Traditionally, financial planning is a lonely profession. Perhaps that's why we get relatively high attendance at industry gatherings. Today, sole practitioners represent well over 70% of all financial advisors and will probably always be the majority of advisors. Yet, while data on this is hard to come by, my experience tells me that the percentage of solo advisors has fallen in recent years, and I suspect this trend will continue well into the future. In fact, the advisory industry will probably end up closely mirroring the more mature accounting profession, where the majority of practitioners continue to remain solo, but with Pareto's 80/20 rule solidly in effect: 80% of the revenues are generated by 20% (or fewer) of the practices.
In the advisory business, this is a long-term trend that has only been accelerated by the relatively recent downturn in the financial markets. In the 2002 FPA Staffing and Compensation Survey, for instance, we found that from 1999 to 2001, the average revenue of participating firms increased from $682,000 to $729,000. What's more, average assets under management rose from $37 million to $48.5 million and the average gross profit margin increased from 52.8% to 53.7%. However, during that same period the average practice's operating profit fell some 30%, from $97,000 to $70,000.
What's going on? The underlying cause is simple, and inescapable: economics. It's becoming harder and harder to make a living as a financial advisor--particularly a financial advisor who is going it alone. In a world where overhead, client satisfaction, quality control, time compression, margin compression, transition options, and retaining trained staff are becoming increasingly important, the inherent efficiencies of ensemble firms become increasingly attractive.
Now I'm not suggesting that creating an ensemble firm is for everyone. Every advisor has to find his or her own solution. But the question every advisor must ask and answer is whether the pleasure of remaining solo is worth the pain, or whether building and growing a business (as opposed to a book of business), providing greater service to more clients, and making more money in less time with less stress would be more fulfilling.
Either answer is right, but how you answer is completely dependent on your personal definition of success.
Why Fly Solo?
Remaining a solo practitioner offers many advantages, some of which are the reasons most folks became financial advisors in the first place. Freedom is high on most advisors' priority lists, as in the freedom to practice the way you want, service your clients as they require, work with whom you choose, where you choose, and the hours you choose, without answering to anyone (except your spouse, and there's really no getting around that). In short, most advisors I know very much enjoy being "the boss." But the solo model by its nature leads to certain problems, including:
o Limited access to skill sets. You can't be an expert in everything, especially the myriad disciplines necessary in providing comprehensive financial advice. Unfortunately, the vast majority of solo practices can't afford to hire people who know much about anything, let alone experts. That usually means the services they can offer are limited to their own expertise and the referrals to other professionals that they can provide.
o Limited leverage. Again, since you can't afford to hire high-level talent, most of the tasks that require a professional level of skill will have to be done by you. That means your "job" has become what's known in the management consulting business as "labor-intensive." Thus, your level of service, and your income, is directly and solely related to your time, energy, and abilities.
o A cap on growth. Since you only have so much time and so much energy, the number of clients your firm can service effectively is finite, and relatively small. This is the trap that many advisors have fallen into recently: if you try to grow your way out of shrinking profits, you only make the problem worse, and make yourself crazy in the process.
o An inability to spread operating costs over more revenues. Ironically, many of the fixed costs (such as staff, rent, and technology) that deplete much of your limited financial resources really offer more than your limited services require. But since you can't hire half a receptionist, buy half a network software program, or half a phone system, you end up paying for excess capacity that you will never fully utilize.
o Limited time to maintain a high level of service to clients while adding new ones. If your resources are stretched to the limit serving the small number of clients that you now have, where are you going to find the time to recruit new clients, let alone service them?
If you don't care about these things, then stay the way you are. If you do, then I challenge you to take another look at your operating model.
The Benefits of Togetherness
The economic advantages of ensemble firms are hard to ignore. In the 2002 FPA Survey we also found that when compared to solo firms, ensemble firms showed more revenues per professional ($500,000 vs. $420,000), more revenues per staff ($192,000 vs. $175,000), more than twice the revenues per client ($5,700 vs. $2,600), and double the pre-tax income per owner ($762,000 vs. $385,000).
As compelling as these numbers are, what they don't show you is that in addition to more income (in most cases, a lot more), owners in ensemble firms also work with wealthier clients, offer them broader services, work fewer hours, and enjoy a more pleasant working environment, surrounded by and supported by other professionals. Ensemble firms also have far greater resources to confront current challenges in our industry such as evolving the service model to a team approach, supporting pricing based on the value of the service delivered, creating professional career paths for younger professionals, merging or consolidating with other firms, hiring professional management, and making the bottom line at least one of the firm's priorities.
As I said, an ensemble firm isn't for everyone. But if the advantages of working with other professionals seem to be a good fit with your personal definition of success, here are some things you should consider as you go about building your firm:
o Don't forget your core strategy. You cannot build a successful business unless you know what your strategy is. First ask yourself, who do you want to serve, and why? This will suggest what products and services you should offer, and consequently, dictate both how your practice structure will look and what type of talent you need to add.
o Don't chase volume to cover overhead. One of the traps that growing firms typically fall into is the panic to cover overhead by adding revenues from any source. Remember the old joke about losing money on every transaction but making it up on volume? This would be funny if it weren't so widespread in our industry. Generating more revenues is only better if they are higher-quality revenues, that is, revenues with a higher profit margin. Adding staff and professionals to handle business with falling margins is taking your business in the wrong direction, and can lead to disaster.
o Use job matching to hire and develop staff. Before you hire anyone, have clear descriptions of what that person will do, and where that business will come from. Growing your firm doesn't have to be like playing Russian Roulette. A carefully considered growth strategy combined with expansion in small increments can mitigate most risks associated with getting bigger. Remember that intelligent growth is the key to success, not speed. Just as you tell your clients, you should set long-term goals and take regular, small steps toward meeting those goals.
o Treat staff like investments, not expenses. If you're building an ensemble practice, the success of your business depends on the people you bring in. This applies not only to the other professionals you associate with, but also to the support staff that will enable you to leverage those professionals and attain higher margins. Investing in your staff means not only competitive compensation, but time and resources to train them and enable them to keep growing professionally. A good rule of thumb is that total salary should equal what each job is worth plus what each individual contributes to the firm. Employees who top out in contribution top out in compensation. Folks whose contribution continues to grow can continue to earn more. And that growth is the responsibility of the employee--and the employer.
o Monitor and measure operating performance. Nothing focuses job performance like clearly defined goals and observable measures of progress toward them. Rather than setting a menacing tone, performance monitoring can be helpful and rewarding to an employee. We all like to know how we're doing and that what we do matters to someone else. Performance measurements can also help identify areas where an employee could use some help, or reveal the need for a new direction for that employee. A large part of growing any firm is showing your people where to go and helping them to get there.
Unlike my friend Mark Hurley, I'm not attempting to make a case for an ensemble practice because of competitive forces, although that could be a legitimate reason in some markets. In my view, this is more about what kind of practice you want to have, your personal economics, and the kind of client service you want to deliver. And, of course, operating pressures are not getting any easier.