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Practice Management

Small-business owners are very appealing potential clients for many planning firms, which can provide services the companies cannot provide for themselves.

This Practice Management article is intended for financial advisors only (registered representatives of broker dealers or associated persons of Registered Investment Advisors).

Sometimes a planner needs a spook.

In February, one the business-owner clients of wealth management firm Rehmann Financial was about to sign on to a joint venture with a company in the Australian capital of Canberra. The Australian firm sounded well established, and the management team talked a great game.

But then Rehman, based in Lansing, Michigan, which manages wealth for thousands of small business owners, put its investigative department on the case. One of the firm's principals, a former special agent in counterterrorism with the FBI, sent "boots on the ground" in Australia to vet the firm's claims. By the time they reported back to Rehmann, the deal was dead.

"We don't know who you thought you were dealing with, but this is who they are," the former agent, Bill Kowalski, recalls telling Rehmann's clients, handing over photographs and documents.

"They were not as profitable as they said," Kowalski explains. "One of the directors was fired from a previous job for fraud. Rather than being an elaborate 200- to 300-person corporation, it was a storefront."

For firms like Rehmann, effective planning for one of the most lucrative subsets of clients—entrepreneurs—can verge onto territory located far, far off the map covered by the CFP exam. And the planners who are best at serving this group say doing it well requires that planners take a few tips from the world of sports.

"Our whole focus is bringing a team of experts to the table to assist clients," says Rehmann planner Joe Heider. Having an in-house investigative arm provides an invaluable service for many clients, he notes. But every firm, including Rehmann, must tap outside specialists to wrangle with the diverse needs of business owners, he adds: "We want to work well with them rather than have everyone seeking to protect their turf."

"Without that quarterback relationship, without somebody who is touching each advisor, the total planning starts to get compartmentalized," says Derek Holman, co-founder of EP Wealth Advisors in Torrance, California. "Sometimes our job isn't to have all the answers. It's to circulate the ideas that are flowing."

Appealing Clients
Small-business owners are very appealing potential clients for many planning firms. Entrepreneurs often have a habit of building one business, selling it, and then moving on to the next—building wealth through a series of what planners call "equity events." (Others will only start and sell a single company, making that deal critical for them and for their planners.)

And there are plenty of entrepreneurs out there: 11.5 million in 2011, representing 6.3% of U.S. adults, according to the Kauffman Index of Entrepreneurial Activity. In 2011 (according to the most recent data available), the index found that Americans were starting approximately 543,000 new companies nationwide every month.

Yet it usually takes years before small-business owners can build up enough wealth to make use of planners. For that reason, many advisors only work with entrepreneurs once their first business is mature and successful—or has been sold.

But not Bethesda, Maryland, planner Jeff Leventhal: He made a decision when he started his career not to focus on wealthy older clients but to find young business owners whom he thought would be both more interesting clients and a better long-term bet.

"For a period of time, they weren't saving anything," recalls Leventhal, of HighTower Advisors. "Now, they are generating free cash flow, and we [can begin] to build a portfolio. We help them get that under control and manage that."

When working with small-business owners, many advisors say one of the biggest challenges is to help get assets out of the business and into retirement accounts. (By some estimates, roughly 80% of typical small-business owners' net worth is tied up in their companies.) Of course, that can be a strategic move for advisors looking to build assets under management, but it's also good for the entrepreneur's personal future and for that of his company.

As an example, Leventhal mentions one of his clients who, after years spent building up his own retirement accounts, had decided to sell his entertainment business. Initially, a buyer offered $3 million, Leventhal says.

Leventhal pulled together a team to assess the offer. He worked with the client's longtime accountant, an estate attorney, and outside experts to value the company—and found that the offer was far below a fair price. Eventually, Leventhal and his client coaxed the offer up to $5 million with no "earn out"—that is, a commitment to working with the business for a set amount of time to earn the remainder of the purchase price.

Key to sealing the better deal, Leventhal says, was a psychological advantage: Because he had already helped the client build up a retirement fund, the client knew he could afford to wait out a negotiation rather than taking the first offer.

"I think the best thing an advisor can do is to help their clients understand that every dollar doesn't [have to] go back into the business," Leventhal says. "If you do that right, then there's even less pressure later when it's time to sell the business, because they have that nest egg."

Financial Planning asked specialized planners around the country about the art and science of working with small-business clients. We then culled their smartest suggestions.

