sample model outlining the steps used in the strategy.

 

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