As for the second group, key staff members who have their own books, this can be a bit more treacherous, but often has much greater upside. This group is the most likely to form your G‐2 contingent. It almost doesn’t matter whether the producer/advisor works for you directly as an employee, works under your roof as a contractor, or is a new or prospective recruit;
onboarding an individual with his or her own book into an ownership slot in your growing business is a challenging but potentially lucrative maneuver.
Understand that bringing this group into the owners’ circle will take a higher level of skill than the previous group and requires a better understanding of how the structural elements in your business work together to make it possible, and advantageous for both sides.
Advisors in this class are a proven commodity, at least in one respect.
They can generate revenue. That does not and should not automatically qualify them for ownership, but it is a major consideration. The bigger ques- tions that naturally follow are: Do they want to sacrifi ce the control they enjoy over their workdays and income stream in exchange for a minority ownership position, some signifi cant debt, and the opportunity to build on top of your business? Can they do anything more than produce revenue?
Are they a good fi t with the rest of the team? Those can be tough questions to answer, but they are impossible to answer if you don’t have a plan for
what you’re trying to build and that clearly illustrates the benefi ts for all involved.
We see three common scenarios when onboarding advisor/producers with their own books into an equity position:
1. The book is small enough and the employer/employee relationship strong enough to make the issue irrelevant.
2. The book is large enough and valuable enough that G‐1 buys it with an exchange of ownership or very advantageous fi nancing.
3. The book is large enough and the advisor capable enough that he or she walks across the street and hangs out his or her own shingle, or legiti- mately threatens to rather than build on top of your business (“The Case of the Super Producer” is covered in the following section).
If you helped G‐2 get started with knowledge and/or a contribu- tion of your smaller clients, and if you don’t wait too long, and if the value and cash fl ow from the book is not too great (typically not more than about $150,000 in gross revenue, or GDC), it often isn’t diffi cult to onboard this talent level into an ownership position. Assuming that your plan provides the basic elements of seller fi nancing at discounted levels and a profi t‐based note (at least in the fi rst tranche), you have an excellent chance of making this level of advisor an equity partner.
Granted, that is a pretty good list of “ifs,” but it is far better to try to build a collaborative, long‐term relationship than watch yet another advisor/producer grow stronger and become your competitor. Develop a plan and give it a try, and don’t offer too many concessions; all in all, the opportunity is a good one for the next‐generation advisor and he or she is in the business of taking advantage of good investments. Show the advisor your plan for the future and where they fi t in. Remember, equity is a powerful draw, and you’ll see that in the pro forma models for your long-term plan—so will G‐2.
In short order, here’s how it tends to work. The onboarding process starts with an evaluation period—with due diligence being performed in both directions. Remember the general timeframes from earlier—extend an ownership opportunity to G‐2 in years 3 through 5 of full-time employment.
For G‐3, the partnership track should be extended a bit, probably around four to six years of full-time employment before a partnership buy‐in opportunity is extended. Don’t keep your plans a secret—in fact, share your plans from the fi rst interview on, and then see how it goes.
When the time comes to seriously consider an ownership opportunity, start by having your business and the advisor/producer’s practice formally valued (but only if their book is larger than about $150,000 in gross revenue
or GDC), and then have two copies of the valuation results made and certifi ed;
share one complete copy with the other side (be sure to sign a nondisclosure agreement beforehand, and use a common valuation methodology). Share a copy of your comprehensive succession plan with your onboarding prospect and explain what you’re thinking, where the prospect fi ts in, and what’s in this for both of you.
If interest remains strong and it is a good match after additional thought and exploration, you’ll need to physically bring the two models together to operate side by side and under the same roof (if they aren’t already). This is not a merger or a marriage, just two owners moving in together to see if a permanent union is warranted and wise. This might sound quaint or old‐fashioned, but this is a big step, and creating a permanent equity part- ner out of a satellite offi ce with someone you only talk to over the phone is often impractical and unworkable, at least if your goal is to build one strong enduring business.
If it works out, the owner of the book, the prospective G‐2 producer/
advisor, will sign a contribution agreement and contribute all right, title, and interest in the book to your business. Your business, in exchange, can use its treasury stock (authorized but unissued shares) to purchase the book, often using the respective values of the business and the book to determine the correct ownership ratio, or at least to form the starting point for the negotiations. On this point, G‐1 often argues that G‐2 has no infrastructure and no “real business,” and that somehow that mitigates or even eliminates any value to the G‐2 book. That is a good argument, but it almost always loses. The simple retort is that G‐2 won’t do that deal and sacrifi ce autonomy and control over his or her cash fl ow for an at‐will employment situation and a minority ownership position and a formal debt obligation, and why would they?
The bigger issue is taxes. If you are set up or taxed as an S corpora- tion, the owner of the book of business who exchanges what that advisor/
producer has built for an ownership position in your business is taxed on the fair market value of the stock received just as if he or she had sold the book and been paid for it (from the IRS’s perspective, that is exactly what happens). That’s a nonstarter for G‐2 unless the transaction also includes a signifi cant cash payment, which tends to make it a nonstarter for G‐1 as well. The more common solution for this problem goes back to the element of long‐term, friendly fi nancing and the ability to buy in on a discounted basis with profi t distributions largely derived from the future growth of the business; the after‐tax effects are mitigated by time and cash fl ow mechanisms.
In other words, a smaller book serves more as the “ticket onto your ship” than an immediate windfall and automatic and full equity position.
The process might sound complicated, but we’ve seen it done hundreds and hundreds of times—it works, if you know what you’re doing. The equity position will be immediate, but the equity is usually bought and paid for on an installment basis over time using future growth and profi t distributions to make the payments and sometimes the process will need to be augmented with stock grants. Experience dictates that most G‐2’s/G‐3’s will take this deal and run.
The S corporation entity structure is rigid and infl exible which correlates to a rather predictable result given the limited but straight‐forward options available. That can be a very good thing. The LLC model, in contrast, at least when taxed as a partnership can offer some distinct tax advantages and fl exibility when faced with these issues, so if onboarding talent is a pos- sibility, the LLC structure is probably the better entity choice. Regardless, the problem is solvable if both sides see the advantages of working together and want to solve the problem. Taxes are always a high hurdle, but almost never an impenetrable wall.