From the March 2006 issue of Investment Advisor • Subscribe!

March 1, 2006

Glory Days

Financial planners need to decide whether they want stardom or the benefits of a growing firm

I've been working with one of my established clients to merge with a much newer firm. The goal is to create more than just two parallel practices--both partners want to share clients, overhead, and management decisions, and split profits evenly. Since both partners are reasonable, goal-oriented, and committed to making the new business work, most decisions have been easy: new office space, furnishings, additional staff, technology issues, and even working together on clients have all gone as smoothly as if they had been together for years. Yet in working out the structure of the new firm, there is one issue that's proving harder to get right, and it occurs to me that it's at the root of much of the planning profession's current struggle with career paths and integrating younger advisors into established practices.

My clients agreed that their compensation (in addition to their owners' return which will be split 50/50), would be based on the share of revenues they bring in: The more they make for the firm, the more they get to take home. At least that's the idea. In practice, of course, that simple formula is fraught with complications. For instance, how do you determine the relative values when both partners work with the same clients? What's the appropriate split when one partner brings in a client for the other partner to work with?

But the biggest challenge they face is that their plan is for the junior partner to eventually assume responsibility for "operations;" that is, to manage the people who do much of the client service work, leveraging the senior partner to bring in more business and focus his expertise on projects that generate higher revenues with larger clients. How do you determine the value of that leverage? How do you create a revenue-sharing structure to reflect that value?

This knotty problem of determining the relative value of leverage vs. revenues makes my clients a microcosm of the financial planning profession today. Studies show financial planning practices are growing at an unprecedented rate. Planners everywhere are realizing that if they leverage themselves, their lives will be better--shorter hours for more money--while their practices can offer more, higher-quality services to a larger number of clients. So more and more practices are not only adding support staff, but also younger professionals to do more of their clients' planning and investment work.

A New Model Needed

Advisors have yet to devise a model for valuing the contribution of professionals who don't, strictly speaking, generate revenue, but provide the leverage that enables a senior partner to bring much more money into the firm. This failure to fairly compensate these junior planners for their contribution to their firms' economic success leads to one of the industry's most counterproductive trends: hiring and training young planners for four or five years, only to lose them and some clients, as they move across the street and hang out their own shingle.

The more I consider this problem, the more it seems to stem from a misunderstanding over how advisory practices evolve as they grow larger and more successful. When most planners start their practices, they are the firm: they attract the clients, provide all client services, make all business decisions, and take all the financial risks of launching a new venture. They also have all the professional knowledge and expertise.

If not right away, then relatively quickly these advisors realize they'd have more time to work with clients and get new ones if they didn't have to answer phones, schedule appointments, or file client records. So they hire an assistant, and the process of leveraging begins. Soon other support tasks become time-consuming and more folks are added to take these jobs off the planners' desk.

During this leveraging process a curious thing happens. The advisor becomes more productive, spending almost all their time working with existing clients, or screening and getting started with new clients, and like magic, client rosters and revenues grow. But the advisor's relative value to the firm (that is, the percentage of those revenues generated solely from their own efforts) is decreasing. Not a lot: in the early years, maybe down to 80%. The advisor's portion represents more money than at the start, but it's a smaller piece of a bigger pie. But the practice is no longer a one- or two-person show--it's a team effort that is more successful than an advisor could be by herself.

With the addition of more staff, the advisor's contribution continues to shrink. Still the star player, but on a bigger team. As the firm grows, with more and wealthier clients with more complex needs, the advisor herself has more and more work that only she can do. Even working longer hours with fewer days off, there's only so much one advisor can do.

This is what's currently referred to as "The Wall" in management-guru speak. It means that no amount of additional staff will make the advisor, and therefore the firm, more productive. The advisor is maxed out, and the practice is stagnating.

This is a watershed moment in the life of a financial planning practice. The advisor has to make a choice: Stay small, and take steps to maximize efficiency; or add professional help. The studies, and my experience, tell us that more planners than ever are opting for door Number Two, and adding younger professionals to further leverage the founding advisor.

Juiced, Sort Of

The good news is that adding professional leverage, if handled properly, is like a shot of anabolic steroids to a planning practice. At its core, financial planning is a labor-intensive business. Screening new clients, writing initial financial plans, meeting with clients, solving client problems, and creating, monitoring, and updating client portfolios all take the work of a professional that can't really be applied to more than one client at a time. But having more professionals means that more of this work can be taken off the desk of the senior advisor.

In fact, as the junior advisors gain experience, training, and maturity, eventually they can assume all of the duties of the senior planner. Somewhere along that curve, the senior partner finds she is working less, having more fun, and making more money than she thought possible.

There, as the bard said, is the rub. Remember the notion of relative value to the firm? Well, as soon as that young advisor walks in the door, the relative value of the senior advisor goes down, way down. From the start, that junior planner can do many of the things the senior planner is doing. Being fresh out of school, they can do some things--writing financial plans, screening mutual funds--better. What's more, after some training by the founder, they'll be able to do it all.

The addition of a junior planner, or planners, frees up senior planners to bring in and work with more clients, and generate more revenues. It also means that the founder can lay claim to sole responsibility for a much smaller portion of those growing revenues. As time goes on, and those revenues grow, that portion shrinks.

Yours may still be the name on the door, but if the majority of client work is being done by other professionals, your compensation and equity structure had better reflect that reality. An inequity in compensation will not be lost on your junior planners. The failure to address it most likely will result in what we see over and over again: young planners getting frustrated, leaving with some of the clients, and the senior planner left to start the cycle of over-work and training professional help all over again.

What to Do?

So what should you do? First, you need to accept the reality of how practices grow. Think of it this way: In the early days, the entrepreneurial drive and professional expertise of the founder is the key to a successful firm. But ironically, as the firm grows and prospers, and the founder reaps the benefits of growing support, keeping the clients becomes more important to the business. Which means the advisors who work with more clients become more important.

Many advisors are not comfortable with this decreased role, no matter how much more money they make. Entrepreneurs often value control above all else, and there's nothing wrong with that. The important thing is to recognize what's important to you. I think we consultants often do a disservice to many advisors by implying the best or only path to a successful practice is to grow bigger. That's not the case at all--solo shops can and do run very profitably and deliver high-quality client services, while offering a very comfortable lifestyle to advisors.

But if you opt to grow you firm and add other planners, you need to understand the implications. As the careers of those young advisors progress, your value will continue to decline to the point where you're just one of a number of advisors, maybe even not the most productive in the firm.

Denying this reality leads many planners to refuse to change their compensation and equity formulas to reflect the economic reality. Others try to maintain their position by underutilizing young professionals, giving them clerical tasks or menial tasks, and refusing to part with work the younger planners could do as well or better, or training them to do more. The result is inefficiency and frustration at best, and financial disaster at worst.

If you can live with less stardom in return for a better firm and a better life, then you need to create a structure that helps to increase the contributions by younger planners and reflects their growing value. Formulas based on revenues are doomed to failure, especially in firms where principals can claim to generate most of the revenues. A true profit-sharing program is better, putting everyone's interests in line with the interests of the firm. Draws against profits can be based on the level and volume of work each advisor does. But it has to be fair, and it has to be clear; so that everyone understands what they need to do to move to the next level or stay on their current level. The bottom line is that everything--including compensation--has to be about the firm, not about the senior partner. If you're not comfortable with that, stay solo--and be happy.

Angela Herbers is a virtual business manager and consultant for independent financial planning firms. She can be reached at angieherbers@cox.net>.

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