1. Build the Team
Every small-business owner will need a CPA, an estate planning attorney, a business attorney, and experts in life, property, and casualty insurance. When starting work with a new client, Holman says he gets to know the existing team before assembling a broader one. "We contact both their accountant and attorney right away and introduce ourselves," Holman says. "Most of the time, the CPA and attorney have never spoken with each other, nor have they spoken with the investment manager."

After getting the conversation under way, make sure you have the right expertise on board. "You don't want an insurance agent who sells State Farm" or other generalists, Heider says, nor do you want a family law attorney. "If the wealth management advisor is serving as the quarterback, it's incumbent on him to make sure that the team members have appropriate backgrounds and expertise to be on the team."

Teams may require some or all of the following subject matter experts: an accountant, a bookkeeper, an actuary, a trust officer, a geriatric care manager, a divorce specialist, or mediator—and even a psychologist.

2. Befriend Bankers
A planner also should have good relationships with two kinds of bankers: a local bank that can extend lines of credit, and often an investment banker to help launch an initial public offering or find acquisition targets, buyers, investors, or merger partners.

Small to midsize companies won't be served by the likes of Goldman Sachs, which require multimillion-dollar fees, so find smaller, reputable banks. "The investment banking firms I work with don't do a ton of deals a year, maybe five deals or 20 deals on the high end," says Tepper, the planner. "If I can provide them with two of my clients a year who are looking to sell their business, they are thrilled."

Tepper also writes free financial plans for the clients of these bankers, thus priming the referral pump. "One of the fears of the investment banker is, 'I don't want to put all this work [into a deal] when it's a $5 million offer and the client says, 'Well, I need $10 million to retire on time.'" A financial plan, delivered early in the negotiation process, can help ensure no one wastes their time, Tepper says.

3. For the Good of the Team
Running a team that plays well means managing egos, so get yours out of it. Sometimes you may even have to stand down if a client's attorney or accountant will serve as the best team leader, then invest your energy in being an effective team member, not engaging in power clashes.

"We believe you have to let go a bit," Holman says. "In general, we try to be on the calls with the different advisors and be engaged in the process. We want to let the other advisors know what [everyone is] doing, but we don't want to get in the way."

4. Stay Client-Focused
There's one risk to this approach: A well-oiled team can work too well for its own good, steamrolling right past the client's own wishes. Heider offers a recent example: a CEO who had no debt and plenty of savings, and continued to draw a good income. The team agreed she should keep her investments in equities, he points out, but she seemed more comfortable with her savings in very conservative fixed-income investments, like bonds and CDs. "I know this is a terrible investment," Heider recalls the client telling him.

In response, he told her that he'd noticed that the market swings were bringing her nothing but agitation. "She said, 'You are right. That's exactly how I feel, and no one understands.'"

5. Respect Older Relationships
A client's longtime advisors can sometimes pose problems. While you don't want to alienate them, they may no longer be able to serve a client's best interests. "That's always a dilemma," Heider says. "In many cases, that business owner has outgrown their CPA, they've outgrown their property and casualty advisor. Those are difficult conversations to have."

Many planners work to keep a client's longtime advisors on the team, but it's not always possible.

"I had a client a few years ago who was going to hire us to do one piece of his overall plan, and I didn't fundamentally agree with his other advisors," Heider recalls. "I said, 'You either get rid of them or I'm not coming in.' He didn't choose to work with us. I think that's the toughest part of this business."

But it would have been worse, Heider says now, trying to work under those circumstances.

In another case, one of Heider's clients owned a single corporation that ran multiple lines of businesses. To protect them from the possibility of a disaster in just one unit, she needed to break them up into different corporations, he says. Very quickly, Heider says, it became apparent that her long-time local attorney couldn't handle the work of splitting up the firm. At least, Heider says, he was spared from making the call: "When this happened, she told me, 'I'll talk to him.'"

6. Find an Investigator
Some clients may think that hiring an investigator is overkill. Perhaps this story would convince them otherwise: A few years back, one of Rehmann Financial's business-owner clients decided not to invest $2,500 for an in-depth background check on a CEO candidate he wanted to hire.

It turned out to be a bad decision, because a couple of years later the client called back and said, "I'm missing some money." It turned out the executive had created a fictitious vendor and filed fraudulent invoices to pay himself about $75,000, Kowalski says. "It's not an uncommon scheme."

If the client had done the pre-employment investigation, he would have discovered similar problems at the executive's previous job, Kowalski adds. "I wonder why every wealth management firm doesn't have an investigative division."

