Independent advisory businesses were relatively simple 20 years ago. Most firms were small businesses, owned and run by advisors who founded these practices not only to be their own boss, but usually and more importantly, to deliver a high quality of client-centered financial advice without any outside conflicts or influence.
Since then, the independent advisory industry has undergone dramatic change. Now, most firms are larger. When I started consulting, the average size firm was $400,000 in revenue, a major difference from the average $4 million today. Plus, many of today’s top firms manage $1 billion or more in client assets, and others are setting that mark as their goal.
Along with this prosperity have come other shifts, which while beneficial, also have created challenges for owner advisors. One of these changes typically applies to larger firms and the recent availability of private equity capital.
These outside investments often come at a price — pressure to increase revenues and profits by means that are contrary to those “best interests” of the clients that the founder went independent to protect.
The CEO Challenge
Another new obstacle that today’s independent firm owners are facing — and what I’ll focus on here — is the introduction of a new CEO into an advisory business.
Several aspects of designating someone else to be CEO can be a challenge for advisory firm owners. Let’s start with the CEO’s compensation package: Poorly structured comp plans can create financial conflicts between the CEO, the clients and the business itself.
For second-generation CEOs, the first snag is that they don’t own a controlling interest in the business. I’m not suggesting they should be given a majority stake, as founding owners are not going to go for that, nor should they have to. But in lieu of an ownership transfer, both the firm owner and the new CEO should be aware of the issues created by this situation and take steps to mitigate the challenges it can cause.
The first step is to fully understand the position of a non-founding CEO. The basic problem for second-generation CEOs is that they have control, but no real power, which stays in the hands of the majority stock holder(s). The owners can countermand or refuse to take any steps that the CEO suggests.
This raises the question: Who really is the CEO? Having the title doesn’t always mean you have the power in advisory firms. The solution should come from the firm’s majority owner.
To effectively transfer leadership to a new CEO, the owner has to be clear about which decisions and actions the CEO has the authority to make and which will stay in the owner’s control. Furthermore, the new CEO has to stick by this structure.
A new CEO and his/her firm owner also need to understand that the CEO will constantly be in conflict in a way that the owner never was. It’s worth realizing that businesses in the financial services industry are constantly in conflict. That’s because there is almost always more money to be made by acting against — rather than in — the clients’ best interest.
That said, the owner of an independent advisory firm is in the unique position of only having to answer to their own conscience for decisions and actions. In contrast, the second-generation CEO has two fiduciary duties: The first is to the clients of his/her RIA firm, and the second is to all the shareholder owners of the firm.
Most second-generation CEOs don’t fully understand the position they are in. As a result, balancing these conflicts becomes quite a tough situation in terms of successfully serving clients along with the interests of employees, shareholders and their own agendas.
An Effective Leader
In addition to clearly understanding the limits of a CEO’s own authority and that of the owner, I recommend a couple more steps.
To ensure everyone is on the same page and that the CEO is guiding the business in the right direction, I suggest mapping out a “vision strategy” (which is different from a “vision statement”) that explains where the CEO wants to take the firm. This should be signed off by the owners.
A good vision strategy is a detailed document that describes what the CEO wants the firm to be, how he/she wants it to change, how he/she wants those changes to happen, and who’s responsible for making them happen. It is a blueprint for both the firm owner’s and the CEO’s commitment to running the firm. It also ensures that the firm is heading in the agreed-upon direction, without confusion.
When we help next generation CEO’s develop these long-term strategies, a good “vision statement” is included (such as “serve X number of clients through fiduciary advice”). This outlines the owner’s and the CEO’s priorities. But a word of caution: If the vision statement mentions money (e.g., “build a $X million company”), it needs to be changed to focus on the clients. Otherwise, you’re running a business that puts shareholders’ needs first and clients’ needs second. That’s not fiduciary duty — that’s Wall Street.
The next step is to reduce conflicts in the CEO’s decisions. To do this, an owner should take profit out of the CEO’s compensation structure.
I get into a lot of heated discussions about this when it first comes up in the client relationship. Most advisory firms are not publicly traded, and compensation based on profits sends the message that financial success is more important than acting in the best interest of the clients, which is what many large brokerage firms and private equity firms tend to do.
Instead, tie the CEO’s comp to operating income and revenue combined and/or valuation.
While it’s difficult to have incentives based on client well-being, a focus on profits can send the wrong message to the CEO about his or her priority. This can be a tough sell to the owner(s); yet, if they don’t change the firm’s focus, it is not truly client oriented.
The financial reality is that the sole client-centered way to increase revenue is to have it come only from the delivery of professional advice, not from sales of propriety products, commissions or other financially incentivized sales. Therefore, don’t put your CEO in the position of generating these types of revenues. Instead, in the vision strategy, have the CEO spell out that the firm just sells advice.
Over the years, I’ve found that one of my firm’s major jobs is to help CEOs make client-centered decisions and communicate better with the shareholders of their firms. Part of a good CEO’s role is to remind shareholders that, regardless of revenue, acting in the best interest of clients is always better for the firm and its shareholders.
A CEO’s No. 1 job is to protect the brand by acting in its best interest, which is serving the client. This enables the firm to attract more clients and to keep its clients.
These days, with so much media coverage about fiduciary duty and the need to act in the clients’ best interest, independent firms can ill afford to get a reputation for acting otherwise. I believe that a major part of a CEO’s fiduciary duty to a firm’s shareholders is to prevent this from happening.
In this era of increasing pressure on independent advisory firms to boost profits, it’s essential for firm owners, shareholders and CEOs to work together to ensure that their firms continue to deliver the highest possible level of client-centered financial advice. It’s by far the best way to protect your brand and to continue growing a successful independent advisory business.
Angie Herbers is an independent consultant to the advisory industry. She can be reached at email@example.com.