Control versus valuation in the financial adviser succession debate

As stakeholders in the advice industry wrestle with how to teach their clients about the looming two-pot retirement solution, they cannot lose sight of the unique challenges that exist in the financial and risk advice contexts. The truth is that financial advisers and planners who hope to leverage ownership in their practices to fund retirement face unique challenges of their own, spanning concepts like motivation, timing and valuation.

Beware of these succession pitfalls

“You cannot [rely on] replacing the income from your practice by selling it to someone and investing the proceeds,” warned Jaco van Tonder, Advisor Services Director at NinetyOne. His message to the independent financial planners (IFAs) and Certified Financial Planner (CFP®) professionals gathered for the 2024 FPI Professional’s Convention was clear: if you want a replacement ratio of more than 50% at retirement, then you may have to accumulate additional capital outside the business. His presentation, titled ‘Succession pitfalls and how to avoid them’, focused on the intersection of psychology and numbers in the succession process. 

“Retirement is the other side of succession,” opined Van Tonder, as he set about dismantling some of the misunderstandings around when and how financial advisers actually step away from the industry. The presentation opened with some insightful statistics on the timing of retirement, and the financial ‘clout’ of advisers in various age bands. Using data on over 1000 advisers in the NinetyOne universe, the presenter showed there were almost no advisers aged under 25; a solid representation in all of the key ‘working life’ age groups; and a normal distribution all the way to age 75. 

“The first message that we should take away from looking at the data is that there appears to be a large number of young and upcoming advisers in the 25 to 45 age group who are the succession plans for the future; the story that the advisory industry is an ageing industry that is going to go the way of the dinosaur is not borne out in these numbers,” Van Tonder said. The data also supported that advisers are quite comfortable working well past the preferred retirement age of 65. “When I ask advisers when they are going to retire, the number that is most often mentioned is age 65; this graph tells us they are only half right: half retire by 65, the rest work longer,” he said. 

Delaying retirement an IFA reality

The preference among advisers to work beyond age 65 is influential in the succession planning discussion. “Being realistic about when you are going to stop working is a key ingredient for a successful succession plan; you should plan to work later and then leave earlier if all goes well rather than the other way around,” Van Tonder said. He also drew attention to the irony of corporates pushing for retirement as soon as possible versus the value added by experienced advisers staying on board. 

Shifting focus to the ‘average book by age’, the presenter concluded that very few wealth advisers built up a meaningful book before age 25, with the biggest value exhibited in the 35-55 age group. This data suggests that to have a realistic, internal, organic succession plan, your candidate should be at least age 35 when they start to move into that ownership space. The ‘when and how you plan to retire’ and succession discussion was then framed as follows: advisers under 25 have not had enough time to gather assets; there are enough people in the 25-45 age group to ‘feed’ the succession machine; half of advisers work beyond age 65; and most advisers retire by age 75.

The audience was reminded of four generic succession planning models, each of which had various pros and cons. “You should focus on the model that is attractive to you; but you must understand its pros and cons because those are what you are going to have to deal with when you execute your plan,” he said. FAnews offers the following précis of the models which were explained against two axes: time to implementation and impact on advisers’ control or legacy. 

The legacy versus valuation trade-off

The first model involves selling your practice to a large corporate institution. According to the presenter, these transactions can be completed relatively quickly; offer little ongoing control to the selling adviser post-transaction; and have the potential to achieve higher valuations. The warning: “If the buyer has full control, they will do what they need to do to deliver the earnings that the people who provided the capital to buy your book in the first place insist on getting.” 

The second model involves two companies sharing infrastructure. “These firms may run under different FSPs initially, but they share office space; they share a front house brand; and there is an agreement about what happens when one of the two partners passes away or falls ill,” Van Tonder said. The third model, described as quite popular in South Africa at present, formalises this arrangement by executing a formal shareholder sale. “The FSPs merge; there will be a share swap; both entities will get shares in the new company; and the new company will continue to exist as a single entity and run as a single FSP,” he said. 

Finally, you have the option to go the organic succession route, described as the dream outcome for many IFAs. “This solution gives you full control over the business because the business remains and a successor takes over while the founder or entrepreneur's legacy is preserved,” Van Tonder said. Clients benefit too because they deal with the same brand. The downside to this solution is that it takes far more time than most people realise. “The founder determines the speed with which the transition happens; he or she remains in control until they fully retire, even if that only happens at age 85,” he said. 

Do not forget your own retirement funding needs

Much of the presentation centred on the valuation of a practice, and the risk to owners of not considering their own retirement in the succession planning process. Beginning with valuation, Van Tonder pointed out there was no single correct valuation for a company at a given point in time. You can ask four experts to calculate the valuation of a business based on its latest annual financial statements, and all four will give you a different number that should be within the realms of being correct. 

Financial advice practices were described as relatively simple businesses that are easy to value. And while CFA-types love detailed bottom-up valuations, you can get “a hell of a long way to the right answer” with a price-to-earnings (PE) ratio or revenue multiple. An example was provided based on an advice practice with a recurring fee revenue of R5 million per annum; cost-to-income ratio of 70%; income growing at 10% per annum; and expenses growing at 8% per annum. This practice was valued at just over R12 million for a PE of 11.5 and 2.5 times revenue. “That 2.5 times revenue number is always in the mix when you value a wealth business,” Van Tonder said.

But his stand-out advice was to decide on the timing of your exit and preferred succession model first; then thrash out the broad brushstrokes of the deal; and only then consider valuation. The presenter suggested kicking off the negotiation with an assumed value of around 2.5 times revenue and talking about the objectives of the transaction; the formal valuation is done to close the loop at the end of the negotiation process. There was so much ground covered during this 45-minute presentation that it is quite impossible to cover everything in one newsletter. 

Valuation is not all-encompassing

The presenter offered an excellent close, acknowledging “succession as an incredibly important but often completely misunderstood and underestimated task in a financial adviser’s business.” He called on advisers to dedicate enough time and effort to choosing deal structures and partners or successors, and to keep in mind their own retirement needs. And he urged corporate acquirers to let advisers stay in the business past age 65. Finally, he said: “valuation is important, but it is not the most important.” 

Writer’s thoughts:

One of the interesting observations from this succession debate is the clear trade-off between ongoing control and valuation. Would you rather sell your practice for less and retain control until you decide to fully retire, or take a larger sum and walk away sooner? Please comment below, interact with us on X at @fanews_online or email us your thoughts editor@fanews.co.za.