Book succession battle ends up in tax court

About 10 years ago, part of my job included acting as a consultant for advisors looking to acquire or transfer books of business. Two cases stick out in my mind.

In the first, the advisor had a succession blueprint in place a decade before he planned to leave. But two costly and time-consuming mentorships failed. The exasperated advisor was on the cusp of retirement, ready to jump at almost any expression of interest.

In the other case, the advisor was considering selling, but wasn’t convinced it was better than maintaining licensing and a minimal staff. So, she went on vacation to think about it. But she died during the trip, and by the time the estate could address the matter, her book had plummeted to a fraction of its previous value. Between these two predicaments lies the as-yet-unresolved case of investment advisor Allen Eisen’s estate.

Frustrated succession plan

Allen Eisen joined Union Securities in 2009 through an employment contract that included a transition payment for bringing clients over from his previous employer. The contract had a provision stating, “All accounts opened by you will be owned by you and may be sold within the company at the time of your choosing, subject to current policies and procedures.”

A supplementary letter a month later allowed Eisen to employ his son as his assistant. The son was in the process of obtaining required licensing, with the apparent intention of following in his father’s footsteps and eventually taking over the practice. Allen Eisen died in early 2010.

Pursuant to its regulatory obligations Union appointed another advisor to supervise the book. The son remained employed as assistant, and Union committed to him taking over the book after obtaining appropriate qualification. But he didn’t follow through and left the company a few months later.

The supervising advisor also left the firm, taking at least one of those legacy clients with him. Union itself was sold to a new firm.

The Eisen estate filed a lawsuit against Union and the succeeding advisor for the property value of the book.

Motion for dismissal dismissed

The defendants took the position that an estate could not be licensed. Therefore, Union had to be the owner after the advisor’s death to comply with its regulatory oversight obligations. They conceded that, while alive, Eisen had control over the accounts.

A generic Union employment policy document found among Eisen’s personal papers stated that all accounts of a deceased advisor belong to Union.

It was not clear how Union applied this policy, or if it had been incorporated into the Eisen –Union relationship. But it emboldened the defendants’ claim to sole ownership without requirement for compensation, unfair though it may appear.

The estate countered that the specific employment contract terms in the 2009 letters superseded the generic policy. It also argued the defendants’ reliance on the generic policy was contradictory: the policy asserts Union as sole owner of the accounts at all times, but the 2009 letters establish Eisen’s lifetime right to sell, which the defendants had acknowledged.

On a defendant motion for summary judgment brought in February 2013, the judge found that “[a]s a matter of legal logic, neither side has a legal argument that trumps the other.”

On the one hand, the defendants are right that an estate cannot be licensed. On the other hand, the plaintiff estate is correct that trading authority is distinct from property rights and that there is something nonsensical about these rights evaporating on death.

The judge ruled full discoveries and a trial would be required to obtain evidence sufficient to dispose of the issues. Notably, it cost the defendants about $15,000 for the failed motion. Whether or not litigation progresses to full trial will be determined by the opposing parties.

Selling your book

You want to sell. But can a buyer pay what your book’s worth?

The downturn’s made it harder for business owners to access credit, as evinced by a 2011 report by the Canadian Financial Executives Research Foundation.

And securing credit isn’t necessarily any easier just because you’re in the financial sector.

If a bank lacks financing programs geared specifically to advisory practices, you’ll be put into the same queue as any other company seeking succession financing, notes chartered business valuator Sondra Stewart.

“Banks are going to expect the buyer to come in with some cash,” she says. “They’re only willing to lend a percentage of what they think the business is worth.”

What’s more, loans are based on expected future cash flow — and not on standard industry multiples. Exiting advisors frequently accept down payments from their chosen successors, followed by installments, or a modified work-to-own arrangement that puts stock into the buyer’s hands.

But Stewart warns “as long as you’re waiting for a dollar back from the sale, you still have risk.” Until all the money changes hands, your buyer could fail to make payments — or even default.

So, even if you’re ready to exit, you may have to hold on until someone can scrape together enough to buy you out. And if you can’t, then you may be obliged to accept a lower price. How do you avoid this? Prepare early to make sure your book is attractive. You may plan to work another 10 to 15 years, but it’s never too soon to inventory what’s valuable about your practice.

Once you’ve done that, quantify how those things contribute to your annual cash flow and profitability. That makes your book more appealing to a buyer and, consequently, to a financier.

When sale time comes, avail yourself of government programs, regardless of the credit landscape. The Business Development Bank of Canada, for instance, exists to promote entrepreneurship. Let it help you, or your buyer, secure financing.

While the BDC’s loans cost more, it’s often willing to partner with you or your buyer’s bank to finance any shortfalls. It may also offer longer repayment terms and exclude a buyer’s personal property from the collateral requirements.

— Melissa Shin is managing editor of Advisor Group

Doug Carroll, JD, LLM (Tax), CFP, TEP, is vice president, tax and estate planning, Invesco Canada.