The newly-created Schwab IMPACT award for best-managed advisory firm, its Best in Business designation, was not given to an advisory firm in the usual sense but to a CPA firm–Plante Moran Financial Advisors, which is owned by a regional accounting firm with a huge footprint in Michigan, its toes in Illinois and Ohio.
Plante Moran has a staff of more than 110 people in its wealth management group and oversees more than $5 billion in assets. This makes it one of the leading independent RIAs in the U.S. and certainly the largest advisory firm associated with CPAs.
Plante Moran is clearly the best of breed in a growing population of CPA-affiliated financial advisory businesses. According to the 2006 Moss Adams Financial Performance Study of Advisory Firms, CPA affiliates also tend to be better managed. The gross profit margins of CPA-affiliated firms exceed the industry average by 5%, and their operating profit is on average 8% greater. (In the spirit of full disclosure, Moss Adams is also a CPA firm with an advisory firm subsidiary.)
As an industry-wide statistic, one of many survey results that impressed us was the sheer size of the participating firms: The average revenue was greater than $1 million. Firms owned by a CPA parent fared even better; they were almost three times larger than the average advisory firm!
The evidence of growth among CPA-affiliated firms was further validated by a 2005 research project Moss Adams conducted for BAM Advisor Services, a turnkey provider for CPAs out of St. Louis, Missouri. According to that study, BAM-affiliated accounting firms grew assets under management in the preceding year by more than 100% and revenue by more than 60% compared to the average growth rate in revenue for the industry of around 36% for the same period.
Of course, size alone is not the most important measure. So let’s consider the profitability margins. Particularly for growing advisory firms, it is a challenge to maintain profitability when the firm is making operating investments ahead of the growth curve. Again, the CPA-affiliated advisory practices shone with an operating profit margin of 26% compared to the average of 18%.
The Reasons Why
So why are CPA-affiliated advisory firms performing so much better than the advisory industry in general? There is a lot to be said for having a captive client base who, through liquidity events, accumulation of assets through businesses they own and tax planning, often seek out their accountant as their trusted advisor. Of course, not all accountants within a CPA firm support the notion of providing investment advice or even financial planning to their clients, but obviously, the firms in our survey have managed to overcome some of those cultural hurdles.
Another reason the CPA-affiliated advisory firms appear to be performing well as businesses is because of their natural orientation and understanding of business management, a skill set neither inherent nor developed by the advisory community in general. Clearly, the accountants managing advisory firms have the same DNA as their tax and audit brethren when it comes to pinching pennies, as one can tell by their overhead expense ratio, 38% of revenue (compared to the industry standard of 42%). It is extraordinarily difficult for advisory firms to manage their overhead costs in this environment because of compliance pressures, rising staff salaries, and other infrastructure costs that are going up faster than revenues, in most cases. The closer a firm gets to a 35% overhead expense ratio, the more it is operating at optimal efficiency.
In addition to overhead expense control, CPA-affiliated advisory firms really shine in how they manage to produce superior results at the gross margin line. As readers of this column know, we put a great deal of emphasis on managing gross profit margin, which is the measure of profitability that comes after a firm pays professional staff level salaries (Direct Expense). How one approaches the client service experience while keeping everybody aware of what affects profitability can make the difference between a top quartile and a bottom quartile business. In other words, it is not possible for advisory firms to manage to profitability by controlling costs alone. When the gross profit margin is rising over time or ahead of the benchmark, this is an indication of better client selection, a scaleable service offering, coherent pricing, and the productivity of their professional staff.
Productivity can be measured in a variety of ways, including revenue per staff, revenue per client, and clients per staff. In one comparison of CPA-affiliated firms to the average, we found that their revenue per professional staff and AUM to professional staff were both higher. Yet, on average, they also managed fewer clients. As these practices grow, they continue to add professional staff in order to have capacity to take on more clients. The difference is, they are effective in timing their hiring close to their need instead of having to carry new staff for a long period of time without seeing a return on investment.
A third reason why CPA firms appear to be outperforming their advisory firm peers is that they have access to technical capability in which they have already invested. Therefore, they are able to leverage expertise without additional cost. Most of the CPA firm participants have clearly adopted the “wealth management” model of full service that includes financial, estate, and tax planning; risk management; charitable strategies; and investment consulting.