Greg Gagne’s Affinity Investment Group is a storybook small-business success story.
Gagne recently celebrated the 20th anniversary of the advisory business in Exeter, N.H. There is no shortage of concerns going forward — from tax rates to regulation and myriad potential threats to the world economy.
One thing Gagne, 48, doesn’t have to worry about is the future of his business should something happen to him. He took care of his succession planning a while ago.
“A lot of advisors basically leave the keys in the door on the day that they retire and their whole career just kind of stops. And that didn’t sit well with me,” Gagne said. “I had to get rid of that situation and wanted to have an organization that would live longer than I would and continue to provide value to the clients that we served.”
Gagne put in place an Employee Stock Ownership Plan (ESOP) that would enable his five employees to buy the business while providing for a five-year payout plan for his family. ESOPs provide tax advantages while transferring ownership to employees (see sidebar).
“So we now have an organization that will outlast me, which was a decision I needed to make,” said Gagne, an 18-year MDRT member.
Succession planning is a crucial task on the to-do list for many small-agency owners like Gagne.
But agencies are already struggling with monumental shifts in the economy, especially in the insurance and financial realms. A key dynamic is the push toward fee-based holistic advising and away from commission-based product selling.
That momentum was accelerated by the Department of Labor’s fiduciary rule. Although the implementation of the rule has been delayed a few years and the rule itself is likely to change substantially, the financial and insurance industries have already sailed in the fee-based direction.
But even though the transition to holistic retirement planning has been painful for some advisors, the shift is yielding a perhaps unexpected return for advisors themselves. They have secured a better retirement themselves by adding substantial purchase value to their agency.
ValMark Financial Group is a holistic investing firm consisting of five companies spanning the gamut of financial planning. More than 100 member firms working with the ValMark broker-dealer give the company a unique view on industry trends, said Lawrence J. Rybka, president and CEO of ValMark.
Every year, “three or four member firms” are sold — either internally to partners or to other firms, Rybka said.
“Firms that have recurring fee revenue sell for a much higher multiple than commission-based products,” he said. “You can look at every study and at transactions, and there’s no question — recurring fee-based revenue is a higher multiple than commission-based and I think some of the uncertainty around DOL and what will happen has probably depressed the value of commission-based firms.”
The DOL rule regulation has many in the industry facing an uncertain future. Ironically, it puts many advisors and carrier executives in the shoes of their clients when it comes to retirement security.
A classic problem for insurance agencies is the commission sales model. It does little to build up intrinsic agency value that will accumulate years into the future while providing a retirement nest egg for owners.
That problematic lack of value revealed itself in the high-profile sales of advisor forces over the past year.
“You don’t need to look much farther than the sale of some of the broker-dealers, not only at an advisor level but some of the sales that have occurred recently are almost giving firms away,” Rybka said. “You look at the transaction involving MetLife and MassMutual. They essentially gave them 8,000 reps for nothing.”
In a deal completed last summer, MetLife sold its broker-dealer to MassMutual Financial Group for $300 million. More recently, Kestra Financial acquired H. Beck, an independent advisor and broker-dealer platform, from Securian Financial Group in an August deal.
“If you read the articles, it looks like it was at a significant discount,” Rybka said.
‘How Could I Re-engineer?’
Gagne recognized the value limitations of commission-based selling more than 20 years ago. He finally converted his firm to a fee-based advisory in 1997. At the time, Affinity was 90 percent commission and 10 percent fee. Today, it is 95 percent fees.
“The peaks and valleys of being in a transaction-based business just didn’t fit well with me,” Gagne said.
“It works great for some folks but it just didn’t work great for me. So I had to decide if I wanted to stay in this industry, which I really wanted to. I loved it. How could I re-engineer the way I’m compensated so I could remove these peaks and valleys?”
At the time, the move to fees was about immediate survival. But it ultimately added great value to the business that Gagne will pass on to his colleagues. Affinity’s assets under management doubled “six or seven times” to roughly $220 million.
