Nobody Wants Your RIA
But they do want your assets!
by Jim Palumbo
The value of your RIA is likely $0.00. The RIA itself is not the real value that a buyer or successor is seeking because the real value of a small to mid sized investment advisory practice is not the individual registration or corporation, but the client relationships and recurring revenue of the firm. Balance sheet assets, the value of proprietary trade-secrets and technology, trademarks, or copyrights may also add value to the RIA, however, these are not common among small to intermediate RIAs. The real value of a Wealth Management practice is in the recurring gross revenue, the quality of the client relationships, the level of institutionalization in the investment management process, the percentage of AUM vs commission business, the demographics of the business, and other variables. The challenge that small RIAs face is that they spend 80% of their time on the business of the business of the RIA and only 20% of their time on the assets of the business that store the true value.
But I Need to Be My Own RIA – It’s natural for wealth managers to seek independence, the freedom to determine their own destiny, and the pride of ownership as they grow their practice. Twenty-five years ago, the only way to accomplish those aspirations was to form your own RIA and build everything from the ground up. When I started in the 90s, I filled out my first draft of Form ADV with a pencil, then completed the final draft on an old-school typewriter. I received my performance reporting software updates in the mail on a floppy disk and reconciled the performance reporting software myself. Billing was calculated on a giant-sized Unicom calculator with 20 feet of 2-inch paper chattering out-the-top of it.
Today, wealth managers have numerous technological and outsource solutions that reduce time and cut costs. There are also relationships available to fee-based advisors that enable them to “tuck-in” with a larger regional or national firm, outsource ALL of the administrivia and compliance while they focus on clients and growth. Wealth Managers that utilize these types of relationships can more realistically achieve the aforementioned value targets that position the practice for sale or succession. These may include increasing and deepening client relationships, institutionalizing the investment management program, migrating to 100% fees, and improving the demographics of the client base and profile.
Expenses and Gross Profit – People, Technology, Compliance, and Time (tic-toc) are the biggest overhead variables that drive the gross-profit of your practice. For small to intermediate practices, these costs are often not appropriate to the size of the practice and its revenue. Using a simple revenue model of 1% fees on AUM, a $50M AUM practice will generate $500K of gross revenue to a stand-alone RIA. If that firm had to hire a Chief Compliance officer that could cost between $150-200K. A qualified staff member or two and technology could cost another $150-200K. So, $300-400K in overhead on a half-million of revenue leaves the advisor only $100-200K of actual profit and in a single person or partnership firm. This equates to a 20% gross profit margin. Not great for a professional practitioner. Not to mention that the advisor spends most of his or her time on administrative duties.
Indeed, there are innumerable variables in each practice. For example, one practice may outsource the Chief Compliance Officer position to an FTE (Full-Time Equivalent) CCO for 40-60%[i] of the cost of an in-house CCO. Another may go light on technology or skip the compliance all together and just wait for the SEC or a client to eventually push the RIA to make a change. Most firms take the D&D approach—Delay or Do Nothing. The D&D approach is more common as we observe firms downline in the AUM ladder. For example, a $100M firm will have more systems and procedures in place than a $20M firm.
The phantom wild-card in these equations is the excessive amount of time that a principal dedicates to administration, compliance, and portfolio management. I call it phantom because it’s not on the Profit and Loss Statement yet it is the most significant expense in the advisor’s practice. A recent Kitces survey found that advisors spend 17.6 hours per week on administration,[ii] while Cerulli suggests that top advisors spend up to 28 hours per week just on trading and research.[iii]
Can You Do It vs. Should You Do It – “We have met the enemy and he is us,” said Pogo. For many practices, the biggest obstacle to growth is you! You believe you can wear all the hats and still grow the business. Most of the time, this is not true. You know you can do I; the question is should you do it? You have the intelligence and acumen to be administrator, marketer, accountant, human resource director, accounts payable, trader, and billing clerk: the real question to ask is not are you able, but should you do it? Is it the highest and best use of your time? Most industry observers would say emphatically, NO! You are needed at the front lines! Your client and future clients need you away from the computer screen and keyboard and engaging with them to help them solve their problems and plan their future. Do what you love!
Stock Purchase vs. Asset Purchase – Another misconception is that a financial services corporation is a viably sellable entity. Most buyers will buy your assets, not your corporation. There are not many sources for reliable statistics to measure how many financial advisory practices are sold as a stock sale versus an asset sale, however, informal polls with advisors we encounter indicate that most practices are asset sales. An asset sale allows the buyer to step up the basis of the assets and insulate themselves somewhat from the potential or unknown legal liabilities of the predecessor firm. They don’t want your RIA! But they do want the assets. Those assets are the client relationships and the recurring revenue they represent.
