John Turner of Live Oak Bank on Succession & Exit Planning

What Is Live Oak Bank?

John Turner is the senior lending advisor for Investment Advisory Vertical (Industry) at Live Oak Bank. (If you haven’t heard of Live Oak Bank, you’ve likely never used Succession Link, where Live Oak’s ads are plastered everywhere.) Live Oak bank specializes in financing financial advisory business succession plans. What quantifies specialization? Last year, Live Oak closed 340 deals with financial planning businesses, Turner reports. Here are some fun facts on those deals:

• Average sale price was $1,100,000 each.
• Roughly one-third involved registered investment advisors.
• Most of the deals were outside acquisitions — only 13 percent were internal succession plans.

I had the fortune of interviewing John Turner about some of his best practices for succession planning. Here’s what I learned.

Finding the Right Fit for a Financial Practice Succession Plan

Before we talk about the numbers, it’s critical to understand that succession planning is not always just about the sale price — or even the infamous multiple of revenue. For a succession plan to work, Turner cautions, you need to have the “three Cs” in place:

• Character
• Cultural fit
• Competency

Why are the three Cs so important? An oft-cited factoid in the succession planning space is that there are 50 buyers for every one seller. Turner says that in some states, such as Florida and Texas, that figure can be 100 to one! But there is a huge difference between interested buyers and qualified buyers. When it comes to qualified buyers, it’s more like four to one. It’s the three Cs that separate those two groups of buyers, Turner says.

Cultural Fit

To determine cultural fit, compare your approach with the firm you are looking to acquire. Consider examining:

• Your investment philosophy.
• Your approach to financial planning.
• Your firm’s value proposition.

The question to ask is: “Is there a match between what you are doing and the business you are looking to acquire?”

Character

Why are the three Cs so much more important than the sale price? Consider the second C — character. Imagine the exiting advisor (the one selling the business) living in the same (small?) town as his or her clients. Will that exiting advisor be slinking around the grocery aisle dodging former clients because she regrets the choice of her successor? Or will that exiting advisor walk around town with her head held high because she knows she chose a very capable successor?

Turner stresses character. “Is the person honorable?” he asks. “Do they have integrity? Will the seller be proud of their once-in-a-lifetime decision?”

Another manifestation of character is how you show up on the Internet. This is not just your team member bio and firm’s description on your website but anything that may show up on other sites. Turner shared one anecdote about how a poor Yelp review was a deal-breaker for one exiting advisor.

When it comes to the tangible world, presentation still matters. This means having a physical office space that the exiting advisor can appreciate.

Competency

Last year, the average financial advisor business sale financed by Live Oak Bank had 198 clients. This begs the question: Is your firm prepared to take on an entire book of business? Do you have the right staff in place? Does your staff have the right training? How’s your workflow? Are you working with a polished multi-step process in your CRM that delegates tasks out to team members with distinct responsibilities? The critical processes that need to be well-oiled machines, Turner says, are:

• Client onboarding,
• Client meetings, and
• Managing ad-hoc client service requests (such as a one-time portfolio distribution).

More important than multiple of revenue or EBITDA are the three Cs, Turner emphasizes. If you’re strong on the three Cs, you don’t have to be the highest bidder.

How Young Financial Advisors Can Find a Book of Business

In succession planning verbiage, triggering event can mean an older advisor dying or becoming disabled. This “triggering event” is what can sometimes get the succession planning process started. But for Turner, triggering event can mean something else entirely.

Just like clients, finding an advisor from whom to purchase a financial planning business can mean simply getting out there. “Meet people. Have coffee. And mention that you’re in a relationship with a bank,” Turner says. While an advisor may not be looking to sell his or her financial advisory business today, meeting the right younger person can be the “triggering event.”

“You don’t get the business until you pick up the phone and call. You need to get out and circulate to make it clear to those around you that you are in buying mode,” Turner says. One way to put this into reality is to schedule a time to do just this. For example, you can devote two to four hours every Friday for business development, Turner suggests.

Once out there, younger advisors who are looking to buy a book of business need to swallow their pride, and listen to and get excited about how the exiting advisor is serving their business. You need to listen to what’s important to them, Turner says. This may be a challenge when there is a difference in investment or financial planning philosophies between generations.