“That has just put me in a position where my organization has enterprise value,” Gagne said. “There’s a value to my firm because there’s recurring revenue that far exceeds my ability to produce a transaction with a client.
According to a new Nationwide survey, Gagne is in the minority.
Sixty-five percent of owners report that they believe it’s important to choose a successor for their business as recommended by the Small Business Association, but only 37 percent actually have a business succession plan in place.
While many business owners are not prepared for the risks they face, the younger business owners seem to have a better grasp. Millennials are more likely than boomers or Gen-Xers to say it’s important to create a business succession plan (38 percent).
Commissions Still King
More common is the small agency owner wedded to a long-standing commission model that worked well for decades. For Juli McNeely, 48, it’s been a matter of don’t fix what ain’t broke.
Her McNeely Financial Services agency in Spencer, Wis., was started and run by her father. Then he retired and moved to Arizona.
McNeely Financial sells life insurance, disability, annuities, long-term care planning insurance, and has a small securities side as well. For 45 years, the business has been mostly commission-based in a small town of 1,925 residents.
Establishing a firm valuation is hard when the book of business is all commission accounts, McNeely said, even for an agency with strong local name recognition.
"People know where we are. They know what we do,” she said. “But it is really hard to get the value from the name and the reputation, especially if the person that created that name and reputation retires out.”
In the independent world, you own a block of clients, but is there value there?, McNeely asked. “Not nearly as much as you might think.
“Unless you can transition that to someone who’s going to continue to work that block of clients, continue to build those relationships that have already been established, and continue to have repeat sales, then there’s value to that.”
McNeely has no succession plan, but it’s high on her to-do list. Meanwhile, the company is transitioning clients to fee models. So far, it’s been surprisingly easy because of the long-standing relationship the McNeely agency has with most clients, she said.
But many firms are having trouble with the process, said McNeely, former president of the National Association of Insurance and Financial Advisors.
“A lot of it is just, to be truthful, I think a mental roadblock in the advisor’s mind that this is the way we’ve always done it,” she said. “And now we’ve got to shift over. I will tell you, our firm is really looking at things very differently now because we see the potential there to perhaps not have commissions anymore on anything.”
The industry as a whole needs to take succession planning more seriously, she added.
Succession Planning a Brisk Business
To get her succession plan off the ground, McNeely hopes to touch base with FP Transitions. Founder David Grau authored the industry bible on the subject in 2014: Succession Planning for Financial Advisors: Building an Enduring Business.
FP Transitions, in Lake Oswego, Ore., is doing a brisk business, said Brad Bueermann, FP CEO and principal.
Financial services practices listed on the open market are being sold in less than 80 days, he said. In fact, the entire industry is “super busy” with movement, Bueermann said.
“We also will set a record this year in terms of number of succession plans that we’ve launched,” he said. “We continue to expand our firm.”
The pressure to produce succession plans is not just due to regulations and changing industry dynamics, Bueermann explained. One result of that focus and publicity is a client base that is both more informed and alert to the details.
“We’re constantly hearing back from people who say, ‘Hey, I need to get a succession plan in place,’ ” Bueermann said. “We say, ‘What’s driving this?’ and they go, ‘I’m just getting questioned constantly by clients saying, ‘What am I supposed to do when you retire?’”
A transition plan is generally to prepare the company for an external sale or for an internal takeover. Passing the business on to family heirs, or employees, are examples of the internal transfer.
Those internal transfers usually take longer and can be fraught with difficulties, Bueermann said. On the plus side, the young, would-be future business owners bring energy, ideas and enthusiasm.
“But they seldom bring money,” Bueermann said. “And so because they don’t have money, how do we sell a firm that could very well be valued on the open market in the millions to a group of young professionals who are mid-career and they’re trying to get their kids through school and buy houses and buy their next car and doing other things?”
The answer is by setting up a plan that allows them to buy into the business slowly and reinvest the cash flow they realize as owners toward completing that purchase.
