Ever since getting his CFP designation in 1987, wirehouse rep Paul De Rosa had hankered after a way to focus his practice more on giving advice. Finally, in 2008, after the meltdown, he and his three long-time teammates at Merrill Lynch decided they'd found the answer: start their own RIA. They hired a consultant specializing in breakaway brokers and, about a year later, in January 2010, set out their own shingle with the aim of continuing their focus on both wealth management and retirement plans.
About six months in, however, they got some unexpected news. Their b/d was going to be bought by LPL. While having access to the resources of the larger b/d was appealing, they had chosen their original firm because they'd wanted a small place that also specialized in retirement plans. “We needed a b/d that was the right fit for us,” says De Rosa. So, the team then spent another six months on the time-consuming process of looking for a different b/d, finally making their selection from a list of six finalists, all with a retirement focus.
Then, the team had to go through the process of explaining to clients why they were making another switch and asking them to fill out yet more paperwork. “This was certainly not something we planned for,” says De Rosa. His firm, Gateway Advisory in Westfield, N.J., now has about $350 million inassets, but he hopes to have the $600 million in assets the team handled back at Merrill Lynch, once all his retirement plan sponsors agree to make the switch.
Sure, there are a lot of good reasons to become an independent. The payout is better. You generally can use whatever products you want. You're your own boss. You don't have to defend your employer's actions to increasingly skeptical clients. Still, taking the step also comes with all sorts of potential problems, especially in the first year or two in operation. Some are highly predictable, while others, like De Rosa's b/d hassle, are less so.
No matter what the nature of the problem, however, it's best to know what you're in for, so you can prepare for what's ahead.
#1: You're on your own
Unless you choose to join an existing firm, when you become an independent you also turn into a small-business owner. And that's great, if you're an entrepreneurially minded person. Otherwise, the experience is likely to come as a shock. Even if running a business feels like the most natural thing in the world, you're going to find the adjustment difficult. “When you're in a wirehouse, you take a lot of what your b/d does for granted,” says De Rosa. “When you're an independent, the rent, the phone system, your computers, your health insurance — you have to take care of it yourself.”
De Rosa's new office, for example, was continually plagued by snafus with the phone system. Six months after starting out, it became clear the system, which repeatedly went down or had poor reception, wasn't working. That meant researching new phone system providers and getting the office rewired — a disruption coming just when the team needed to focus on transitioning clients. “When you're starting a business, you're working as fast as you can to get upstream one inch,” he says. “This just slowed us down.”
Billy Peterson, an advisor in South Ogden, Utah, had a particularly scary moment shortly after he left Morgan Stanley to become an independent in October 2009. That's because a nearby company sued him for copyright infringement, claiming he had used a logo in his marketing materials that mimicked theirs. Peterson immediately went to his new b/d and asked for help — only to come up empty-handed. “They said, ‘We'd love to help, but you're an independent contractor and this is an issue you're going to have to deal with,’” says Peterson, whose practice, Peterson Wealth Services, now has $150 million in assets. “That was an eye opener for me.” Peterson then contacted an attorney who quickly resolved the matter.
Similarly, about a year after starting up, Peterson decided that, instead of buying another computer from his b/d, he'd save some money and buy it on his own. Trouble was, he also assumed that his b/d would provide support services in case he had a problem. Turned out, it didn't service other software and hardware, so Peterson had to hire an outside IT specialist. “It was another headache and expense I wasn't prepared for,” he says.
#2: Your team breaks up
Sure, it seems a lot easier — and potentially more lucrative — to start your own practice with someone else. But, in many cases, according to Brian Hamburger, managing director of MarketCounsel, a consultancy specializing in independent advisory firms, reps form a team without thinking through all the issues that might come up, from how to share profits to who will take the lead in business development. Of the problems that can result, disagreements over compensation may be the most common. Hamburger points to three advisors who left a wirehouse about a year ago and set up shop together. But the arrangement was that each would handle his own clients and profits would be divided equally. In short order, they began having disagreements, with bigger producers complaining that they should get more money. After eight months or so, the team broke up into separate practices. Says Philip Palaveev, president of Fusion Advisor Network: “An equal split often turns out to be a mistake. There has to be an alignment between contribution, equity and compensation.”
