Yogi Berra was renowned for making nonsensical comments to reporters that surprisingly made a lot of sense. For instance, “When you get to a fork in the road, take it.” My favorite wasn’t about business, but it could have been: “If you don’t know where you’re going, you’ll end up somewhere else.”
I find this quote especially apt for owners of independent advisory firms whose informal business plans often boil down to: “Get some clients, give them financial advice.” To help my new clients (and sometimes my old clients) get a better handle on where they are going and make better decisions about what to do next, I walk them through a breakdown of the basic business models that independent firms typically use. The model they choose will dictate the direction in which their business will go.
Here are the five basic business structures that independent advisory firms fall into:
Investment Management Firms This is a business model primarily used by some baby boomer generation owner-advisors. These businesses do not provide any financial planning services. Instead they generate revenues from asset management and, to a lesser degree these days, the sales of financial products (mutual funds, insurance, annuities, IRAs etc.), using advanced portfolio allocation strategies and products.
Due to their relatively low overhead, these businesses typically generate comparatively high revenues that translate into large profit margins and high owner income. However, with high competition for clients these days, including that of digital investment management platforms, these businesses tend to have lower market values than the more full-service firms in this sector.
Hybrid Firms These firms combine investment management with financial planning, but typically on an informal basis. While these businesses normally use advanced portfolio management strategies, they also provide financial planning as needed, without regularly scheduled client meetings or even the use of financial planning software. Consequently, if they charge for their financial planning services, it’s not very much and often is included in what’s already being charged to the client for asset management or given for free as a value add.
Because of the financial planning services offered by these firms, the clients tend to be more loyal and, therefore, less likely to be recruited by other advisors or lost to a digital platform. Consequently, while they typically will generate lower revenues than pure investment management firms, their higher client retention tends to make them more valuable as businesses when the time comes to sell.
Wealth Management Firms These are the most “full service” businesses in the independent advisory pantheon. Wealth management firms typically offer investment management (including both passive and active strategies), financial planning supported by planning software, multiple client meetings per year and a variety of service models to meet the needs of a broad range of clients. As you might expect, with their large service overheads, these firms tend to have lower profit margins than many smaller firms—but due to their deeper connection to typically more wealthy clients, their market values are generally the highest in the independent advisory world. In the past 10 years, these firms have been the fastest growing types of advisory firms in the industry.
Financial Planning Firms These firms typically focus on the financial planning process to provide the direction of each client relationship. They generally use cutting-edge financial planning software, create complete financial plans including short and long-term goals, and provide cashflow projections well beyond retirement—with client assets moving over to their management only after the client has seen and accepted the financial plan.
Their advisors meet with clients at least four times a year. And their investment strategies are typically passive, in low-cost ETFs or funds.
Usually they charge financial planning fees in addition to AUM fees. These businesses typically offer their owners a balance of cashflow vs. business value due to the strong relationships they develop with their clients. If the transition is handled prudently, a large majority of these firms’ clients will transition to a new owner with a similar philosophy on the financial planning first, rather than investment management strategy.