Financial advisors can do much for small business owners, including establishing a retirement plan, creating a business succession plan, creating a benefits plan and other key elements of the business’s finances. But many advisors have failed to have some of these elements in place for themselves, especially when it comes to business succession plans. Advisors need to have a clear roadmap in this area that will spell out exactly what will happen to their business if something happens to them, so that their clients are protected from possible uncertainty if this occurs.

Buy-Sell Agreements

Advisors need to have a definite plan of action that will go into effect if they become unable to run the business for any reason. Part of this plan will usually involve a buy-sell agreement that will provide a smooth transition to a successor if the advisor becomes incapacitated. (For more, see: Advisors Falling Short on Succession Planning.)

“Practice what you preach. As an RIA and advisor, you make sure that clients who are business owners have a clear plan that helps them prepare for the unexpected. If you are doing it for them, you should do it for yourself,” Mark Schoenbeck, a CFP and senior vice president of business consulting at Kestra Financial, told Financial Planning. “Don’t be the dentist’s kid with bad teeth.”

Schoenbeck went on to say that a buy-sell agreement will eliminate any possible ambiguity regarding the transfer of the business if it is done correctly. The agreement can be triggered by such events as death, disability, divorce or even debt, but it should leave no room for error regarding who will take over the business. The agreement should include a clear description of how the business will be valued as well as the source of funding, which will often be from a life or disability insurance policy.

“For all of these provisions, clarity is the key,” Schoenbeck says. “RIAs should eliminate any chance for confusion, misunderstanding or interpretation in the buy-sell.” Schoenbeck went on to caution advisors that simple rule-of-thumb formulas may not be adequate to accurately assess the value of the business and instead advises the use of a clear formula and process that will correctly determine the selling price. There should also be a moderator in the equation to help settle any disputes regarding the valuation of the business.

And arriving at the correct valuation can vary widely, depending upon the two parties that are involved. Schoenbeck said that a buy-sell agreement between two existing partners can be priced at a higher level than one where the two parties involved have not been connected in any way. And the “friendly” buyouts tend to be based more on the revenue generated by the business than other factors such as earnings before interest and taxes. (For more, see: FAs Should Factor Clients into Succession Plans.)

Other advisors also say that it is important to make sure that the source of funding is kept current. If the agreement is funded by a life or disability insurance policy, then the size of that policy needs to grow with the business. Failure to pay attention to this matter can create a big problem when the time comes for the buyout.

The Bottom Line

Financial advisors need to keep their own houses in order in the same manner as with their clients. Having a buy-sell agreement in place can effectively cement any succession plan with a fair price and ensure a seamless transition to the new owner. Advisors who neglect this issue run the risk of seeing their businesses collapse if they become unable to manage them. (For more, see: Tops Tips to Prep Your Advisory Practice for Sale.)