Advisors we talk to say that for the most part, business is good, yet many express concern that they are not growing fast enough with the right clients. To remedy this situation, advisors may choose to create financial incentives for referrals among centers of influence or to rely on custodians to create business leads. In either case, there is a cost: not just in money, but in firm culture and identity.
When you abdicate control of your brand to others you have stopped building a self-sustaining business. You have also diminished the need for others inside your firm to learn how to build proper relationships with the marketplace. These personal relationships are the lifeblood of all service companies. Business growth under a referral scenario becomes a mere financial transaction. Your firm becomes a product manufacturing enterprise that sells investment advice, financial planning or wealth management via a distribution channel.
In spite of my righteous indignation on this topic, advisory firms commonly form strategic alliances with other professionals such as accountants, insurance agents and lawyers. It is commonplace for money to change hands in return for the opportunity to serve each other's clients. This approach may work, but only with clear expectations, measurable terms and aligned goals for the client experience.
Every party to a strategic alliance should understand that the relationship is meant to be short term. Either it works extraordinarily well and the parties create a more formal business structure, or it works poorly and the relationship dissolves. I have rarely seen anything between these two extremes result in long-term success. Even for the short term, each party should agree to certain conditions and answer certain questions:
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What is the value of the referral to the advisor?
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What should be paid to the source of the referral?
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What are the profitability implications for the receiving advisor?
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Should the referral source have performance expectations?
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Should the arrangement be disclosed to the prospect or client?
Let's begin with the economic implications of this strategy. A number of referral arrangements dictate a fee split of 50/50 between the source of referral and the recipient of the lead. More commonly, the advisor who gets the referral pays a higher amount in the first year and a lower amount in subsequent years. This could start in the 20%-25% range on the first year's revenues and drop down to 5%-10% of revenues in subsequent years. Some arrangements require that amount to be paid for the life of the relationship, but in the best situations for the advisor, the payment will be limited to a defined term, somewhere between two to seven years.
Two things to keep in mind: First, whatever you pay for the opportunity to do business with a particular client is the same as putting a value on a book of business. Second, over time, the client relationship transfers to the advisor. The referral source is no longer connected to the economic value once the advisor has built a strong and trusting relationship with the client.
To test a referral arrangement, apply the total referral payout over the projected life of the relationship times the revenue the advisory firm receives from the client. If the value is more than two times annual revenue, then you will have paid too much. (And frankly, for most advisory practices, two times revenue is too high.) Imagine that the client stays with you for 20 years — at a 50% payment to the source of referral, you would pay the equivalent of 10 times annual revenue to acquire that client. What has the referral source done to justify such a premium?
