Recruiting and developing a skilled team of advisors is one of the most difficult challenges facing the ownership of a financial advisory business. It is, after all, the people that are the real assets of any business, and nowhere is this more true than in a professional services industry.
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But recruiting and training a core team is actually only half the challenge. The other half is retaining key employees now and into the future – a future that may extend beyond the current owner’s lifetime. Operating your financial services business as an entity (corporation or LLC) provides some important options and opportunities, such as setting up an internal ownership track. While this strategy may not produce a successor to the business, it is all about succession planning.
The advantage of creating such an internal ownership path stems from its ability to turn key employees into active investors who see their value grow through their own hard work. In addition, retaining and motivating key employees is a major step in preserving the value of the business in the event of short-term disasters such as the sudden death or disability of the founding or majority owner. Creating an internal ownership track is an integral part of managing and growing the equity in a financial advisory practice.
Cast in this way, an internal ownership program becomes part of the overall “equity management” of a firm, a concept focused on helping investment professionals monitor, protect, and realize the value of an advisory business while providing for the long-term care and retention of the client base. By creating an ownership platform for the next generation, investment professionals have an opportunity to create a stronger and more stable business model that can grow, with the client base, from one generation to the next, while growing the equity and hence the reward for all of the “owners” of the company. This is succession planning. As I’ve said before, succession planning is NOT about selling the business; it is about control and rewards and choices, if you plan ahead.
Providing ownership to employees need not be a complex undertaking, but it does need to be set up and administered properly. At opposite ends of the spectrum are two well known approaches – gifting the stock (along the same lines is the use of equity compensation), or using a formal program such as an Employee Stock Ownership Plan, or ESOP.
Many owners think the simplest, most effective approach is to simply gift a small or minority portion of stock (or membership interest in an LLC) to one or more key employees. While this approach can achieve, at least in part, the objective of moving an ownership interest to a key employee, there are a host of valuation and tax issues that accompany such transaction, especially in a non-family transaction. (Gifting stock is far more complicated that most people realize – don’t do it until and unless you and the recipient of the stock fully assess the tax and legal consequences.)
An ESOP is an employee benefit plan governed by ERISA which provides a tax-advantaged mechanism for transferring the ownership of a company to its employees. The regulatory requirements for maintaining and administering an ESOP, coupled with the cost of setting up such a plan, make ESOP’s impractical for all but the largest financial advisory firms.
So where is the middle ground? An ISOP, or Internal Stock Ownership Plan may provide the answer. An ISOP is a structured, non-qualified plan which allows employees to purchase stock (or LLC membership interests) at fair market value, at preset time intervals, and on established, but flexible terms. A carefully drafted Internal Stock Ownership Plan navigates around the regulatory issues of an ESOP by establishing a formal but voluntary program in which licensed employees individually elect to participate and to invest their own money (although a payroll bonus plan is often included as a part of the funding mechanism).
It is important to understand that creating an internal ownership plan is about growth and stability – it is unlikely that an employee will end up buying out 100% of the company. While we do many internal succession plans from owner to employee, or parent to son or daughter, they only work when the owner is willing to finance the transaction over a decade or more. If this is your goal, you cannot start early enough.