Many financial advisors are thinking about the concept of critical mass — what it will take their firms to thrive in today’s changing marketplace. Until now, it was relatively easy to maintain a rewarding lifestyle without large investments in people and processes or a unique proposition to consumers.
Advisors could create personal wealth from current income and not worry about having to sell their practice to fund retirement. As a result, there was little need to divert personal capital into building an enduring, self-sustaining business.
The landscape is shifting rapidly, however. Brand-name retail firms are pushing their advisory solutions via aggressive marketing. Consolidators are receiving millions in capital to grow market share. Dominant regional firms are winning the talent wars, and large firms are negotiating more effectively with their vendors and service providers for better pricing and greater access to solutions.
Advisors within small practices are starting to worry about not being able to keep up with their competitors. This may be one reason why lifestyle practices rely on referral programs from their custodians to grow, while larger advisory businesses focus on creating their own brands independent of a pay-to-play platform for new business.
Advisor mortality presents another practical concern. When the advisor dies or retires from a lifestyle practice, so does the business.
In midsize practices, employees often depend on the founder to be the rainmaker, which means the business will struggle once the creator transitions out. This lack of depth in smaller firms creates a fiduciary concern: the absence of a succession or contingency plan somewhat violates the advisor’s responsibility to act in their clients’ best interests.
What to Do To avoid this scenario, small and midsize firms must choose an effective competitive strategy. Should they stay small and personal as a competitive advantage, leverage affiliation groups such as the XY Planning Network to access new technology and new ideas, invest to create size, brand presence and a deeper offering, or merge, buy or sell in order to become part of a larger platform?
The key factor in each strategy is the achievement of critical mass. What is critical mass? Scores of definitions dance around the periphery of the advisory business, but none brings the idea into the spotlight.
Businessdictionary.com defines critical mass as “revenue levels at which fundamental changes can occur in a firm and can make it largely self-sufficient in resources for continued viability, vitality and growth.”
Businesspundit.com says, “critical mass happens when a business or market gets big enough to undergo a fundamental change, usually resulting in a significant increase in profitability.” Investopedia states, “Critical mass is the point at which a growing company becomes self-sustaining, and no longer needs additional investment to remain economically viable. It is a crucial stage in the development of a growing company. It is the point at which the business becomes profitable enough to continue growing by itself and no longer requires investment from outsiders.”
The advisory business has never been balance-sheet heavy, so in the past there was limited demand for capital from outside investors. Principals in a firm would fund the business through deferred compensation or retained earnings over a matter of years, until they could begin reaping larger and larger distributions.
New World Now our industry is experiencing a transformation. Many firms are accelerating their growth with capital from outside investors.
This provides funding for acquisitions, new locations, investments in proprietary technology and branding. As I write this, roughly 30 firms are racing to become national brands in the fiduciary space, though some may aspire to become super regional firms or dominant in a unique segment of the market.
Ironically, many of these growing firms are acquiring small outposts in communities that are a great distance from each other and that follow no logical pattern for branding purposes. They are just people sitting in random locations, with different cultures, different types of clients, different ways in which they create business, different technology and workflow and different demographics.
This acquisition strategy makes the pursuit of critical mass even more difficult. Not only does the consolidator need to achieve a level of sustained growth and a consistent client experience at the firm level, they have to do the same for each location they now have.
For example, if a firm chooses to buy a practice with three partners in their 60s, eventually they will need to replace the advisors. Chances are the clients of that practice are older than the advisors, so the client base will have to be re-created.
Staff and technology likely will need training and upgrading as well. At the corporate level, each of these elements must be linked so that the running of the business and the delivery of advice become standardized while the specific advice to clients remains customized.
Future Framework For those who choose not to pursue the consolidation route, more attention must be given to how the firm will outlive the founder. Critical mass is also the answer in this circumstance. I view critical mass in an advisory firm as the point at which you have redundancy in each position while at the same time achieving reasonable profitability and revenue growth goals.
Think about what that means: 1. Redundancy. People come and go, they get sick, they take vacations, they leave for other companies. Advisory firms must ensure that every function, critical or not, can be performed consistently and superbly when shocks occur. This means investing in the training and development of your people and hiring sufficient staff at all levels to ensure continuity in the roles.
2. Profitability. A well-managed advisory firm today should be able to generate a 25% net margin after fair compensation to the professional staff including the owners, and all reasonable business expenses. The top performing firms are closer to a 30% net margin. Small advisory firms find it difficult to achieve this level of profitability.
They also have a hard time sustaining optimum performance when adding people, expanding offices and purchasing better tools of their trade. How large does your firm need to be to absorb important expenditures without affecting the bottom line in a meaningful way?
3. Revenue growth. The rate of growth in the average firm has slowed over the past few years, due in large part to a lack of capacity to serve more clients, inadequate branding and marketing and de-accumulation of client assets.
How will your firm sustain a 5–10% year-over-year growth rate exclusive of market appreciation? Will this come from new clients or revenue from existing clients?
Every dollar of investment in staff, processes and technology requires business owners to calculate their expected rate of return on that investment. Generally, it takes 18–24 months for a new hire to become fully productive, so the time over which that return is measured must be taken into account.
When advisors begin thinking about what critical mass looks like for their firm, they begin to define the next phase in their business lifecycle.
You made it through the pioneering, entrepreneurial days in which planning was done over a couple of beers and work was executed in a panic. Now your business is becoming more systematized, the workflow is becoming more standardized, productivity and operational advantages have improved.
Seize the moment to create critical mass. Oftentimes the business is your most valuable asset. You have an opportunity to transform it into an investment that works for you, rather than the other way around.
Mark Tibergien is CEO of BNY Mellon’s Pershing Advisor Solutions. Tibergien is also the author most recently of “The Enduring Advisory Firm,” written with Kim Dellarocca of Pershing and published by Wiley. He can be reached at firstname.lastname@example.org.