The growth of financial advisory firms reveals distinct phases of firm development. We’ve observed that each stage has unique characteristics, challenges, and opportunities that must be addressed in order for firms to progress from one stage to the next. Firms change profoundly as they move through the evolutionary cycle. Over time this change affects the organizational structure, creating specialization and new positions.
We define the five stages of firm evolution as follows:
Early Solo: These firms have one owner/professional and are in their first 10 years of development. The focus of these practitioners is on growing their businesses. In many cases they are making staffing decisions for the first time. The typical early solo practitioner invested $144,707 in compensation for herself and her staff in 2006. This investment in human capital yielded the average early solo a return on labor (pre-tax profits divided by total compensation-related expenses, which includes base salaries, incentive pay, payroll taxes, and all benefits) of 73%, translating into pre-tax income per owner of $119,428. Income per owner increased nearly 20% from 2005 to 2006. Fifty percent of solos looking to add staff indicated they anticipate bringing in a partner and evolving into an ensemble structure.
Mature Solo: Mature solos have been in business for more than 10 years. A typical firm most often comprises an owner/advisor, one administrative assistant, and a client service administrator. The challenge for mature solos is to create an organizational structure that fully allows them to leverage their professional time. Some mature solo practices may yet recruit a second professional and evolve into ensembles, whereas others may choose to work on their own for the rest of their careers. These firms generated median revenue of about $403,979, a return on labor of 55%, and median income per owner of $223,283. Top-quartile mature solos in terms of income per owner have twice the number of total staff as all others.
Early Ensemble: Early ensemble firms have multiple professionals but gross less than $2 million in annual revenue. At this stage, firms typically add a second-tier advisor, effectively creating a career path, and many begin to add dedicated management staff as well as technical specialists With the addition of a second professional, who in many cases is a second owner, early ensembles are just beginning to formalize their organizational structure and approach to compensation. Their comparatively low return on labor of 31% relative to solos is overshadowed by their greater pre-tax income per owner. Owners of these firms took home a median of $236,100 each in 2006.
Mature Ensemble: Mature ensemble firms have multiple professionals and generate $2 million to $5 million in annual revenue. Having grown to this size, their challenge is to drive further growth by continuing to improve efficiency, creating better-defined career paths, and expanding ownership. Owners of these firms invest heavily in human capital, earning a return on labor of only 26%, but they typically reap the benefits in the form of $492,894 in pre-tax income per owner. The typical mature ensemble employs 14 full-time equivalent staff members, including dedicated management and technical specialists. High-profit mature ensembles are more apt to use incentive compensation plans, which likely contribute to the greater productivity of their staff relative to other mature ensemble firms.
Market Dominator: Market dominating firms are ensembles with greater than $5 million in annual revenue. They are sophisticated in management and service capabilities and deal with complex organizational structures, compensation processes, and recruiting and retention practices. Market dominators invest well in human capital, earning a slightly higher return on labor of 30%, yet a market dominator owner reaps the full benefit of greater scale in the form of $1,111,409 in median annual owner income. Income per owner is up 76% in just the last year. These firms are typically comprised of a team of 11 professionals supported by three technical specialists, in addition to three dedicated managers: an operations manager, a CFO, and a compliance officer. Market dominators are the only firm type in the five stages to consistently use incentive compensation plans.