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Internal Succession – the appeal and the challenges it presents

Internal succession is the preferred option for most IFAs

In a recent survey of 314 IFAs in SA by Insight Discovery, 64% of the IFA respondents were over the age of 50, and a further 20% were over the age of 40. Put another way, only 16% of the respondents were under the age of 40. Despite what might seem a small respondent group, it is safe to say that it can be regarded as a representative sample of the IFA community in South Africa. With this age profile, it is not surprising that most IFAs have succession uppermost on their agenda.

There are a number of options for IFAs to consider when deciding how best to implement a succession plan for their business, so we thought it would be useful to write a series of articles on these options to try and help IFAs assess what is the best route for them to follow. In this first article, given that the Insight Discovery research indicates that internal succession is the preferred option for IFAs, we will explore the appeal and challenges of internal succession.

Key appeals are consistency, reassurance for clients and unlocking full value

In our view, there is much appeal for going the internal succession route, with probably three key factors that make it the preferred option for IFAs. Firstly, you can guide and mentor your successor. Essentially you can ensure that the business will operate in a way that has your stamp of approval, even after you are no longer involved. This can be very reassuring for clients who have got used to things being done in a certain way.

Secondly, your successor can develop a relationship with your clients while you are still at the helm. Your clients trust you, and invariably they will be reassured by the fact that you are introducing them to the person who will take over from you, particularly if you are still going to be around for a while in the background. This also means that you don’t need to relinquish client relationships with any pressure.

Thirdly, it means that you can have full control over how you unlock the value of your business. This is a critical factor because it means that not only are you able to realize the full value of your business, but it also means that you can remain a shareholder for as long or as short a time as you wish. This is important, because a financial planning business, by its nature, is an enormously attractive business, with consistent annuity income and a cost base that can be managed very effectively. With technological advances, it is also has huge potential to be a very scalable business.

Key challenges are finding a “mini-me”, funding and “letting go”

One reason this option often fails is that business owners can’t find the “right people” to be their successors. Often this is because advisers are looking for a “mini-me” to take over their business, forgetting that their business is at a point where no longer does it necessarily need an entrepreneur at the helm. Particularly given that most businesses that have a succession problem have usually got to a point where they are now growing primarily by referral. This means they need successors who can service and maintain clients, and grow through referral, rather than an entrepreneur who wants to go out and get their own new clients. This was the job of the founder, hence the danger of hiring a “mini-me”, who spends a couple of years getting to know the business and then leaves to follow their own entrepreneurial instincts.

A second factor that often impacts on the success of internal succession is that even when the right successor has been found, they are often unable to fund the purchase of the outgoing shareholder’s shares. Frequently the value of these shares is such that a potential successor either needs to borrow the money from the outgoing shareholder himself or herself, or this funding is via bonus and dividend payments that are foregone until the equity has been fully paid for.

A third challenge to the success of internal succession is that very often the exiting owner, particularly if they were the founder of the business, struggle to let go of the reigns, even after they have sold some or all of their shares. This is why we see a very important part of the succession process is “depersonalizing” the brand, so that the founder has less attachment to the business because it no longer has their name “on the tin” so to speak.

Despite the appeal of internal succession, IFAs are searching for alternatives

Despite the very strong appeal of following the internal succession route, it is clear that it is not without its challenges. So advisers are increasingly being drawn into looking at alternative options for succession, very few of which have the same level of financial value and business continuity appeal.

Three factors seem to be driving the search for an alternative. First is the age profile of the IFA community, which as noted earlier is an average age well over 50, so there is a growing sense of urgency and the feeling that possibly there is not time to groom a successor. Second is the prospect of RDR and the clear need that many IFA businesses will have to change the way they operate. And finally, linked to RDR, is the scare mongering that seems to be going with it, where prospective buyers of businesses are telling IFAs that they won’t survive without a “big-brother” whether that be another IFA business or a financial institution. We will explore this phenomenon in a subsequent article, but in the meantime we urge advisers not to surrender themselves to an alternative succession plan without having fully explored the internal succession route.