Whether you are thinking of retiring and passing on the reins to an internal successor, or selling to an external buyer, developing a suitable succession plan is essential to securing the future of your practice.
An internal successor can ensure the continued vision and culture of your practice, but finding the right future leader can be a challenge for small practices, which often lack the budget and management time to hire and mentor potential successors.
“To spend money on somebody and bring them through, and who can then have the money to buy the owner out and take over the client relationships is a tall order,” says Keith Underwood, managing director of practice advisory firm Foulger Underwood.
It can take years to groom a suitable second-in-command, so owners should start training the potential new heads – who are often recruited for their technical knowledge rather than commercial nous – in business development and management skills as soon as possible.
Start early
“Timing-wise you can’t start early enough,” is the advice from Paul Shrimpling, managing director of Remarkable Practice. According to Shrimpling, it is common that the incoming owner won’t have the same commercial edge as the founding partner. So, firms must be willing to compromise on hiring a technician in favour of candidates with good people skills, which Shrimpling said will “ultimately determine whether they are actually going to be a good second-in-command or not”.
Clients of small firms are traditionally very partner-loyal – not necessarily firm-loyal – so it is essential that they are compatible with the individual who is going to take over.
But typically, it is only the top 20% of high-value clients that generate 80% of fees and margin because they are buying multiple services, they trust the owner and are willing to pay more.
Clients will only build that trusting relationship over time. Shrimpling advises starting the process of introducing other people in your firm into the relationship with that client at least three years out from exit.
“If you have quarterly meetings with those clients, whoever you want to have a trusted relationship within your firm with that client is to be in eight meetings with them, minimum,” Shrimpling says. “It’s a three-stage process. They get to know you; they get to like you; they get to trust you.”
Ask the right questions
As regards financing, apart from establishing at the outset whether the potential new owner has sufficient free equity to make such a purchase – even, for example, on a deferred three-year basis – the big question is not usually asked when recruiting. There are situations where external funding can be arranged through banks with the facility guaranteed by the business or departing owner.
But Keith Underwood warns these arrangements “are becoming more difficult to negotiate and interest rates have recently been hiked for this type of funding”.
The willingness of a management buyout candidate will ultimately come from their ability to grow and sell the business, which could be complicated by repaying a loan.
Paul Shrimpling suggests that an outgoing owner could stump up the cash themselves and continue advising the buyer as consultant “to ensure that they get their pay away from their capital value and to reassure the incoming owner that they are going to be able to continue growing the firm”.
If goodwill is recognised as part of the deal, then retentions or profit share and salary need to be made to cover the goodwill value and to fund the working capital of the business, explains Underwood.
“These funds will go towards paying off the owner of the business and re-paying the capital account which is used to fund the trading. Such deals with the right person, where there is a good cultural fit and sufficient profitability, can be deferred over five or more years.”
Ultimately, owners need to work out if they have the time and resources to get a successor ready to take over. There are recruitment issues to deal with, training and development, and trust needs to be built among clients.
“Finding the right person, bringing them on so they can take over the business has a very high failure rate for practices of under £500,000,” Underwood says. His advice is not to worry about succession, but to run the practice and take it to market due to the ‘profitability loss’ associated with the cost of nurturing a business development specialist.
“The investment in that premium individual usually means you are making less money than you would be if you just sell it,” he concludes.