#3: You choose the wrong b/d
De Rosa is by no means the only advisor to encounter unexpected problems with a b/d. As a novice, it's easy to make the wrong bet on a firm. Take Wayne Wagner, Scott Stoltenberg and Laura Swift. They were working as a team at Piper Jaffrey in Davenport, Iowa, in 2006 when the firm was bought by UBS. Three years later they decided to go out on their own. Although they had their eyes on starting their own independent RIA eventually, they figured their first move would be to affiliate with Chicago Investment Group, a b/d with an investment banking arm. Because a former colleague had an executive position there, they reasoned it was a sound choice. Turned out that the investment banking arm was experiencing major difficulties and, nine months after the team started with the firm, the b/d shut down. “We basically ended up providing their cash flow for a while before they couldn't make it anymore,” says Wagner.
Fortunately, the team had already realized its mistake several months before and had decided to set up its own RIA. They received notification that their SEC registration had gone through the day the b/d announced it was shutting down. The upshot: As soon as they got the news, the three launched their firm, using Raymond James, the same company that they'd been using as a custodian. They also took over the lease for the office they were already using and kept the same phone number and name, Quad Cities Investment Group. And they were able to send a letter to clients, letting them know there had been a change in custodians, but without asking them to fill out any new paperwork. The firm has about $120 million in assets.
#4: You face snafus transferring clients
Of course, your goal is for the switch to be as smooth as possible for clients. “You want to provide the same level of service they used to get,” says Paul Bedinger, a former wirehouse rep in Nashua, N.H. who went on his own in January 2010. “You want them to stay with you.” At the least, however, it takes a good six months of intense work before you can contact clients, get the paperwork done, and start bringing in enough assets to begin making money again.
In the process, you're likely to meet with a host of other problems while you try to transition your clients over. Bedinger is a case in point. First, he not only had to explain to his 150 clients why he was making the move, but also found he had to assure them about the solidity of the small b/d he was using. “It's not a household name,” he says. “And there's a lot of skepticism out there about our business in general.” While a lot of the communication was via phone calls and e-mail, he ended up seeing about 30 clients face to face, in part, he says, “so they could see I had a legitimate office.” What's more, not long after going out on his own, he decided to start using more than one clearing firm; that meant contacting clients again, providing more explanations and asking them to fill out additional forms. “That wasn't a great thing, when I had clients who weren't that sure about what I was doing,” says Bedinger, who has “$25 million to $50 million” in assets. Still, in about six months, he was able to move most of his clients over.
For Mary Owens, who became an independent in December 2008, the client transfer process was made more difficult thanks to her tracking system. Thinking that the information was a one-time event, the Grass Valley, Calif., advisor had her staff track everything on an Excel spreadsheet, instead of using their much more sophisticated CRM system. But that only slowed things down. What's more, even though her team included three support people, she now realizes she should have hired temporary help to handle the mountain of paperwork. She reckons there were seven to nine forms per account that had to be signed and put through. “On our very first day, we place an ad in the paper and we had close to 60 people walk in the door,” says Owens. “That was a lot of paperwork to get processed.”
#5: You set unrealistic expectations
To encourage clients to make the transition, advisors have been known to lower their fees. But if you do that, then later on you'll most likely be unable to go back to your old charges. “The price you use in the beginning is going to stick with you for many years,” says Fusion Advisor Network's Palaveev. What's more, lowering fees probably won't affect the number of accounts you transfer, because, according to Palaveev, the price of advice generally is one of the least important factors in clients choosing an advisor or deciding to remain after a switch. Another unproductive move aimed at motivating clients to remain with you: customizing portfolios. That's because, at some point in the near future, you're likely to find providing such a high level of customization to be too time-consuming, ultimately eating into profits. Says Palaveev: “You can't start out with unreasonable expectations.”