From the November 2006 issue of Investment Advisor • Subscribe!

Operation Ownership

Why are established advisors reluctant to share ownership?

At a conference I attended a few years ago, one of the panelists in a "best practices" session proudly boasted that his successful practice had trained virtually all its competitors in his mid-sized city. Maybe it's a good line for bragging rights in the locker room, but I thought to myself: How much more successful would your firm be if all those advisors still worked for you?

I was reminded of that panelist when I attended the FPA's first NexGen Conference in August. While the program covered a wide variety of topics of great interest to young professionals, the buzz between sessions revolved around firm ownership. The attendees weren't talking about the kind of entrepreneurial ownership that comes from starting your own practice: Nearly 80% of the attendees were next-generation employees interested in buying into the existing firms where they had worked for several years. As I listened to their eager conversations, I wondered how many of them would be able to attain that goal.

One of the major failings of the independent advisory industry has been the reluctance of advisors with established practices to extend ownership to junior professionals who helped them attain their success. The profession has collectively realized, however, that even the best advisors have a finite capacity for the number of hours they can work and the number of clients they can handle. To grow beyond that, they need to add more staff to leverage themselves, and more professionals to handle more clients.

These firms have grown, most frequently by adding junior professionals. At first, things go smoothly--young planners are happy to be learning their profession, and owners benefit from offloading the rote work of creating portfolios and writing plans so they can focus on working with clients. Sometime later, usually after four to seven years, junior planners start to get a little restless. By this time, they're working with clients, typically along with the principal, and some have even brought in a client or two of their own. They see the firm growing, and the owner making more money, and can accurately assess their contribution to both. They start to wonder at that point, however, where their job is going: are they at a dead end, or will they become minority owners in the firm they're helping to grow?

Unfortunately, the answer for most junior planners has been somewhere between dead end and vague promises of ownership that never seem to become reality. So they're placed in the position of having to leave the firm if they want to grow professionally and financially. For most firms, it's a huge setback, whether the junior planners take any clients with them or simply take their years of training and experience across the street. Ironically, judging by the conversations at the conference, it's the last thing most young professionals want to do. But they feel forced to do so by the lack of any viable alternatives.

If this scenario described an isolated incident or two it would be a shame, but this scene plays out in hundreds of practices around the country every year. On such a scale, it's nearly a crisis. So why are advisors so reluctant to share ownership, even to the point of greatly stunting the growth of their firms and their own incomes?

The answers I hear to this question from both owners and employees are remarkably consistent. To gain a better understanding of the situation, let's explore the top five:

"They don't deserve it."

Many established advisors seem to feel that to "earn" ownership in an advisory practice, young planners need to face the same struggles they did: starting a firm from scratch, financing the early years with credit cards and second mortgages, slowly attracting clients one at time, struggling through market or economic downturns, and so forth.

This is more of an emotional response than a thoughtful, long-term strategy. It's only natural to view the practice you started and painstakingly built as, well, yours--and to cringe at giving up even a small piece of it. But in truth, the issue isn't really fairness, is it? After all, let's hope none of us gets what we really deserve.

Consider how many Microsoft employees have become mega-millionaires on the coattails of Bill Gates and Paul Allen dropping out of Harvard to spend years in virtual poverty convincing IBM and the world that DOS was the future. Are happy, financially successful employees merely an unfortunate side effect of your own success? Or are they one of the great benefits resulting from your entrepreneurial drive and determination?

"I can't afford it."

Many established advisors cringe at the thought of how sharing their ownership stake would affect their own compensation. It's hard to deny that, at least initially, giving up even a small piece of the pie will be felt in your pocketbook.

But remember that your junior partners will pay you for their ownership interest, at the current value of your practice. They're gambling a much larger portion of their income and net worth that, with their help, you will grow your firm substantially, giving them and you a very handsome return on the investment. With that kind of confidence from folks who probably know your professional abilities better than anyone, how can you respond with anything less than: "Let's roll!"?

"They can't afford it."

It's a far more prudent question to ask whether young professionals can afford to buy part of your practice at its fair value. Under the current, commonly accepted deal terms--two times annual fee revenues paid, 33% down, and the balance over four years--very few employees can.

Of course, you control the deal terms. Tax considerations require you to price ownership at the current market value, but spreading their obligation over as many as ten years can make a small stake in your firm reasonably affordable for many associates. Your employee will be paying today's practice value out of tomorrow's ownership distributions, which will increase as the firm grows. This gives your new partner tremendous incentive to maximize the growth of your firm: exactly the kind of agenda that help you take your firm well beyond the next level.

"They don't bring in new business."

This common lament of many owner advisors flatly demonstrates an ignorance of how young professionals benefit a practice. Here's how the economics work: Say a relatively successful solo advisor with 12 years of experience decides to hire a junior associate with a couple years' experience gained at another firm. The goal is to use the young professional's current skills to leverage the owner--allowing her to focus more of her time and energy on revenue-generating tasks, typically working with clients and prospective clients.

Relatively fresh out of school, young planners typically excel at writing financial plans, researching complex issues, and creating and monitoring investment portfolios--tasks that would otherwise consume as much as half a senior planner's workweek. Lacking experience, and often professional maturity, these associates typically haven't yet developed the people skills necessary to bring in clients of their own. Requiring that they take a crash course in rainmaking (on the owner's nickel) diverts their ability to leverage the owner-advisor, who is far better suited to grow the client roster. An advisory practice can attain the greatest growth and the highest revenues by allowing both junior and senior advisors to focus a maximum amount of time on the jobs at which they're best.

"I don't want partners."

This is by far the best reason for not offering ownership to associate professionals. In fact, I suspect that the majority of financial advisors would prefer not to share any ownership in their firms. They like the autonomy of running their own businesses, making their own decisions, controlling their work environment, and answering to no one but themselves and their clients. Not only is that more than okay, it's the reason many independent advisors became independent in the first place.

The problem comes when these advisors don't acknowledge their preference to retain sole ownership to themselves or communicate it to their junior advisors. Instead, under pressure from industry gurus and current wisdom, they announce honest intentions to add junior partners at some point in the future. But somehow they can never quite bring themselves to follow through. Understandably, this eventually leads to dissatisfied junior advisors, low morale throughout the firm, and eventually employee turnover.

A far better approach would be to build a business plan around your true definition of success. In my experience, there are a fair number of young professionals who don't want ownership in a practice, either because they don't want the financial risk or the commitment in terms of time and energy. Or you might create a business model around hiring highly motivated young planners and offering them three or four years of training and experience, with the understanding that they will eventually move on to ownership in another firm.

Either way, identifying the professional employees who will best help realize your vision for your firm will become much easier if you can clearly articulate what you're looking for, both in your job postings and in person during the interview process. Managing the ownership expectations of your junior professionals will create happier employees, a better work environment, and put you on track to create the practice that you really want.

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