“Whether they ultimately turn that cash flow into the ability to take out a bank loan and complete the purchase, there has to be something that they’re buying into, and there’s the rub,” Bueermann said.
It’s a difficult plan to craft in a commission-based practice. The “eat what you kill” model generally makes money for everyone in the form of commissions, incentives and other payouts, he explained.
“The problem with that was there’s nothing to buy into,” Bueermann said. “So if you own 10 percent of the company, or 20 percent of the company, that typically would entitle you to 20 percent of the profits. But if there aren’t any profits, then we have a problem.”
A New Model
The first order of business in this example is to re-engineer the compensation systems in order to create a business that fits into traditional valuation models. So the progression to fees fits right in with what consultants like FP Transitions try to accomplish with succession planning.
The movement to fees will likely have a domino effect, Bueermann said, with product manufacturers following along with the recurring revenue model.
“That will make it easier to professionalize the compensation systems and supports more of an advisory type of practice than a sales-based practice,” he said.
In fact, manufacturers are increasingly working with agents/advisors and providing feedback on new fee-based products. Consider the Index Protector 7 fixed indexed annuity developed by Great American Insurance Group in Cincinnati.
Since Index Protector 7 was launched Aug. 22, 2016, more than 50 registered investment advisors (RIAs) — Raymond James, Commonwealth Financial and Brookstone Capital Management among others — have agreed to sell the annuity.
But first, both sides worked together to iron out issues distributors had on the back end.
For example, advisors wanted to be able to withdraw their fee from the annuity instead of from a separate account. It is common in the RIA channel for the advisor fee to come from the third-party money manager that is managing the client’s assets.
Great American obliged and made that option available in their fee-based FIA, a company executive said.
The industry reported an estimated $21 million in fee-based indexed sales in the second quarter, double the volume from the first quarter but still a fraction of overall indexed sales, according to LIMRA Secure Retirement Institute.
Distributors like Commonwealth Financial Network, one of the nation’s largest broker-dealers/RIAs, say they’ll keep fee-based products on their shelves as long as they show some sales life.
“If and when the DOL standards are applied and we were to switch over to all fee-based annuities with qualified money, that would really tell us how popular these are,” said Ethan Young, director of annuity research at Commonwealth.
That transformation means a more traditional advisor force with company buy-in. Instead of commission salespeople, Bueermann said, firms will be staffed by advisors being paid salaries and bonuses.
As that evolution takes root, it all adds value to the business. And it places a greater emphasis on succession planning to ensure the growth and stability of the business.
“The transformation is going to be super good for the industry,” Bueermann said. “The people that make the turn are going to make a ton of money, because it’s making their businesses more valuable, and I think that we’re going to deliver better services as an industry to the clients. But like all changes, it’s painful to some people.”
A succession plan is about the transfer of the business to new stewardship, often carried out over a number of months, or even years. Not enough financial services firms have a solid succession plan down on paper.
Fewer still have what Bueermann calls a “continuity plan,” or an emergency plan. The plan that dictates a course of action should the firm president die unexpectedly tomorrow. Life insurance is often a big component of that plan.
“Have you put a plan in place that allows the firm to continue to run and something also that protects the value of what you have built?” Bueermann asked. “A startlingly low number have any kind of plan. Less than 15 percent of the people that we survey or do valuations with have a continuity plan, and we would say when we review that, under 10 percent of those are executable.”
A properly structured continuity plan that includes life insurance can provide the following safeguards, Pacific Life Insurance Company points out:
Continuity of management and control for the remaining owners.
A source of income for the decedent business owner’s family.
A captive market for often nonmarketable business interests.
Liquidity to the decedent’s estate for estate taxes and administration costs.
A fair valuation of the business interest for federal estate tax purposes.
A fair return to the decedent’s estate for his or her business interest.
To some degree, agency owners enjoy the clients and the business part a lot more than they enjoy the details of running the business, Bueermann said. That might explain the lack of a forward-thinking strategy.
