June 27, 2018
The Wealth Management Firm Owner’s Dilemma?
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Are smaller wealth management firms becoming roach motels where you can get in but you can’t get out? Many owners of these firms have built a very successful regional firm offering truly personalized service and investment advice to individuals and smaller institutions, but they are now facing significant challenges:
One alternative for succession planning exists which many owners in our industry are beginning to consider and which can solve many of the concerns for an owner and employees. As one owner was looking at this alternative it seemed to present the following positives:
This solution is called the Employee Shareholder Ownership Plan. It was created by the government in 1974 in order to encourage ownership of US companies by employees. It has grown dramatically especially from 2000 to 2010. Currently, there are 5,429 ESOP companies and an additional 1306 companies who have adopted a KSOP with matching contributions in company stock. Together they cover some 13.9 million employees and $262 billion in employer securities. Of these, 92% are private companies and 57% have less than 100 employees. Further, 78% of the companies are in other than manufacturing businesses. As you can see this is not a little known or fringe “loophole” type of solution.
In simple terms how does it work? The Company’s owners determine to set up an ESOP. They hire a firm or individual conversant in this area. One such firm Menke & Associates has set up over 3,000 plans. With their help, the owner determines the plan structure using a questionnaire technique. It will deal with such things as vesting schedules, buyout arrangements, forfeitures etc. Many owners who have 401k plans have already dealt with most of these issues. If the owner is going to be selling shares to the ESOP then there is the need for an independent trustee and valuation firm. In all cases, there is the need for a planning committee. All of these are picked by the owner and can be replaced by the owner. Before proceeding many companies want to have an indicated value which can be determined by a valuation firm who will not be involved in the actual valuation for the sale by the owner. If the owner feels that the price is within an acceptable range then the Company moves forward and establishes the plan. A knowledgeable individual can meet with employees and explain the plan and its benefits to all employees. One added benefit of the ESOP is that you can create the plan and receive a deduction for the year it was created but don’t have to decide on how much you are going to contribute and whether you are going to sell shares to the Plan or just issue new shares until the Company files its tax return.
Eventually, some employees will leave before they are vested. Their shares are distributed to those remaining employees. Later in the life of the Plan when an employee retires most plans call for the Plan to repurchase the shares generally over a period of time, but some allow the former employee to continue to own the stock.
The above is not an exhaustive discussion of the ESOP, its benefits and how it functions but rather an overview of its benefits and what it takes to set it up and operate it.
As for out of pocket costs, it will probably cost in the neighborhood of $40,000- $50,000 to initially set it up with ongoing administrative, trustee and valuation fees in the range of $25,000-$30,000 per year. These can be paid by the plan or more generally the Company
I strongly believe that this solution is the key to allowing smaller wealth management firms to transition ownership to the next generation of “employee owners” and reward those who have built the business. In addition, this solution will allow these firms to continue to provide the individual service that has been so attractive to individual and smaller institutional clients and which is not available from large institutions today.
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