Financial advisors have a lot to consider when planning to exit their practice — who they want to hand the ball to, how their clients will receive the transition and what they’ll do on the other side.
Another factor is how to structure their succession plan. They can choose a complete or partial sale with added options under those two umbrellas that include share sales, asset sales and hybrid sales transactions. Each option comes with its own tax, legal, regulatory and financial implications.
“It’s definitely an underappreciated area of the succession plan,” said Joe Millott, founder and principal of Toronto-based Acquatio. It provides guidance to buyers and sellers in the Canadian wealth management industry.
“Everyone’s focused on how much they will get. They don’t think about how much they will get after tax.”
Complete sales vs. partial sales
There’s no one-size-fits-all approach to structuring a succession, said Tyler Wilson, director of advisor finance at Newmarket, Ont.-based Care Lending Group. The company offers business financing solutions to the financial advisory, condo and strata, golf and health-care industries.
“It really depends on the operational plan, the current ability level of the successor, whether they’re ready to go or need a bit of mentorship over time, and the overall lifestyle choices and wishes of the advisor who’s looking to potentially step back or make a full exit,” he said.
In a complete sale, the exiting advisor transfers 100% control of their practice to the buyer. The seller could exit immediately or after an agreed-upon transition period.
Also, they could receive cash up front from the buyer on close, or a combination of some cash and a portion of the purchase price in instalments as spelled out in a vendor note, Millott said.
In either case, it’s assumed that the buyer is “comfortable in being able to retain that book of business and maintain that value going forward,” Wilson said.
In a partial sale, the seller transfers a portion of their business to the buyer, while continuing to participate either operationally, financially or both. This process typically spans multiple years.
A partial sale allows the exiting advisor and the buyer to “test the waters,” Wilson said.
“It gives the successor a chance to step into part of the business and understand how things are operated, get a beat for the overall philosophy and how to interact with the clients and what their expectations might be,” he said.
If things go smoothly, then typically the end goal is to sell the remainder of the business, as a block or in stages, Wilson added.
Many sellers go the complete sale route because it gives them more certainty over the outcome of the sale, Millott said.
“If you can execute a sale today for 100%, or at least greater than 80%, then you’re locking in the proceeds at a price that’s attractive to you and not taking any future risk on the performance of the practice,” he explained.
“With partial sales, the owner is still taking the risk there may be deterioration in the practice,” Millott said. “They might lose clients, or when they’re looking to do the full sale, at that point they may not be able to do it at the price that they previously agreed [to] on the partial sale.”
But partial sales have their advantages, too. They facilitate continuity of client care and can help ensure that an exiting advisor’s legacy is maintained.
“The phased partnership buy-in over time is a popular mechanic and really ensures a smooth transition of a book of business,” Wilson said, noting it ultimately depends on both parties to decide what makes the most sense for them.
Structuring the transaction
Complete and partial sales can be structured as either asset sales, share sales or a hybrid of the two.
A share sale involves selling shares in a business or transferring an ownership stake in the business to another party. It tends to be more seller-friendly because the seller could transfer liabilities and potentially benefit from the lifetime capital gains tax exemption of up to $1.25 million.
In some cases, buyers may prefer a share sale if there are contracts and employment agreements within the exiting advisor’s corporation “that are identified as valuable to maintaining the goodwill of the business,” Wilson noted.
Meanwhile, an asset sale involves selling individual components of the business, such as a client list, ongoing revenues and physical assets like office equipment, rather than the legal business entity itself. It’s typically preferred by buyers as it allows them to select specific assets to purchase and avoid unwanted liabilities, whereas sellers aren’t able to benefit from the same potential tax advantages a share sale would offer. “It doesn’t actually make any difference whether it’s a share sale or an asset sale in terms of the flow of funds, but it does have an impact on the seller in terms of how tax efficient the structure is,” Millott said.
“Because employment income is taxed at the highest marginal rates, structuring a sale for capital gain is ideal. If a share sale is not possible, liquidating dividends from a corporation are typically taxed more efficiently than regular income.” In some cases, advisors may opt for a hybrid sale, which combines elements of a share sale and asset sale to balance risk and tax implications for the seller and the buyer. These sales are more complex, however, and require careful consideration.
Further, advisors are limited as to what kind of sale transaction they can proceed with depending on the regulatory regime they operate under.
As it stands, mutual fund-licensed advisors outside of Alberta can incorporate, meaning they’re able to exit their business through an asset sale or a share sale.
Securities-licensed advisors are limited to asset sales unless, for example, “they’re selling to an investment counselling firm or a dealer that is willing to exchange the value of their practice for value in shares, and then eventually buy those shares back from them” Millott said. He noted, however, that these advisors’ ability to structure the deal in a way that can benefit from the lifetime capital gains exemption depends on the length and the status of the dealer or firm at the time the shares are acquired. That’s expected to change, as the Canadian Regulatory Investment Organization considers reforms that would allow securities-licensed advisors to incorporate.
Other considerations
Whether they’re exiting a business or purchasing from someone who is, advisors need to budget for tax and legal professionals. They can help structure a transaction in a way that optimizes tax efficiency and minimizes risks.
“Everyone in the transaction tends to pay their own tax and legal advisors,” Millott said.
“And I’ve seen … in the low end for a specialist M&A tax support, those fees can be $30,000 – $50,000. On the high end, they can be $50,000 – $150,000. And those professionals will be paid whether the deal proceeds or not.”
As well, advisors should avoid jumping the gun when it comes to their exit, Millott recommended. He noted that many advisors tend to do so when their practices are not growing or in periods of market volatility.
“That’s just counterintuitive, because most practice owners should be looking to sell when they’ve had a great year in terms of growth, not looking to sell when they’re having a less-than-ideal year,” he said.
“I would draw parallels between most investors, [who] like to buy shares when they’re going up in price vs. when they’re coming down — it’s a similar case with practice owners.”
Wilson said he’s seen some advisors change the structure of their succession plan because they’ve had a change of heart, or a lack of preparation went into the plan.
“Making a good, solid plan early can really help mitigate against any potential obstacles along the way,” he said.
— With files from Jonathan Got