From the April 2009 issue of Wealth Manager Web • Subscribe!

Don't Quit on Me Now

The higher you climb, the farther you fall. We went as a profession and an industry from the heights of income, valuation and prestige in 2007 to layoffs, financial losses, uncertain valuations and being compared to Bernie Madoff. The difficult decisions forced on us by the market and the emotional drain of seeing the devastating effect on clients is causing many advisors to consider quitting.

The reasons firms consider selling usually center on an advisor's inability to make difficult financial decisions or the lack of capital to withstand the crisis personally. Inevitably, though, exhaustion and fear combine to drive the decision. It's critical that we separate the emotional reasons from the financial.

If you're ever inclined to sell your firm (for solo practitioners) or your share of the firm (for those in ensemble firms), the very first questions should be why? What will you achieve by selling? The answer could be (a) to take cash out and retire; (b) to raise capital to withstand the crisis; (c) to change the expense structure of the firm; or (d) to soften the blow of difficult decisions that need to be made. All of those are legitimate reasons that apply to different situations, but in each case we have to make sure that the cure is not worse than the disease.

Reasons for selling

If the reason for selling is, "I will cash out and do other things," then the discussion should focus on the cash: How much and when? This applies particularly to advisors who are already close to retirement and who want to accelerate the process. They should determine whether the cash will be enough to retire on and whether it will be guaranteed or conditional on the performance of the firm after the sale. Experts from FPTransitions and Jet Wales, my former partner in Moss Adams, tell me there are still buyers out there and that valuations are holding up in terms of multiples. But they also say deals are contingent on a firm's performance in the next three to five years, with 10% to 30% of the price paid in cash up-front.

In such a sale, the biggest problem may not be whether the price is high enough, but continued exposure to the market. If the advisor's desire is to isolate his personal wealth from continued market decline, a sale contingent on performance won't ensure that. The advisor will still be exposed to the practice's results for the next three to five years. The down payment will reduce the exposure, but the sale won't eliminate it. As a result, selling a practice to escape exposure to the market works only for advisors who are financially ready to retire and who can get comfortable with the contingencies.

Another reason many firms look into a sale is the need for working capital or a reduction in expenses--or both. The first question in these cases should be, "What can they do that we can't?" If the answer is that the merger or acquisition partner will provide scale, resources and capital, then there is a significant potential for a good deal. But if the partner will either manage the firm or cut expenses that you don't have the heart to cut, then I would argue otherwise.

First, every advisor should have enough money to meet immediate personal expenses. Before giving up on the equity of the practice, an advisor should ask whether the practice can continue to produce the required minimum for a year or more. If the practice can do so even under conservative scenarios, then it's probably better to wait before considering a sale or merger--even if the advisor is concerned about long-term
equity valuations.

For most wealth management firms, neither overhead expenses nor professional compensation--including the owners'--should exceed 40% of total revenue. This means that a firm should be able to have normal profitability of 20% after owner compensation. Thus, a 20% decline in revenue should not yet threaten owner compensation. Various expense cuts should normally provide another 10% cushion for revenue drops. The real pain starts when revenue falls by more than 30%, and owner compensation becomes at risk. Then it's time to consider a merger, sale or drastic restructuring of the firm.

A merger with another practice can be a viable way to reduce expenses or find working capital. But financial factors should be a catalyst for a merger, not the driving force behind the decision. A merely mechanical financial combination can provide some short-term benefits, but eventually always presents challenges and a high potential for failure of the union once the money is gone.

A good merger is driven by a tangible, strategic benefit that derives from joining forces, usually some form of specialization of skills or access to an important resource such as an investment management department. A good merger also requires a match of cultures and to some degree, personalities, and last but not least, mutual respect--personal and professional.

Avoiding tough decisions

Many firms are considering selling or abandoning independence because the owners want someone else to make emotionally fraught decisions to cut spending. This is particularly true when it comes to letting go of longtime staff. But delaying the decision doesn't make it easier, and delegating the task to someone else won't change the outcome.

In the end, an acquirer will buy a practice for its cash flow, the source of which can be either the bottom line or, potentially, the top line. This means the acquirer will either have to make the same painful spending cuts in order to achieve the bottom line or will have to generate additional revenues from the top line. If you're resisting the bottom-line cuts, you may be jumping from the frying pan into the fire by choosing an acquirer who will increase fees or in some other way hurt clients. Usually, the right solution is for the advisor to take charge and make the painful decisions.

The price of independence

It's shocking to me that some independent firms are even considering joining a wirehouse, taking the recruiting bonus and working on a payout. But I shouldn't be so surprised. Joining a wirehouse makes sense in that it provides the advisor with some cash for personal financial needs and offers an environment to practice free of operational and bottom-line risks. The reason I'm surprised is that giving up independence is not just a financial decision; it's usually more of a philosophical decision.

A recruiting bonus of 120% of revenue can solve a lot of financial problems. It may even be a good substitute for the equity of the practice, and a good spreadsheet can analyze the merits of equity versus bonuses with a great deal of detail. However, no spreadsheet can analyze the effect of having a "manager" whose job is to "manage" you. Going back to a full-service firm is a lot like moving back in with your parents--it's something of a capitulation.

We are wealth managers. We've invested our education, careers, efforts and talents to become wealth managers, and most of us have also invested our passion and our ambition into this profession. We're also business owners. There's no way we can minimize our exposure to the investment industry and the risks of owning a business unless we abandon our entire investment in this career and this business.

The decision to sell the firm or change the model of practice is a very personal one; it's driven by a combination of emotional and financial factors. I can't argue with the emotional reasons, but the financial ones are another matter. They say that Ph.Ds never start businesses because, if you really analyze owning a business, it makes no sense. I'm no Ph.D, but I would say that if you already have a business, it makes no sense to ever leave it.

Philip Palaveev ( is president of Fusion Advisor Network.

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