Back in the early 1990s and before joining Moss Adams, I started doing benchmark studies of financial planning practices sponsored by the International Association for Financial Planning (one of the predecessors to today’s FPA). These were the relatively early days of independent RIA firms and independent contractor reps affiliated with broker-dealers. Compared to today, most firms were tiny. Very few had over $100 million in assets under management (AUM), or multiple partners and staff. Much has changed.
In the recently released 2013 InvestmentNews/Moss Adams Advisor Compensation and Staffing Study sponsored by Pershing, we found the median participating firm is generating over $2 million in revenue with more than $200 million in AUM—the median! By comparison, the first of these studies that we did under the auspices of Moss Adams in 2002 showed the average participating firm generated $350,000 with $25 million in AUM.
The most notable number in our 2013 study comes from the 57 participating firms that have revenue over $5 million, the firms we now refer to as “super ensembles.” These particular firms average revenue of $11.8 million and AUM of $1.5 billion.
By Small Business Administration (SBA) standards, these are still regarded as small businesses. But as advisory firms, they clearly represent the direction and momentum that the independent advisor movement is enjoying. With size come benefits:
More opportunities to do business
More points of contact in the community
A process for recruitment, retention and development of people
For example, super ensembles have revenue per staff of $465,000 compared to $213,000 for solo practices, yet have only 33 clients per staff compared to 45 for solos. Super ensembles are generating $1.3 million of revenue per professional staff compared to $587,000 for solos. The average income per owner within a super ensemble is $769,000, compared to $348,000 for solo practitioners.
These are a lot of numbers to digest, but from a financial point of view it appears that bigger is indeed better. The question is whether being big contributed to the better ratios, or whether a focus on growing their firms in a disciplined way resulted in better numbers as well as bigger numbers. From our 25 years of observing the operating performance of financial advisory firms, we conclude that the answer involves a little of both.
Top performing advisory firms tend to do several things right.
First, they develop a clear proposition and a clear idea of who their optimal client is and build their business around these principles. What’s interesting in looking at the top firms is that they each have different strategies, different markets, different geographic locations and somewhat different offerings. The top firms are more effective at communicating which market they choose to serve, however, and articulating how their approach would benefit their clients. Rarely does their messaging focus on education or job history or years in the business, but rather on why what they do is in line with the expectations and desires of their optimal client.
Second, they create organizational structures that allow them to leverage work flow, technology and staff. When advisory firms delegate much of the work to non-partners, they increase the number of relationships the firm can serve and increase the overall productivity of its rainmakers and wisest advisors.
The impact on profitability is obvious. If you can accomplish the same work using a person being paid $120,000 versus a partner earning $240,000 in base compensation, your cost for delivering the solution goes way down. Super ensembles have a ratio of partner to non-partner compensation of 0.55, meaning that for every dollar of partner compensation, there are almost two dollars of non-partner compensation. Top performing firms spend 14% of their revenue on operations staff while other firms spend 18% on operations staff. This is the power of leverage.
Aside from the financial impact, we have observed that when a partner is responsible for reviewing the work and recommendations instead of performing all the details of the task, the quality of the advice tends to improve as well.
An improved organizational structure also allows firms to grow faster without as much strain as smaller firms who have to juggle many balls on any given day. This growth leads to a larger market presence, which begets even more growth. Size also makes a difference in attracting larger clients. On average, super ensembles generate $13,500 per client annually compared to a solo practitioner’s average revenue per client of $6,500.
The third characteristic that distinguishes the top performing firms is the premium price they pay to recruit premium talent. Compensation is not the only reason why larger firms are able to attract good talent, however. They also tend to provide challenging work, recognition, responsibility and opportunities for growth. In smaller practices, owners find it difficult to sustain these components of a successful working environment. At the same time, the top talent recruited by larger firms consists of skilled individuals who are more effective at attracting top clients—and so the rich get richer.
Fourth, the top performing firms actively manage to profitability. Not only do they tend to have lower overhead expense ratios (expenses ÷ revenue), but they tend to have better discipline around pricing, client acceptance and evening out work flow. Most of the larger firms can now afford to hire professional managers, so they usually have somebody dedicated to observing these metrics and managing the outcome.
Philip Palaveev, my former Moss Adams colleague and a collaborator of this year’s compensation and staffing study, coined the term “ensemble practice” when we worked together on these studies a decade ago. He also came up with the concept of the “super ensemble” as a way to distinguish the larger, more sophisticated advisory firms from the rest of the pack. He rightly observed that much of the success of super ensembles can be attributed to the quality of their client base. The average relationship in a super ensemble firm is over $2 million, compared to the average of $755,000 for solo firms that participated in this year’s study.
The implications for the independent advisor movement are becoming clear as data such as this continues to emerge. More and more firms are establishing larger footprints in their primary communities, and many are establishing branch offices elsewhere. More firms are actively recruiting talent not just from their competitors, but also fresh out of college. Firms can then mold these smart young adults to fit the firm’s culture and the way in which they do business.
There was a time when some pundits dismissed independent advisors as “failed brokers.” For many of these independent advisors, that moniker may actually be a badge of honor. These innovative, intelligent client advocates have demonstrated that they can build a business on their own that has equity and value and recurring income, instead of relying on an employer for a paycheck. Now that so many firms have moved successfully from the solo to ensemble model, watch for the next wave of super ensembles that, in fact, will be equal in size to many mid-sized broker-dealers.