Firms that don't have one of their own can help clients retain outside investigators. Rehmann's intelligence arm also helps its clients' companies recover from hacking attacks, teaches children of wealthy clients how to safely using social media sites, runs background checks on domestic help and investigates potential arsons, among other services.

7. Become a Gatekeeper
Leventhal's practice vets every business and investment pitch that comes the way of his clients. "What happens when you become this successful entrepreneur is that every cousin and relative calls and says, 'I've got this great idea,'" Leventhal says. "But nine times out of 10 there is a reason why they shouldn't be doing this."

Leventhal's unique service removes this burden from his clients' shoulders. "We have an actual process to determine what makes sense and what doesn't make sense," he says.

8. Know the Big Picture
Working with the right number and mix of experts will help a client set big-picture goals for the long term. "I don't want to sound trite," Heider says, "but first and foremost you must earn and keep [clients'] trust as an advisor. To do that, you need the big picture of where it is they want to go. "I think it's critical to have an advisor who is looking down the road and helping them by bringing in the right talent and working as a team," he adds, "because time goes by really quickly."

Valuing Your Client's Business: Eight Key Questions to Ask
By some estimates, roughly 80% of small-business owners' net worth is tied up in their companies. Yet, according to experts, most entrepreneurs have not taken the time to formally value their companies.

"The value is the amount your business would be worth if you were to sell it to a third party," says Mark Tepper, president of Strategic Wealth Partners in Seven Hills, Ohio. Tepper, who specializes in working with small-business owners, has devised a multistep process for doing back-of-the-envelope valuations for his clients.

"We put the valuations together as part of our wealth management package," he says.

Given that certified valuations cost between $5,000 and $20,000, Tepper says many of his clients prefer to use his process at first before making the larger investment. Although he warns that his line of questioning offers only a rough number, he says it can still give clients a preliminary way of thinking about the value. "These are not certified valuations," he cautions. "You can't take these to IRS court and challenge a gift-tax or estate-tax ruling. But we can turn [them] into a certified valuation in roughly a week's time" if necessary, he says.

To estimate value, Tepper applies a multiple to a firm's EBITDA. He subscribes to two databases—Bizcomps and Pratt's Stats—that provide ranges of multiples for recent comparable sales. Then he gives clients a 15-question online survey, and gives the company a "sellability score" that helps him determine which end of the range to use, he says.

"If they score between 80% and 100%, they will typically fetch an above-average multiple," he says. "If they score between 50% and 80%, they will fetch an average multiple. If they score below 50%, they will get a below-aver-age multiple or their business is not sellable."

These are some of the questions Tepper asks:

  • Can the business stand on its own two feet and operate independently of the owner? "A good litmus test is if you don't have the ability to take a month-long vacation from the business, and shut down e-mail and phone communication for that month, then the business is not independent of you," according to Tepper. "No acquiring buyer is interested in buying a job. They want to buy an investment."

  • Does the company have a stable and motivated management team? "Those are really the biggest assets in an acquisition," Tepper says. "We want to make sure [the management team] will stick around post-sale." To ensure this happens, he says, owners should have some sort of non-qualified deferred compensation in place: Valuable team members "should want to continue working so that their account will vest every single year," he explains.

  • Are there operating systems in place that can improve the sustainability of cash flows? To make sure a company is a well-oiled machine, Tepper says, there should be a how-to manual, so that when somebody acquires the venture, they don't have to learn everything from scratch. "This also helps to protects you when employees leave," he says, "even if it's just a receptionist."

  • Is there a diversified customer base? "You don't want to generate 70% of your revenues from one big company," he says, "because if they leave, you are out of business."

  • Are there recurring revenues? "The greater percentage of your revenues that are recurring, the greater the multiple that you will attract" when selling the firm, Tepper says. Recurring revenues "would be something like a cell phone contract," he says, "not like buying toothpaste. You want sales on a subscription or contractual basis. The acquiring owner would expect those revenues to continue."

  • Are the financial statements easy to understand? Buyers want to make sure your client is not running a lot of lifestyle expenses—such as nonessential cars, vacations or country club memberships—through the business. Those would make the company's tax profile look better than it is in reality, Tepper says.

  • Is the appearance of the facility consistent with the asking price? There can't be broken windows or unkempt grounds at a $10 million asking price, Tepper says.

  • Is the cash flow not only good, but improving? A buyer wants to know he is getting an asset that promises to increase in value.

Ann Marsh is a senior editor and the West Coast bureau chief of Financial Planning.



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