Recipe for Trouble

After two years of operating an independent practice, a seasoned advisor is ready to take on two partners. He wants the experts to tell him how they should divvy up the pot.

After two years of operating an independent practice, a seasoned advisor is ready to take on two partners. He wants the experts to tell him how they should divvy up the pot. They say he may have a bigger problem: First he needs to figure out what kind of practice he wants to build and what kind of partners to include to provide the appropriate skills and disciplines. Only after he does that can he focus on details like compensation.

Our Fix My Practice experts are Julie Littlechild, president of Advisor Impact, a training and consulting firm in Toronto; Hellen Davis, president of Indaba, a strategic-positioning consulting firm in Tampa; and David Devoe, director of M&A for the strategic client group at Schwab Institutional.

THE SITUATION:

Michael Chrysler, 52, took the long route to operating his own financial shop. He started his career with a 10-year run working with his father and brother in the family business, a holding company in Amarillo, Texas, that did a mix of venture capital and mergers & acquisitions work. Chrysler spent most of his time serving on the boards of companies in which the firm had a financial interest.

He was already questioning the direction of the company when he was told he would have to move — after already relocating three times for the firm. Happy in his Lake Oswego, Ore., home, he didn't want to uproot his wife and children again. So, he sold his interest in the firm to his father and brother and quit.

He opened an import-export business, but quickly tired of the traveling and closed its doors after a year. What next? Figuring he knew a lot about the financial workings of companies, he decided his best move would be to become a financial advisor, emphasizing portfolio management. He joined Shearson Lehman Brothers — later absorbed into Citigroup — where he stayed for another 15 years.

Eventually, however, Chrysler realized that he wanted to be his own boss and opened up Chrysler Asset Management, which is affiliated with Raymond James Financial Services. His goal was to get a bigger payout, and he was able to take most of his Citigroup clients with him. A year later, two advisors with their own independent practices, both of whom had also been with wirehouses for about 10 years, started working as subcontractors, sharing office space and giving Chrysler a portion of their revenues.

Over the past six months, however, Chrysler has started to rethink his plans, looking for what he calls “a more collaborative environment.” He's talking to his subcontractors about joining forces and combining into one firm with total assets under management of approximately $50 million. Why? For one thing, according to Chrysler, the move might reduce his compliance exposure. “Now, if one advisor is specializing in something more speculative, it presents a lot of additional risk to me,” he says. More important, he anticipates plenty of opportunity to build the business, thanks to what he sees as complementary areas of expertise.

One advisor specializes in executive stock option plans and is a certified financial planner, while the other focuses on 401(k)s. Chrysler, who is not a CFP and does not concentrate on retirement plans, considers himself to be a portfolio manager, with most of his business coming from separately managed accounts. Another reason for bringing the two advisors into his practice is that they have similar clients, mostly business owners and executives in their mid-40's to mid-60's. A third and final motivation for joining forces is that Chrysler wants to build equity in the business so he can sell it before he retires.

However, Chrysler doesn't know just what type of compensation model to use in his new partnership. He's leaning toward something similar to, “What you might find in a law office,” he says, with junior and senior partners paid a salary based on a number of factors, along with bonus payments for achieving certain benchmarks. But, he's not sure. There's also the issue of how to share revenue. They might divide it equally, he thinks, but that would leave open a number of questions. How, for example, do you compensate the rainmaker bringing in most of the assets? And what about the person responsible for managing client relationships: What share should he receive?

Then there's one final question mark: whether or not to share clients. It's a tricky question, he feels, because their books are of different sizes. Chrysler figures the advisors would continue to handle their existing accounts initially. “I have had my client relationships for many years, I think they're pretty happy with the service they're receiving,” he says. But new accounts would be served as a team right away. Ultimately, revenue from all the clients would be shared — probably. “It's all part of the challenge in designing the right compensation model,” he says.

THE ADVICE:

Julia Littlechild, Advisor Impact

I think this is really a strategy issue, because the type of business you want to put in place ultimately drives how you pay your partners. If he understands who his clients are and the best services to offer based on their needs, then that will tell him how to structure the business. For example, if it's a wealth-management firm, then that calls for certain areas of expertise. That decision will influence everything else in the practice.

He's talking about people with different skill sets, but that doesn't mean he has a strategy. For now, he seems to be thinking more of tactical issues. Rather than stepping back and saying here's the expertise we need to reach a particular objective, he's looking at these guys who have certain strengths and saying, “What's the best way we can work together?”

I think that it's fraught with danger to have a mixed approach to clients. He needs to draw a line in the sand and say either everyone has their own clients or they share them all. He might need a transition period, and it has to be planned with a clear timeline.

After that, they can deal with the tactical issue of pay. In general, they would have a base compensation with profit sharing, so they're all pulling in the same direction. Also, they would look at the value of the firm, what each person is contributing now and what the ownership split should be. If Chrysler brings in more assets and value, then he would own a greater part of the business and receive a larger proportion of the profits.

Hellen Davis, Indaba

The compensation has to be decided based on who brings in the business. An equal division doesn't work. It creates a tremendous amount of distrust. When one person's book gets really big, he just goes on cruise control/maintenance mode. And the other guys get resentful. It happens time and time again.

The law firm model is the only one that's going to work. And if you're performing service work, you bill at a lower rate than would somebody bringing in accounts. Rainmakers would make the most. So, if you're doing 401(k)s and I brought you the client, I would get at least, say, 35 percent of that, and whoever serves that client would get maybe 20 percent.

Operating costs are a consideration, too. You have to put 20 percent into an account used for running the practice, plus 5 percent for bringing in additional administrative staff, part-timers and whatever else is needed to build the firm.

That's where financial planners make a mistake. They divvy up what they're currently making and don't put money aside for, say, an administrator they might need in the future or somebody who could do marketing.

At the end of the year, they would split up expenses, but split them pro rata. If I produced $500,000 in revenues and you did $300,000, I would get more money because I brought in more business.

David DeVoe, Schwab Institutional

He needs to consider three major areas. First, he has to determine a valuation for the business before and after the combination, to help figure out how much of an ownership stake each person should have in the new organization.

The second involves setting the roles and responsibilities of each person. If we're looking at a collaborative environment and really want to capitalize on complementary skill sets, I would encourage them to move to an ensemble model right away. You would identify roles and responsibilities based on each individual's expertise. If, say, one advisor were a financial planner, then he would provide that service to all the clients. That approach would make the firm run more efficiently and grow faster.

At the same time, they should try to identify several key success measures for each of the roles. For business development, for example, it might be the number of new clients and assets brought in.

Last is the compensation plan itself. That should have three components: salary, bonus and ownership distribution. Salaries would probably be based on the role of each individual. For example, the rainmaker would have less total compensation come from salary than the relationship manager — maybe 40 percent salary, 60 percent bonus — because that would give him an incentive to grow the firm aggressively. The bonus would be determined according to those success measures established earlier. And distribution of profits would be based on each person's ownership stake in the organization.

Fix My Business is a semi-regular feature that seeks solutions to real-world advisory problems from a group of consultants and industry insiders. Submit your questions to [email protected]

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