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Practice Management > Building Your Business

The Solicitor’s Apprentice

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One of the top concerns for advisory firm owners is growing revenue. When the 2010 InvestmentNews/Moss Adams Financial Performance Study of Advisory Firms asked participants what they wanted to improve in their firm, the top response by a large margin was “marketing and business development.” Interestingly, the second highest priority for participants was “refine our strategic plan,” which in the mind of most advisors means developing a more distinctive identity and positioning in their markets.

Business development challenges have intensified in the last couple of years as advisors attempt to replenish assets and clients lost in the market cataclysm. Building the firm has become a pressing issue for lead advisors who often lack the time or interest to further expand their personal book of clients, but want to see their overall business grow. These issues reflect a pressing need for most firms to get to scale by attracting more of the right clients who will pay appropriate fees for the value delivered.

Advisors deploy a number of standard tactics to generate new business:

  1. Wait for the phone to ring.
  2. Systematically harvest referrals from existing clients and centers of influence.
  3. Train their staff to build centers of influence and develop consultative sales skills.
  4. Employ a marketing specialist to generate leads for the advisors.
  5. Seek referrals from their custodian, or in the case of brand name brokerage firms, leverage the firm’s advertising and presence.
  6. Engage a professional solicitor.

Advisory firms that rely mostly on external sources for new business risk a dangerous dynamic that could imperil profitability and control. Referral programs, for example, can be a good source of additional clients—the cream on the top, if you will—but rarely provide a solid foundation for sustained growth; they depend on the whims of the branch office providing the leads, and make the firm vulnerable to an entity or individual not accountable to the advisory firm. Additionally, the cost of procurement is very high, especially when valued over the lifetime of a client relationship. Further, by depending on another company to generate most of an advisor’s new business, the firm lives in the shadow of someone else’s brand, losing the opportunity to build its own identity. That may be worthwhile when an advisor is just getting his footing, but becomes a big negative when attempting to grow more independently or, ultimately, trying to sell the firm.

The same can be said of solicitation agreements wherein the advisor pays an independent contractor to steer business to them in return for contingent payment. As one source of business, both approaches work—but neither should be relied upon as the biggest pipeline of new opportunities.

New rules are pending from FINRA, and later from the SEC, that will govern solicitation agreements, especially for ERISA-type business. But for now the rules governing payment to an outside solicitor are clear. Less clear are the long-term economic consequences for advisory firms that attempt to grow via this route.

The Deal in Context
Unfortunately, very little data exists on payment structures to solicitors generating new business. While some are paid just for the leads, most receive payment based on the actual business produced. The payout ranges are all over the park, whether in the form of a basis point charge from the custodian for providing the lead, or a percentage payment to the solicitor. It’s helpful to put the payout schemes into context within an advisory firm’s economic reality.

The financial statement for an advisor’s business should look something like this:       

Revenue 100%
Direct Expense 40%
Gross Profit 60%
Overhead 35%
Operating Profit 25%

All payments for actual sales must come out of Direct Expense, which is another term for Cost of Goods Sold, meaning that it is a cost directly related to the generation of revenue. It is expressed as a percentage of revenue. A good target is 40% because it is the higher end of the range of most wirehouse payouts. An employee-based brokerage payout model provides a good framework for determining solicitor payout, though remember that a brokerage firm usually assumes that not only will their broker make the sale, but that they will manage the relationship. In a solicitor arrangement, the business developer acts more like a mercenary and is not committed to the long-term relationship or to delivering advice and implementing strategies.

There are two primary components of Direct Expense—the sale and the service (or advice). So in this example, if you pay 40% for the sale, you will have nothing left over for the advice. If you pay 40% for the sale, 40% for the advice and another 35% for all other expenses, you will lose money. Keeping tabs on gross profit margin and the cost of doing business is key.

Over time, or on average, the sale component of Direct Expense should represent about 15% and the service/advice component should represent 25%, thereby equaling 40%. An advisor may choose to have a higher Direct Expense, but the impact of this decision on profitability is obvious. That said, a gross profit margin below 50% for an independent advisory firm is unhealthy because it reduces the amount left over to cover overhead expenses and produce an operating profit.

It is also important that the advisor limit the term of payment for the sale because eventually the client will bond with the advisor, not the salesperson thereby making the advisor responsible for retention of the revenue; and because the cost of procuring the client will be too much. In addition, a salesperson with a large pot of annuity income often loses incentive to hunt for more opportunity.

Recognizing that one has to pay enough to get the solicitor’s attention, some firms offer a high payout for the initial (first year’s) revenue, say at 25%, then either decrease it gradually over time (20% to 15% to 10% to 5%) or go immediately from 25% to 5% in the second year. The only circumstance where it makes sense to maintain a higher payout for several years occurs when the salesperson remains engaged with the client over that time in an effort to get more assets. This would be especially true in institutional-type relationships such as retirement plans and foundations.

A solicitor payment structure may also include a bonus payment or sweetener should the salesperson hit certain milestones. It is not a positive or sustainable strategy for the advisory firm when a solicitor brings in occasional business, or worse, accidental business. For example, referrals provided from a referral network as an act of last resort because they were going to lose the client anyway will not add to the value of the firm.

As with any joint venture agreement, both parties should have a clear understanding of what they must do to make the relationship work. First, set specific expectations for the solicitor as to the number of prospects they will show the firm, and the amount of revenue that qualifies as a successful relationship. Second, make sure that someone from each side is accountable for actively managing the relationship. Third, monitor the short and long term profitability of such an arrangement to determine if it enhances income, long-term growth and value.