Over most of the long arc of the financial profession, advisors and brokers have focused on “building their book” of clients. The last decade has fostered a different model in which lead advisors are supported by a team of service advisors, paraplanners and administrative staff who ultimately develop into fellow partners.
Many professionals left larger brokerage firms, banks and insurance companies to create their own practices as RIA firms or affiliates of independent contractor broker-dealers. Business ownership created a new set of challenges that many advisors were not prepared to address. Not only did they need to focus on serving clients, owners also hired and retained staff, implemented new technology, complied with new regulation and managed to profitability. Many firm owners shifted their priorities from serving clients directly to building transferable value.
While some traditionalists begrudge the evolution from practice to business, those who have built more enduring enterprises believe this structure has resulted in a greater depth of talent, a richer client experience and valuable continuity for clients.
Many such firms are still operating with a small business mindset, however. While entrepreneurship has its appeal, once a firm develops too many moving parts, professional management becomes an urgent need.
Typically this means naming a chief executive officer to set the direction and be the public face of the business, and a chief operating officer to implement the strategy and manage the day-to-day activities of the enterprise. Some firms have grown to include heads of business development, technology and client service.
Advisory firm founders must assume these top roles themselves or hire others with the requisite management skills. Along with this change in structure, advisors need to recognize the cost and benefit of professional management unrelated to acquiring clients and providing advice. These new roles enable the financial professionals to serve their clients more efficiently and effectively without the distraction of managing a business.
Expectations of the role
When contemplating the addition of professional management, advisors must be clear on expectations for the role. Many firms making a first foray into a highly-paid, non-revenue-generating position give up early. Resentment from the other partners or their own unclear measure of success tend to contribute to their disillusionment.
How will decisions be made with the addition of a professional CEO? Is the CEO a facilitator of group think and group action, or someone who is accountable for making key decisions while keeping the partners apprised of her activity? Either works, but the candidate profile will be defined by the process in many ways.
Advisors must clarify the reporting structure as well. This issue can be difficult, as long-time employees will be tempted to skirt around the new executive if they have a special relationship with the founder. Leaders must balance mentoring and coaching of those employees with respect for the new CEO’s duties.
Characteristics of a CEO
Advisors tend to rely on resumes and experience when hiring top executives, especially when they have little experience with the role they are hiring for. While education, job history and a record of accomplishments are important data points, the line of inquiry should be more subjective:
• Vision – Do they have the ability to examine the market, the competition, the capabilities of the firm and the challenges they must overcome to develop a clear road map for the business going forward?
• Decisiveness – How have they demonstrated critical decision making? Usually, leaders are not tested until confronted by a difficult decision or an urgent circumstance. Good leaders can explain their fact-gathering process and their method of deliberation in crisis situations.
• Focus on results – It is easy to get excited about aspirations; translating ideas into reality provides the real test. Ask how candidates define success beyond revenue growth and profitability. Their responses will reveal their aptitude for business as well.
• Ability to develop others – Ultimately, leaders prove their worth by helping others achieve their potential — even when this threatens their own position.
• Risk management – How will they protect the firm against loss, develop processes where each employee feels safe and ensure the firm maintains its positive reputation in the community and with clients? These skills are critical in today’s environment.
The median salary for advisory firm CEOs in 2019 was $300,000, according to the 2019 InvestmentNews Adviser Compensation & Staffing Study sponsored by BNY Mellon | Pershing. This increase from the previous year proves a high demand for qualified executives.
Most top executives also receive a bonus tied to several key metrics including firm profitability and achievement of certain priorities outlined by the partners. As an example, advisory firm partners may have criteria around client satisfaction, implementation of new technology or improvements in employee engagement in addition to the growth numbers.
The typical (median) target incentive compensation for CEOs was 30% of their total compensation. The average target incentive was 36% of their base.
In many cases, advisory firms choose to hire a COO instead of a CEO, as the lead partner often takes that role as the firm tests the idea of professional management. Generally, a COO will be evaluated on the ability to translate vision into action with a special emphasis on improving workflow and improving the efficiency and effectiveness of the business. COOs may have stronger technology skills and certainly possess a stronger appreciation of detail.
According to the above-mentioned study, the median COO salary shrank slightly (-7%) from $166,000 in 2017 to $155,000 in 2019. While we can only speculate about the reason for this decline, it appears that many firms have promoted staff members to the COO position instead of hiring from the outside.
Historically, many firms have granted the COO title to an office manager or director of operations who has accumulated tenure in the firm as operational scope has grown. This change in position title, however, has rarely resulted in significant changes in pay. As a result, there was a significant difference between “promoted COOs” who had compensation closer to the 2017 median of $166,000 and “hired COOs” who were closer to the 3rd quartile of $204,000.
As advisory firms make the leap to professional management, they must calculate how they will get to critical mass so that the cost doesn’t become a drag on the company. The added expertise should become a catalyst for greater growth and profitability.
When measuring profitability in an advisory firm, it is important not to confuse management or administrative compensation with professional compensation. Direct expense is where one accounts for professional staff compensation.
Management or administrative compensation falls under overhead or indirect expense. Being able to discern the impact of the different costs on both the Gross Profit Margin and Operating Profit Margin is key to managing a successful enterprise.
Advisory firms that can consistently generate a 60% (or better) gross profit margin and a 30% operating profit margin while growing organically at a 4% to 5% rate exclusive of market performance tend to be more enduring firms.
Sustaining these numbers is hard without continuous investment in the business and a discipline around managing pricing, productivity, service mix, client mix and expenses.
Mark Tibergien is CEO of BNY Mellon’s Pershing Advisor Solutions and co-author of “The Enduring Advisory Firm,” published by Wiley. Reach him at email@example.com.