For many advisors, their ideal succession strategy would be to pass on their firms to a son or daughter. But, while this plan may make emotional sense, it may not make practical sense for a number of reasons, explains George Hartman, a coach to financial advisors and president and CEO of Toronto-based Market Logics.
“It’s a touchy area because in many ways the owner’s greatest expression of love, in their view, is to pass their legacy on to their children,” he says. However, a great deal of research has shown that the survival rate of second and third generation family businesses is pretty dismal, he adds.
One obstacle to the successful transition of a firm from one generation to another is that sometimes the adult child or children do not appreciate the full value of the business that is being handed to them. “They often expect to get a deal, and sometimes in fact it is even just a gift, which is the worst thing to do, because there is no sense of value that gets transferred with that.”
Some advisors have built substantial enterprises that have great value. While the parent may agree to hand off the business at a discount to their children, this does mean they are taking money away from themselves by doing so, Mr. Hartman underlines.
Another issue relates to the work itself. Many advisors intend to work for a long time, well into their seventies, for example. “Some will say to me…‘I never intend to retire. I’m going to continue to work with just a few clients.’ Usually they mean the best clients by the way,” Mr. Hartman says.
As a consequence, this means the parent is going to continue to show up at the office after transferring ownership of the business to their offspring. “That means that Junior...is going to constantly feel that the parent is looking over their shoulder, passing judgement – sometimes quietly, sometimes not so quietly – on how they’re running the business.”
Mr. Hartman says the firm's founder would be less likely to judge an independent third party who’d paid fair value for the practice than they would their children to whom they thought they’d given the practice away or given a great deal.
Unqualified for the job
Another problem that comes up is that the child may not be qualified to take on the practice. To determine their suitability for the role, Mr. Hartman says an assessment should be done of their capabilities and interests.
One reason that second and third generation businesses have a poor survival rate is that “the talents and energies of the founder often don’t carry through to the children.”
Differences in work ethic, and differences in ideas about what’s right and wrong and how to progress the business going forward can also cause friction. “Those are the types of discussions…that have to take place so that everyone’s expectations are clear.”
The final major issue involves situations where a fair price is negotiated between the child and the parent for the business, but the child does not have the money to buy the practice outright. Consequently, there are usually earn-out provisions that take three years, five years or even longer to pay out. The adult child may be a very capable person, however, they will have pressure to create wealth in two ways. “They have to pay off the parent and they have to build their own business and create their own wealth.”
In cases where the parent is easing away from the business, the child may develop a nagging sense that the parent isn’t contributing to the business anymore ‘and yet I’m still paying them’.
So, the adult child may feel that the earn-out deal was unfair, depending on its terms, explains Mr. Hartman. “If the terms are based on some percentage of business, then the child may feel, for example, that the only reason the business is doing well is because of her efforts, whereas the parent will think it is because of all the work that he did during the 25 or 30 years prior.”
Solutions and strategies
How can these obstacles be overcome or avoided? Mr. Hartman says, “The first thing is to have a frank conversation early in the process…Really, it comes down to dialogue, to having a blunt and candid conversation about expectations on both sides and about some of the specifics of the deal, such as timing, price, all of those sorts of things.”
This is the stage when a business coach might step into the process. “Having an unemotional, detached third party often allows those more delicate, sensitive, inter-family issues to be put on the table.”
Mr. Hartman also highly recommends that anyone embarking on a family succession strategy take a little time to read a book by author Tom Deans called Every Family’s Business. This book poses “12 Common Sense Questions” aimed at helping families build and protect wealth while keeping relationships intact. Mr. Hartman says that the parent and adult child should answer these 12 questions together to determine if in fact it is appropriate for the child to take over the business.
Creating a legacy
Mr. Hartman says that when the fit is right, passing a business to a family member can be a wonderful opportunity to create a legacy. If the adult child is mature, qualified and can demonstrate their own competence, then such a succession plan is the best of all worlds. Clients will be reassured that the plans they have put in place are going to be managed in a like-minded way by someone with the same value set. “That is the ideal. I am not saying we shouldn’t do this; I am just saying there are challenges that come with any succession plan, but there are special ones that come when it is a family member.”
Has he ever been involved in situations where after frank discussion the parent abandoned their plans to pass on their practice to their child or children? “Absolutely,” said Mr. Hartman. He has even been in a situation where he was the one who had to tell a father that his son was neither qualified nor interested in running the business.
“The father had assumed all along that the son was, but the son had other things that he wanted to do with his life...but he was afraid to tell his father.”
When it comes to succession planning, Mr. Hartman says his overall advice would be to take your time. “This is your life’s work that you are passing on as an advisor. It is your legacy, so you need to be careful about to whom you are entrusting that legacy. That means whether it is a family member or a third party outside your family, the same sort of evaluation of interest, capability and fit is important.”
If it turns out that the adult child is not a good fit, this can be very disappointing and even devastating news for the parent. But, in such cases, they will probably realize that deep down they’ve harboured doubts about their child’s suitability to carry the torch.
In this scenario, the parent should also realize that their legacy is not just what they pass on to their children, adds Mr. Hartman. “Their legacy is really wrapped up in the work they did for their clients. It’s not the name on the door. So if the clients continue to be well served, that is the greatest legacy there will be.”