Multiple Financial Advisor Business Acquisitions

If you’re a financial planner, you’ve likely heard of the H.E.N.R.Y. acronym. At Live Oak Bank, there is also a term for younger financial advisor clients who are looking to buy other financial planning practices: millionaire walking.

Turner shares that if the sale of an advisor’s practice goes well, then that sale won’t be the last for the younger acquiring advisor. That’s because that exiting advisor has friends and colleagues who are watching the financial planning practice succession plan unfold. One successful succession plan can yield six additional deals, Turner says. A successful transition of a colleague’s financial planning firm is a triggering event.

Financing from Live Oak Bank for Your Succession Plan

Turner explains what Live Oak Bank looks for when financing an acquisition of a financial planning practice. The acquiring advisor:

• Must have been in business for at least one year. For most practices, this is a relatively low hurdle.

• Must have a good credit score. This means a credit score of 680 or higher from all three credit reporting agencies. Further, there must not be any instances such as short sales, bankruptcy, etc. on any credit report.

• Must have sufficient cash flow. Live Oak Bank uses the following formula to determine if it wants to finance the acquisition:

total revenue (existing firm revenue + acquisition firm revenue) – expenses (existing firm expenses + acquisition firm expenses) – owner’s compensation (using a formula) = net operating / 1.75

The final figure, net operating / 1.75, must be larger than the entirety of all business debt payments.

Additionally, this financing won’t work if the buyer agrees to purchase a business for more than it’s worth. (This can happen, Turner says.) That is, because the business is being sold for a disproportional amount relative to the cash that it generates, the business being acquired can’t generate enough cash to support the new debt payments.

If a business is going for more than its market value, the solution may be to extend the duration of the loan. Live Oak Bank offers financing terms up to 10 years. Additionally, one can add a seller-financed note on top of Live Oak’s loan — with the seller-financed loan to begin at the culmination of the Live Oak financing. Such a deal can mean great risk for the seller who chooses a second round of (seller) financing to occur after the completion of Live Oak Bank’s financing. The arrangement is risky for the seller because the seller will not see the entirety of his sale price realized as much as 240 months into the future, assuming 10-year financing supplied by Live Oak Bank, and a successive seller-financed note of another 10 years.

If financing your acquisition of a financial planning firm is something that you’re interested in, Turner suggests the following:

• Get familiar with your existing profit and loss statement. You need to know what is flowing to the bottom line as profit.
• Consider waiting until hitting $250,000 in gross revenue before finding financing. Usually, gross revenue below $250,000 can’t make the formula work.
• Consider whether you are willing to take an $80,000/year administrative assistant off the hands of the exiting advisor.
• Consider whether your business can absorb a large addition of clients and serve them well.

Sometimes, this last bullet point can be written into the succession plan. That is, the exiting advisor may want you to take on her administrative assistant as per the terms of the deal. (Consider that the exiting advisor can have a multiyear relationship with her admin support, and thus will want to put them in a good place, just as they would their clients.)

Challenges in Succession Planning for a Financial Advisory Practice

Turner shared some “red flags” for getting financing for an advisor succession plan:

• A revenue stream that is difficult to predict or has limited growth potential.
• A large number of customer complaints.
• A high client attrition rate.
• A large portion of revenue being received via commissions. Quoting Turner here drives this point home:

“One-time commission revenue isn’t worth anything now.”

• Supporting staff who are nearly ready to leave the company.
• If the firm concentrates in pushing unusual products such UITs, private placements, etc.
• Average client age above 70. To this, Turner adds:

“It’s hard to pay for revenue that won’t be around for very long.”

• Concentration or diffusion of client revenue.

If a large share of client revenue comes from a small percentage of clients — or if the average client account size is well below industry standards — it’s going to negatively impact your firm’s valuation. Turner shares a story of an advisor who got a paltry 1x revenue because she had a book of business of 1,500 clients producing $600,000 in annual revenue.

Not All Financial Advisory Succession Plans Use Outside Financing

Of course, it goes without saying that just because you’re looking to buy another practice, it doesn’t mean that you need a bank loan to make that happen. It boils down to the amount of risk that the exiting advisor is comfortable with taking. Of course, an advisor getting the entirety of his firm’s sale price up front means much less risk for the exiting advisor. But, it could also mean different tax treatment. Outside financing may or may not make sense depending upon your particular situation.