Internal Succession

Structuring an internal buyout

In last week’s newsletter, I discussed how selling to an external buyer comes with some moral hazards that for many advisers, they would rather avoid. The issue is, will the new owner treat clients and your team with the same level of care and attention as you did?

Nothing is 100% guaranteed in this life, but selling to an internal successor can be attractive for a whole range of reasons.

The Upsides

Continuity

An internal successor is most likely to understand the culture of the business and therefore most likely to provide continuity of that culture for both clients and the rest of the team.

It’s important to most adviser owners that everyone is taken care of after they step down. It’s why they’re such nice people, and are so loved by their existing clients; they give a damn.

Ambition

Your internal buyer is often chomping at the bit to take the reins and action some of the ideas they’ve had brewing while they’ve worked with you.

Ideally, your successor should be looking to take the business beyond what you’ve been able to achieve, not just maintain the status quo.

Seeing that transformation occur is a lasting legacy you can be proud of, so what I’m about to say isn’t a criticism and shouldn’t be seen as a threat to your legacy. Often, the young pretender can see a lot of the things you could have done better. That doesn’t mean they will get everything right in their future tenure, but in the initial takeover phase, there should be some impetus for change that may well be overdue. This could be because they’re more in tune with new approaches (e.g. marketing and social media), or have more affinity for new technology which will be a driver of greater productivity and efficiency.

They might also just have a bit more energy than you, now that you’ve been there and done that in your career. If you’ve been mentoring them over the years, hopefully they’ve learned to think like business people, focussing on the strategic issues that can drive the business forward sustainably and profitably.

Time Frame

If you’ve been preparing for your succession and identified a candidate early on, then the time frame over which you can complete the transaction can be much longer than in a typical sale to an external buyer.

By establishing some milestones, you can be phasing the financial aspects of the transaction to suit your successor (who is often of more limited financial means than you are). Equity purchases can start earlier. Whilst this is still likely to be ‘small beer’ in the scheme of things, it stimulates that ‘ownership’ mentality in the successor.

You might still require them to stretch a bit, because you want them to have some ‘hurt money’ in the transaction to ensure they really are committed. However once that has been taken care of, the rest of the transaction can be done over a number of years with you still around in some (mutually agreed) capacity. This allows you to continue to provide the experience and mentoring that should ensure a successful outcome for all. Just watch out that it doesn’t turn into meddling and control-freakery (see my second point below)!

The Downsides

So that’s the upside of internal succession, but what about the downside? As you already know, this type of transition is fraught with some obvious speed humps:

Are They Really The One?

It’s imperative that you’re certain about your successor. To be clear, certainty isn’t merely telling each other over and over that “it’s all going to happen”.

You need to be taking active steps that let both of you know that things are serious and moving ahead; steps that require commitment (preferably financial) on the part of the successor.

Without these milestones and commitments, it’s you who is exposed. I’ve seen a lot of deals fall over, leaving the owner with no option but to continue working for longer than they had hoped to, or to instead gear up for an external sale with all the hassle and moral risk they were hoping to avoid.

Are You Ready To Go?

One of the biggest killers in any succession arrangement is an owner who really doesn’t want to let go. Let’s be honest, every single business owner has a high degree of control freak DNA. It’s just how it is. So being self-aware enough to not only recognise it, but to do something about it is really important.

By ‘doing something’ I don’t mean expressing verbal platitudes either. I mean putting in place milestones, commitments and financial structures that ensure you will ‘get the hell out of Dodge’ in the agreed way and time frame. Remember what you are doing here; you are selling your business. Someone else is buying your business. It won’t belong to you anymore. As that pesky song says, you’ve got to “let it go, let it go”.

Financing

Structuring the financial aspects of an internal succession is potentially more complex than accepting a deal from an external buyer. This arises because the selling owner is effectively financing and guaranteeing a large part of the transaction.

The best way to ensure this doesn’t cause you any grief is to be a good student of your own advice as you approach your exit date. The more financially sound you are in your personal financial situation, the easier it is to make your internal deal work. If you are less financially sound, the more exposed you are to the success (or failure) of your internal sale and the trickier things can become. That needn’t be a show stopper, but it does add some nervousness to the whole deal for all concerned.

The Bottom Line

As you tell your clients repeatedly, it’s all about the planning. If you’re thinking about succession nice and early, and taking the appropriate steps along the way, it should all go swimmingly. This is one of those situations where you really do need to walk your own talk.

One of the biggest killers in any succession arrangement is an owner who really doesn’t want to let go