If you’ve reached the stage of considering a transaction, you may well be contemplating the merits of looking for an external buyer or pushing for an internal sale. Each has its own benefits and drawbacks, and your decision will depend on your specific circumstances.
Most conversations with sellers reveal that they perceive an internal succession as the preferable option. However, partnering with an external buyer has numerous benefits when looking to elevate your firm to the next level.
Here’s a detailed look at the internal vs external succession debate and what each option might mean for your business.
Why Opt for Internal Succession?
The perceived advantages are pretty clear when potential sellers are weighing up an internal succession. So let’s unpack them a little to see if they hold up to scrutiny.
Maintain the Status Quo
The first and most obvious benefit is that, by selling internally, you’ll maintain the current status quo. Your junior advisors will already be well-versed in all of your business practices, and your clients will enjoy a relatively seamless transition with little to no disruption to their service.
Change and disruption are one of the biggest fears associated with being acquired, which is why you might initially prefer the idea of internal succession.
Sell to People You Know and Trust
As a business owner, it’s only natural that you’ll feel more comfortable selling to people you know and trust than to an outside third party. You will have worked with these people for years, maybe even decades, and you’ll have a good idea of their work ethic, capabilities, and business acumen.
When selling internally, you’ll be able to manage the transition to some extent, and you’ll have the peace of mind that comes with knowing your business is in good hands – as long as you believe your team has what it takes to run a successful wealth management practice.
While internal successions seem like they are more straightforward, there are a number of pitfalls and drawbacks that accompany that choice, rendering an external succession a more viable option in many cases. Let’s take a look at some of those now.
Why Choose an External Succession for Your Firm?
As mentioned, while internal successions seem less complicated on the surface, external successions often present a number of advantages, which may make them a better choice in the long run.
External Buyers Can Still Solve Your Equity Succession Problem
One of the biggest hangups you might have as someone exploring a sale is that you have, either officially or verbally, made equity or ownership promises to your junior advisors and/or key staff.
An internal sale may initially seem like the best way to solve this problem, but it’s essential to bear in mind that an external buyer takes over that responsibility when they agree to acquire or enter into a partnership with you. Remember, when a buyer acquires your business rather than removing that equity opportunity, the reality is that their opportunity horizons expand in terms of equity and career progression.
An external buyer naturally inherits your succession problem, so they need those juniors in a position to be ready to step up when the time comes. If they weren’t already in place, an external buyer would have to go out and find that personnel. So having these team members in place strengthens the value of your firm in their eyes and thus enhances your negotiating position.
Lastly, an external transaction is often the catalyst of getting equity out of your hands and into the hands of your junior advisors and key personnel. There are often several distribution options on the table, too, including earn-out agreements.
Internal Teams Don’t Always Have What it Takes to Be Business Owners
Another factor that you might not have taken into consideration is the ability of your junior counterparts to run your business. Young advisors can be excellent at servicing clients and generating new business, but they might not have the skills or temperament to be owners/operators.
When considering this question, you need to think about aspects such as strategic planning, investment in new technological infrastructure, and leadership skills. Do the advisors operating underneath you have the business acumen to take your company to the next level? For instance, are they able to take risks or manage the P&L? These are tough questions that need answering before moving forward with an internal sale.
It’s also crucial that you remain objective with the assessment of your junior team members. It can be hard to separate your personal relationship with someone from their ability to take on the role of business owner, but it’s crucial that you do. We often see internal successions result in the degradation of the business because the new owners simply aren’t up to the task, so this is a key consideration.
That’s not to say they aren’t fantastic advisors – but what experience do they have running a firm? Would an external, established firm be better positioned to take your practice to the next level and drive more organic growth? Are they more able to offer you the resources and centralized infrastructure to support that growth?
These are important aspects that you need to consider before deciding on whether or not to pursue an internal succession.
External Transactions Tend to Bring in Higher Valuations
Of course, when looking for a sale, the valuation of your firm is a crucial consideration. When it comes to valuations, external transactions tend to result in higher sale prices than internal ones.
One of the main reasons for this is that external buyers are often looking to buy into new geographical territories, expand existing footprints, or enter the wealth management sector for the first time (particularly those backed by private equity), so they’re willing to pay a premium for the right business.
The multiples associated with external acquisitions have continued to expand over the last decade and have outstripped the rate at which internal valuations have increased. Many of the financial limitations of internal teams simply don’t apply to external buyers, who often have much deeper pockets and a much greater ability to “write the check.”
This isn’t to say that internal successions can’t achieve high valuations, but you need to be realistic about the current market conditions and the expectations your junior team members hold. In many cases, an external sale is going to be the best option with regards to achieving the highest price for your firm.
The Verdict: Internal vs External Succession, Which is Best?
The truth is, when assessing your options for a sale of your firm, the answer to the internal vs external succession debate isn’t always clear-cut. Both options have pros and cons, and the best course of action will ultimately depend on your specific circumstances.
However, what is clear is that, should you be weighing up a potential transaction, don’t simply dismiss the option of an external sale. There are several compelling reasons (as outlined above) as to why it might be the best option for you, your team, and your clients.
Of course, the decision ultimately comes down to you, but if you’re primarily looking to achieve the highest possible valuation for your firm, an external transaction is definitely worth considering.
Does It Have to Be One or the Other?
In short, no, you don’t have to rigidly pursue one or the other. There are a myriad of deal options available, including blended approaches that can present you with the best of both worlds.
For example, it’s possible to sell a majority stake to an external buyer while retaining a minority interest for yourself and/or key members of your team. This can be a great way to balance an infusion of capital with the desire to retain some control and upside potential.
Another option is to sell a minority stake to an external buyer with the option to sell the remainder of the business at a later date. This can give you the capital you need to grow and invest in the business, including training and developing your junior team into successful future business owners while still giving you the potential to exit your practice entirely down the line.
Of course, there are a number of other options and variations on these themes, so it’s important to work with an experienced deal advisor to figure out what makes the most sense for you and your business.
Allen Darby is CEO of Alaris Acquisitions, a mergers and acquisitions consulting company for the wealth management industry. Contact him at allen.darby@alarisacquisitions or by telephone: 704-756-7160. Book time on Allen's calendar here.