Measuring Up

An analysis of partner profitability (see Table 4) could help decide whether another partner would be beneficial to the practice. This may be the case if the number of clients per partner is far above the average, but the revenues or profits per partner are below average. In that situation, the heavy client load may be hampering service to individual clients as well as marketing efforts.

Reviewing employee productivity (Table 5) can also be informative. By looking at clients per employee, assets per employee, revenues per employee, and profits per employee, a practice can determine whether its staff is meeting average productivity standards. It will also have a reasonably sound estimate of the potential added value from expanding staff.

Although financial results are perhaps the most widely used benchmarks, advisors can benefit from comparing any area of their practices to others. Those seeking to enhance their marketing strategy may want information about methods that are highly effective for other practices. Some who strive to improve their use of technology may want to know specifically what software and systems are used by the most successful practices, while an advisor considering a change in custodian may want to compare the popularity of prospective vendors.

Some Useful Perspectives

Based on Tiburon’s analysis of the financial advisor database–particularly on comparisons of advisors with larger and smaller asset bases–we offer these perspectives on some unexpected and somewhat counterintuitive findings:

o Leveraging people does not increase assets. Contrary to popular opinion, larger advisors generally do not work their staffs harder or achieve any higher level of productivity than smaller ones. Larger advisors, however, do hire more employees, and that appears to be one of their successful strategies for increasing assets under management. According to Tiburon data, advisors with more than $500 million in assets average 8.4 employees, compared with an average of 4.1 for all advisors.

o More clients are not necessarily better. Tiburon has found that top advisors may actually have fewer clients per employee or fewer clients per partner, but their clients have substantially more assets, which equates to more assets per partner and more assets per employee. This is a more profitable scenario.

o A lower return on assets can equal greater profits. Larger advisors may tend to have a lower return on assets, that is, a lower average fee. This relates directly to the fact that they typically serve larger clients, and hence offer discounted fees. It is critical to look beyond this to recognize that 40 basis points on $10 million are still better than 100 basis points on $200,000.

o Larger advisors also tend to have lower profit margins. Whereas small firms might achieve a 60% profit margin, larger firms might have a 30% margin. Hiring more people and attracting larger clients, though key to building a larger practice, can also increase expenses and drive down margins. More successful advisors have learned that such investments in the practice can ultimately increase absolute profits.

No “Ideal” Results

There are no ideal or target ratios for advisors. The statistics from these analyses are only averages, and they vary significantly based on the type of practice, the objectives of the partners, and the size of the business. In our opinion, the most effective use of this information is to compare results to the average or to the data for a specific category of advisor, and then ascertain why the results differ.

We caution against misinterpreting the results of a comparison and offer one example. Tiburon has found that the average return on assets or average fee is 74 basis points. If a firm’s average fee is 100 basis points, it may mistakenly conclude that it is overcharging and its fees are not competitive. However, if the practice also takes into account average client size compared to the benchmark, it may find that its fee correlates correctly with the average size of its clients. The way to lower the average fee is not to charge small clients less, but to attract more large ones.

The Value of Benchmarking in Succession Planning

For many fee-only advisors–whose average age is 45–concerns about succession planning have yet to reach a priority level. However, this will change in the next decade as the average age of fee-only advisors rises. Advisors older than the average may need to establish a succession plan and begin positioning the practice to maximize the capital it will generate. In addition, advisors still years away from retirement should question whether they are following their own advice to clients. If the practice is their most significant asset, they may want to consider selling part of it to reduce non-diversification risk and improve liquidity.

Benchmarking is a valuable tool in succession planning, given that one of the greatest challenges of any succession plan is valuing the business. Acquirers of fee-only advisory practices have begun using a basic approximation for valuing a practice, generally estimating that the average advisory practice is worth 6 to 8 times current cash flow.

Benchmarking has two meaningful benefits in succession planning: It provides insight into how to make the practice more profitable and more valuable to potential buyers, and it arms the advisor with the information to negotiate a higher price for the practice. Knowledge gained from comparing the practice to a benchmark can show the buyer that the firm is worth more than the average practice. The advisor will be able to demonstrate that the practice has a higher average fee, a higher profit margin, more profitable clients, bigger clients, or whatever conclusions the benchmark analysis has revealed.

Most advisors have limited options for exiting their practice. Buyers typically fall into two categories: systematic and situational. Systematic buyers seek to buy multiple advisory firms. Of these, financial buyers generally aim to take their aggregated practices public, while strategic buyers such as banks or CPA firms seek to add investment advisory capabilities to their existing services. Financial buyers and hybrid buyers, who are partly financial and partly strategic, have not had much success and are not realistic options in today’s environment. Strategic buyers, on the other hand, are eager to be in the profitable business of investments and have a track record of buying medium to large advisory firms.

Situational buyers, including competitors, partners, and employees, are a much more feasible solution for most advisory practices. These buyers may be in a position to acquire one practice, but are not in the business of acquiring multiple practices and rolling them up into a larger firm. There are several caveats for seeking a situational buyer:

o Competitors may feign interest in the practice to obtain proprietary information about its clients and financial situation.

o Employees may have difficulty raising the capital to finance the purchase.

o Larger advisors might pursue a strategic sale to a CPA firm or a bank that would have the structure and necessary capital to complete the purchase. For advisors who intend to sell to a partner or employee, the key is to begin the process well in advance. To groom junior partners who would maintain the practice indefinitely probably requires five years of planning, compared to a strategic sale which could be completed in as little as six months.

The Final Steps

Probably the greatest value in benchmarking is the dialogue it inspires. A benchmarking tool is as useful for the questions it raises as for those it answers. Here are some suggestions for maximizing the impact of benchmarking tools such as www.FABestPractices.com:

o Complete the benchmarking survey, print the research report, and schedule a series of meetings with your staff to compare the results to the financial advisor universe. Establish targets for areas that could be improved and brainstorm strategies for reaching those objectives.

o Organize a discussion group with five to ten advisors in your area. Have each one complete the benchmarking tool and then meet to discuss the results and share ideas for enhancing your individual business models.

These strategies are aimed at accomplishing the same goal–taking a harder look at how to manage the practice. Incorporating benchmarking into management can help ensure that the practice provides the greatest possible return on the capital and time invested in it.

Chip Roame is managing principal of Tiburon Strategic Advisors in Tiburon, California, and Kenneth Tollmann is an executive director of Morgan Stanley Investment Management in New York. Roame can be reached at [email protected]; a free summary of Tiburon Advisors’ benchmarking report is available at www.fabestpractices.com. Tollmann can be reached at [email protected].