But there’s too much at stake not to have one, he added. And it’s irresponsible to leave clients in the lurch with no plan to smoothly service their accounts in the event of an emergency, Bueermann said.
“Most of them will basically go along and say, ‘You know what? When I’m ready to retire, I guess I’ll just sell the damn thing,’” Bueermann said. “Well, maybe you will, if you have any people left. Or any clients left.”
Advisors Have a Role
Completing a succession plan is no overnight process, cautioned Chip Roame, managing partner of Tiburon Strategic Advisors in Tiburon, Calif. Advisors have work to do to take advantage of the value proposition offered by fee-based services.
Tiburon views succession planning as a five-year process, Roame said during a recent research call.
“It’s not something that you get done in three months,” he added. “If you want to think about making your business attractive to a buyer, you might think about changing your price point; you might want to change your services; you might want to hire different people. All of those things can make one’s business more attractive to a potential buyer, but all of those things take a lot of time.”
Tiburon offers a six-step process to succession planning (see sidebar). The one that gets the most attention, and causes the most angst is business valuation, Roame said.
Most advisory firms are still doing valuations incorrectly, he said. Data shows that three-fourths of RIAs say the most logical valuation method is a revenue multiplier.
“That is absolutely wrong,” he said. “That’s actually maybe one of the worst ways to value a firm. Basic business school 101 is you’re buying the future cash flows of the business. So the right way to value a business is the discounted cash flow method. That’s the only right way to do it.”
The discounted cash method is a better way, Roame added.
Ways to boost value are fairly standard, he said, by strengthening these four areas: revenue sources, institutionalization, benchmarking and client demographics.
A firm’s client base can be a major variable.
“No one wants to buy a client base that’s 80 years old on average,” Roame said. “They want to buy a younger client base. They want to buy fewer but wealthier clients as a general rule. You’d rather have fewer but wealthier clients than many less wealthy clients.”
The coming years are going to bring plenty of activity in succession planning, mergers and acquisitions, as well as outright firm sales, Roame predicted. The drivers are well-known and not going away: aging advisor force, regulation and a changing retirement investing market.
Firm owners need to get better prepared, and fast, Roame added.
“There’s some 40 percent of the people out there who have no succession plans. That’s a little scary,” he said. “I’d also question of the 60 percent who say they have a plan, how well that plan is written.”
Tiburon expects succession planning activity to pick up substantially in the captive world, Roame said.
“They’ve all had succession planning programs for a long time. But they’re kind of ignored,” he added. “They don’t get a lot of attention. I think you’ll see more attention there. They’re not going to want their advisors go independent.”
Likewise, Tiburon forecasts 700 merger-and-acquisition deals by 2019. In 2015, there were 366 such deals recorded. The general idea is that bigger firms can better absorb regulation costs and changing industry dynamics.
General sales trends will veer toward increased professionalism, Roame said. More consultants like FP Transitions will emerge to add targeted services.
“You know, a lot of advisory firm deals still happen without much industry savviness,” Roame said. “Two local advisors hire the local CPA firm and the guy doesn’t even know what an RIA firm is, or they hire some business broker who sold a car dealer last week and now he’s helping two insurance agents merge.
“So that’s the old way, the haphazard way. I think you’ll see the sales processes get a lot more formalized.”
The need for succession planning extends beyond the financial services industry, McNeely said. In fact, advisors have a role to play in helping clients through the process, all the more reason to get their own house in order first.
McNeely, author of No Necktie Needed: A Woman’s Guide to Success in Financial Services, said her next book might be on this topic. A “significantly larger number” of her clients are engaged in the succession planning discussion, she said, no doubt a reflection of a larger trend.
“It’s high time as advisors we start to get very real about succession and very practical, I think, because I think with the increased regulations that are out there, we’re going to see a lot of advisors retiring,” she said. “I think you’ll see a lot of practices sort of merge and be sold. I always say the more proactive and planned that you can be about that succession, the more successful it’s going to be.”