Succession and Ownership: Evergreen Challenges

November 18, 2021

The investment industry has long been a particularly notable hot bed of succession issues. Our industry is perhaps more dependent on the capabilities of its employees and leaders than any other. This is certainly less true for large enterprises managing hundreds of billions or more, but for the overwhelming majority of the 13,500 registered investment advisors in the US, who manage tens of billions or less, a small number of people typically drive their success and futures. Leadership decisions, functional excellence and competitive sustainability can all be boiled down to key individuals. From a P&L perspective, generally 60-75% of aggregate expense in any investment business is represented by total compensation costs. While asset classes, client segments, business models, and strategy choices are the typically dominant themes on the competitive state of our industry, more often the quality and attributes of the key people owning and/or running the business are what makes the business sustainably successful.

What is the primary distinction between succession planning, good and poor? Timing and attention. People get older, retire and die, but that fact appears to be lost on thousands of firms who refuse to address succession early enough, if at all, and often with much less care and thoughtfulness than they would give their portfolios or clients. Moreover, a transaction is often regarded as the de facto solution to the issue. Selling a business or part thereof only addresses ownership transition, not succession. The two topics are often joined at the hip, but good succession requires an ongoing evaluation of age, interest, capability and strategy. It is much easier to ignore until it must be dealt with, and at that point, it’s always too late.

Good succession plans are put in motion long before retirements. Would-be partners and up-and-coming employees of every function need opportunity to grow and become more productive. Lack of opportunity and direction incites turnover. Our industry has a stupefying persistence in sticking to the status quo as leaders and owners pass through their 60s, 70s and even 80s. That observation is often connected to family businesses but certainly not reserved solely for them. Whether a firm has a family dynamic or not, open-mindedness and the best long-term interests of the company should trump entitlement of any kind.

Among employee-owned firms, succession of key roles and ownership transition are often inexorably linked. As the marketplace for M&A of commercial investment businesses has energized over the last decade, owners are faced with a growing dichotomy: either pursue an external sale at the highest price from “acceptable” parties or sell internally at what is and should be a growing discount to third-party valuation. The former still leaves all the functional succession issues on the table; the latter heralds the old school notion that the best owners and leaders of the firm should come from within. Do the partners/key employees want to take the mantle, have skin in the game, and be responsible for the future of the firm? Unfortunately, this just isn’t feasible for many successful multi-billion-dollar managers/advisors, where the growth in the value of the business has run away from the employee’s ability to own meaningful equity, even at highly discounted valuations. Hence the need to begin transitioning earlier.

Very few employee-owned businesses in either asset or wealth management make it to the second generation, and rarer still, a third or a fourth. Whether acquired and disbanded, aging away to a slow business death, or crumbling under the weight of internal disagreements (most often on matters of compensation, role, and strategy) – good succession planning remains the critical factor in continuity and preserves optionality for such firms. Poor succession planning removes optionality and ensures the music will stop.

There is no time like the present to dust off that operating agreement, address these issues head-on, be transparent and over-communicate. The clock is ticking.