So, an advisor who spends years building and maintaining a corporation may find that the buyer only wants to buy the assets of the corporation and not the actual corporation itself (a stock purchase). The advisor is left with an empty company to unwind.
The real take-away, the thing with which you truly want to grapple, is the 80/20 paradox. Should you spend only 20% of your time on the activities that matter most? Most advisors spend 80% of their time on non-client facing and non-income producing activities. Shouldn’t it be the other way around? If advisors spent the last decade or two of their career on client-centric, income producing activities instead of administration, trading, etc., then they would have a much larger, gross-revenue producing practice from which to succeed!
It is important to note that wealth managers can readily find a relationship with a tuck-in firm, wherein they own their book and DBA as an independent contractor and have no significant portability restrictions. This provides the best of both worlds, the ability to be captain of their own destiny, but offload most of the administration to the tuck-in company who has the scale, tech, and depth to handle those tasks cost-efficiently and the staff to provide continuity. Freed to focus on doing the activities they love; the advisor can propitiously grow relationships and assets.
Focus on Growth Up to Inflection Points – Wealth managers should focus on clients and growth up to certain growth inflection points. In my experience, it becomes practical to consider a move from the role of advisor to CEO and launch a fully independent RIA at the point that he or she can adequately and properly insource compliance for under 6% of gross revenue, and administration for under 20%. Depending on the advisor’s location and other variables, that amount might be in the $2.9 – $3.3 M range for gross revenue. In practical terms, build the heck out of your business up to about $3M of income, then start thinking about launching a corporation and building the infrastructure and personnel to support it. Don’t be in a hurry. Spend the precious few hours that you have each week building your client relationships, top line, and on the things that matter most. Having a certificate of incorporation or a state securities board registration hanging on your wall is not worth spending an extra twenty hours a week away from your family while you fill out regulatory filings or compliance responses.
Focus on Winning Strategies and Activities – There are a few activities and efforts in which you can engage that really make a difference. They move the needle. They improve the business. They are good for clients. They are income producing activities.
- Quality – First, spend your time improving the quality of client relationships. Deliver more value such as retirement, estate, succession, and tax planning.
- Share of Wallet – As you deepen your client relationships, you should begin to capture more or all of your clients’ investable assets by household.
- Growth & Retention – Long-term client relationships are best for the client and most profitable for the advisor. According to PriceMetrix, high growth advisors (adivsors growing 20% per year or more) retain over 90% of their clients while slower growing advisors (advisors growing 5% or less per year[i]), will lose over 20% of their clients. If you focus on growth, you will also be doing the activities that lead to high retention.
- Wealth Manager vs. Asset Manager – Are you an asset manager, stock picker, ETF and Mutual fund selector or are you your client’s trusted advisor providing wholistic wealth management that improves their life and overall financial outcomes? Wealth Management is a stickier relationship and yields higher revenue per relationship.
- Institutionalize Investment Management – The level of institutionalization that you bring to the investment management process will dramatically improve results for clients by bringing discipline and consistency to your asset management program. This is good for clients and should add value at the time of sale or succession because the process is duplicable and transferable. Most advisors are now outsourcing investment management in the midst of a rapidly growing trend. Questions to ask yourself:
- Are client’s goals, time horizon, and risk tolerance scored and their assets managed to a model appropriate to their score?
- Is rebalancing done on a consistent schedule within a transferable, sustainable system?
- Are cash and tolerance bands managed digitally within a transferable, sustainable system?
- Are cash flows in and out managed to the target model?
Wishing Is Not A Strategy – Hoping and wishing that the right buyer or successor will present themselves is not a reliable strategy. The advisory practice should be proactively positioning the firm for sale or succession. You owe it to your clients and you owe it to your family. According to Cerulli, the average price paid for financial advisory firms was 2.2 times trailing 12-month recurring revenue; therefore, the business focus of the financial advisor should be growing top line recurring revenue. Toss the CEO, CCO, and COO hats out the window and wear the Wealth Manager hat proudly. This assumes the preceding: that acquiring, deepening, and maintaining quality client relationships and delivering value are the best ways to grow the top-line. Existentially, doing the right thing for clients is the best way to build true value in your practice and position yourself for a rapidly evolving future.
About Dynamic Wealth Advisors
Dynamic is recognized as a premier provider of essential resources to professional wealth management practices. Its turnkey practice platform includes asset management and enables wealth advisors to save money and focus on clients while positioning themselves for success and growth. With myVirtualPractice, a suite of wealth management practice solutions, Dynamic hands the professional wealth advisor the keys to a comprehensive, custom-built virtual office and practice complete with staff, back/middle office, accounting/billing, compliance and even a Virtual Assistant. The wealth advisor need only add clients and a laptop, and they are up-and-running instantly. For many breakaways and independent wealth advisors, being part of a nationwide community of like-minded professionals is one of the most valuable components of their affiliation with Dynamic.