From the September 2008 issue of Investment Advisor • Subscribe!

The Bounty for Captain and Crew

Does ownership pay enough when rewards for employees are so high?

"Every time I see an article on compensation touting the great salaries and easy hours," one independent advisor wrote, "it gets tempting to cut my losses, clean up my r?(C)sum?(C), and jump over to one of these dream firms." In one terse e-mail, this advisor summed up the challenge of growing an advisory business in an environment of increasing costs and compliance risks, ever-more demanding clients, and escalating payout to staff. His dilemma: whether to invest in his own practice or find another advisory firm that will pay him to focus on his passion for giving advice while relieving him of the risk and responsibility of running the enterprise.

In the aftermath of the great emigration to independence, a community of lost and addled small business owners are washing up on our shores. For many, their dream of independence did not include the headaches of entrepreneurship or the financial and emotional challenges of developing others. The ideal of business ownership certainly did not include so many lean years scratching and scraping for dollars while employees at other firms seem to be raking them in.

Advisors who have never experienced being an "employee" in a large financial services company often cobble together an enterprise that works in spite of their lack of business foundation. For refugees from national brand organizations, the experience of having to hire and fire people, cover expenses out of their own pockets, and tend to myriad business issues while still adding and serving clients can be a total shock.

In either case, those early years of trying to get the practice off the ground can be exasperating--especially when one observes the growth of the more established advisory firms in the community. It's hard not to envy a business with a community brand that attracts the right clients, has professional management that addresses their quotidian obligations with relative ease, and a structure that processes business and delivers advice on a consistent, systematic basis.

Don't Despair

Every practice goes through a life cycle. With the wisdom of hindsight, it is common for entrepreneurs to regret decisions made in the face of pressure. Just remember, those who are now operating some of the country's most impressive financial advisory firms had the same trials. Only a few of them claim they actually knew what they were doing. They retell their stories with a mix of brio and warning, often confessing that it was either fear of failing or a passion for building the business that kept them going.

Whatever the motivation, most advisors will reach a point in their practice's growth when they do not feel they are in control, or doubt their ability to reach the next level. When this happens, one must step back from the edge and ask some questions about which direction to take the business.

If the decision is to add capacity to the firm, who will manage these individuals? How will they be compensated--salaries, individual bonuses, team incentives?

Before hiring new staff, advisors must know what they are trying to build. Many advisors serve a combination of retirement plans, high-net-worth individuals, middle-class clients, and retirees. Each client requires a different approach in rendering advice, processing deposits and withdrawals, and presenting reports. Operating leverage makes a lot of sense for a growing business--but which business will you invest in?

The Drawbacks of Small

With the vast majority of advisors still operating as solo practitioners, it is clear that most have decided the questions are too complex to answer, too distasteful to address, or too hard to implement. So by default or intention, they keep the size of their practice within their reach--thus limiting income growth and taxing the firm's ability to support clients.

If the advisor takes on more clients without adding staff, the firm's business model has to change. Will it mean the elimination of certain steps in the planning process? Fewer meetings or phone calls with clients? A scaled-down version of the practice's offering? The decision to remain small is an acceptable choice, but it does have implications for the client service experience.

Advisors who wish to reduce the number of clients they serve in order to keep the practice manageable must also refine their business model. To make this change effectively, advisors should only retain their optimal clients, charging more for fewer relationships because of the depth and value they offer. This is often a harder adjustment to pull off, however, because of the difficulty in getting rid of clients who no longer fit this model.

Aside from what's comfortable for the advisor, client expectations also need to be considered. If a client is paying roughly the same fees as they would to a larger advisory firm with greater depth and capability, stronger support structure, and a higher assurance of business continuity, they are likely paying a premium to you in order to get your very personal touch. Is that in fact what they are getting?

Many in the business will argue that size does not affect quality, but in a practice where advisors are distracted, consumed, and overcommitted, it's hard to believe that personal focus, consistency, and the pursuit of excellence are not compromised. Unless, of course, advisors in small practices take steps to regain control of the way in which they manage and serve their clients.

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Making the Leap

This discussion brings us back to the opening comment. Should advisors who reach this crossroads just chuck the hassles and join another firm? People are saying that there's a talent shortage and good firms need experienced help--and according to the salary surveys, the remuneration for being an advisor in a larger firm is competitive if not greater than that for small firm owners.

The argument for jumping ship is pretty compelling. The business of financial advice is getting more complex. It's harder to recruit, retain and reward the right people on your own. Many advisors really don't have the time to spend on the business the way they should. So what holds them back?

Advisors who join or merge their practices into larger enterprises often chafe at their inability to make independent decisions about staffing, or where to spend company dollars, or resent the bureaucracy that comes naturally with a larger business. Culturally, it's a leap to go from being the big fish in a small pond to a minnow in an ocean. People's self esteem is often tied up in what they do and who they are as well as with whom they are affiliated. When the business defines you, it's difficult to sacrifice one's individual identity to a larger enterprise.

Many advisors cite a desire to ratchet up income and also free time to do the things that are personally rewarding. Generally, the income opportunities in a larger firm are greater in the short term, but the rate of growth in income is often slower because the parent needs to maintain control over compensation to create the leverage that comes with their operating models.

The ultimate reward, however, can still come in the form of ownership. If the advisor is any good, there is a high probability that the larger, more sophisticated advisory firms will provide an opportunity for equity based on achieving certain goals and making a specific impact.

In larger practices owners have a greater opportunity to generate a return for risk as well as a reward for labor. In smaller practices, it is hard to discern the difference and, on a relative basis, the dollars paid to the solo practitioners are usually lower.

So if it's about the money and the leverage, jumping to a larger practice (assuming it's well managed) will almost always be a better choice than trying to create the model on your own. But if you are guided by a desire to design and build something uniquely yours, a desire to have control, a desire to maintain a certain lifestyle, then clearly the winning argument is to remain alone. If this is the decision, however, advisors have an obligation to themselves and to their clients to ensure that their business model is operating at the right capacity, doing the right things for the right reasons.

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