Often, Smaller Can Be Better

Like many financial planners, I’ve had reservations about the current conventional wisdom that practices need to get bigger to survive and prosper. It seems like every practice management guru is talking about the myriad economies of scale and efficiencies to be gained by adding partners, junior professionals, and staff. Yet most of the advisors I work with or talk to have a real antipathy to making a “business” out of delivering financial advice. Not that they’re averse to making money or owning successful practices–it’s just that they’d rather spend their time serving their clients than thinking about “building” a business. So when they hear calls for them to increase profit margins, add young professionals to leverage themselves, or even just to grow their firms, they have a tendency to tune out–or get very defensive.

After spending some time poring over the 2005 FPA Compensation and Staffing Study, I’ve come to realize the ‘gurus’ do have a valuable message for financial planners, but the message isn’t getting to the majority of planning practice owners who desperately need it. In particular, smaller practices and their owners want to understand how to make their firms more efficient and profitable without losing control. Yet this seems contradictory to what industry research is telling them. Consequently, they have no clue how to apply what they read and this wisdom thus becomes useless to them. What’s more, when they consistently hear the message that “bigger is better,” these “loser” smaller firm owners feel inadequate and close their minds to the valuable messages written between the lines that could really help them.

I believe the real value of the FPA Studies is to show an advisor how to make decisions as an owner of a planning business without losing control, regardless of the firm’s size. This will help them become more efficient (while improving the level of client service), be more profitable (reducing the need to worry about finances) and proactively manage the firm’s development (otherwise known as growth).

Does size matter? Sure, it has advantages, but it’s not impossible to reap large-firm benefits from better managing small firms. The key is simply doing the things the gurus recommend, but on a smaller scale, and without making big-time mistakes.

Bigger firms have a greater ability to do bigger things at a higher level, have more options, and can take greater risks with their resources (i.e., money) than smaller firms. There is a significant amount of knowledge to be gained from watching these larger firms go through this trial and error process as they get bigger. This is the kernel of the wisdom contained in the FPA Studies: It can help small firms grow into viable, more efficient and profitable businesses, too. If used correctly, this knowledge will result in smaller firms continuing to dominate the independent advisory industry, despite predictions to the contrary.

I’ve yet to work with or talk to one financial planner who says, “I want to build a large firm and be one of those top 50 firms that Mark Hurley predicts will evolve.” The vast majority of planners reach a point where they are not only content but proud of what they built, happily taking home their low- to mid-six-figure paycheck. They no longer worry about marketing, finding the next client, and putting the next meal on the table for their family. Once they reach this point, they have a sufficiently organized firm to provide high-quality client service. They certainly don’t worry about their profit margins, operating expenses, and client profitability ratios–whatever they are. They have control of their income and their practices. They have enough. They are experiencing pure joy.

Pure joy is the last of three common stages I believe every owner goes through over and over again during the business lifecycle. Pure joy is when you reach a milestone that many times you thought to be impossible. It’s when a firm is at its best. What happens to planners is the same thing that happens to any other well-structured business: They reach the joyful stage, and clients recognize their joy in what they do and confidence in how they’re doing it. That helps to attract more clients. Without any specific effort, they start to grow.

This growth, ironically, drops them back to the first stage of the ownership lifecycle, which is excitement. They get excited about the new opportunities for growth, about helping more people, and about the possibility of more income. As a result, they take on more clients, add more assets, and generate more revenues, without much proactive thought to how they are going to manage or reorganize their firms to accommodate the increased workload. Consequently, they reach disillusionment, the second and most painful stage in the cycle.

Avoiding Disillusionment

Disillusionment is a well-documented trend in the financial planning industry and has been quantified, using other words, in the FPA Studies. It is when you’re working harder for less money because you’ve reactively added additional operating expenses and overhead to manage your own success. Disillusionment is painful because not only are you drowning in your own success, but you’re also unhappy, overworked, and facing burnout. The 2004 FPA Financial Performance Study of Financial Advisory Practices quantifies disillusionment the best, calling it the “$1 Million Barrier.”

Conventional wisdom holds that to overcome the disillusionment stage, advisors should prevent their own growth or try to grow their way out of the problems. To help you better understand what disillusionment is, the 2004 Study coined the “$1 Million Barrier” term and showed that as a firm increases in size, its gross profit margin actually goes down until it generates over $1 million in annual revenues. At that point, firms reach economies of scale and start moving back into nearly optimal ranges for the overhead expense ratio.