Merrill Lynch certified financial planners Mike Jacobs and Brett Bernstein were frequently told by Merrill executives to “start looking at our business as our own business,” Jacobs recalls. “We said, ‘You're right, it is our own. Let's make it a business.’ ”
In October 2004, Jacobs, who had been with Merrill for 10 years, and Bernstein, an eight-year Merrill veteran, took Merrill management's advice to its extreme: They made the leap to independence, joining LPL. Just for good measure, their friend Rob Kantor, another Merrill rep, came along, too. In sum, the three walked out the door with about 90 percent of their assets, or about $125 million.
The reason is oft heard: “We weren't treated fairly,” says Jacobs, 36. “Merrill was taking 63 percent of our revenue. We were trying to justify giving away that much money.” (That said, Jacobs freely admits that his ML training and experience has been crucial to his success as an indie.)
Two years on, the three partners haven't looked back. They have formed XML Financial Group in Rockville, Md., and expect to have about $225 million in assets under management by year's end. Annualized production should be around $1.4 million — and they're getting a 92 percent payout. That's right, a 92 percent payout — which compares favorably to the 37 percent payout they got at Merrill.
In reaching their decision, the three spent about nine months interviewing “about four big banks, four big wirehouses and six independent platforms,” Jacobs says. Going to another wirehouse was tempting, since Jacobs recalls sign-on bonuses and deferred comp ranging from 90 percent to 150 percent of trailing 12-month production. While reps love to gripe about their payouts at wirehouses, in fairness, as an employee of a major firm, you don't have many of the headaches that plague small business owners. In the bosom of Mother Merrill, you don't have to fuss with IT issues, office space and you don't have to negotiate health insurance and payroll.
But Jacobs figured another wirehouse still wasn't worth it. “I took a look at the revenue we were bringing in and took into consideration a moderate growth rate and thought, ‘I can get a 92 percent payout by going independent, cover my overhead and pay myself those upfront bonuses,’ ” he says. And, although he's not looking to sell any time soon, Jacobs claims another company has offered him and his partners $4.5 million upfront, or five times pretax net income, to acquire half of XML with additional earnouts at three and six years for the remaining half (a total investment of $6 million).
Many a rep dreams of going independent, if only for a minute. But is it worth it, especially these days when most firms are offering record upfront signing bonuses? It can be, that is if you are the kind of advisor who wants to operate as a true entrepreneur — paying for telephone service, rent, buying equipment, making payroll and the other things that are now provided by traditional brokerages.
Here is a simple example to guide you in figuring out if it's worth it. Jodie Papike, a vice president of Cross-Search in Jamul, Calif., an independent recruiting firm that helps match advisors with broker/dealers, says it usually is worth it to go independent — even factoring in the big upfront bonuses that wirehouses are offering.
Say you have an advisor who is producing $300,000 a year. The best way to figure which route is better is to forecast gross production over five years, Papike says. Assume the FA who switches to another wirehouse would earn a 35 percent payout. That nets him $105,000 each year, or a cumulative gross of $525,000 after five years. Add an upfront bonus of 100 percent of trailing 12-month production, but assume half is cash and half in stock options and deferred compensation, which is a relatively common deal these days. That leaves the wirehouse rep with $675,000 after five years, plus stock options and deferred compensation. (One caveat: Deferred comp and company stock can become a substantial amount of money: The XML partners each left an average $230,000 behind.)
Now consider that the same $300,000 producer chose the independent route instead. On the low end, Papike averages annual expenses for an independent advisor to total about 25 percent to 35 percent of total gross production. The first expense would be paid off the top to the b/d — typically about 10 percent, or about $30,000 in this case. Another $45,500 can be allotted to office space, employee salary, telephone and computer systems and E&O insurance. Add on $10,000 for ticket charges each year (Papike says the average ticket price ranges from $15 to $45 dollars each, and most wirehouse reps who go independent are surprised to learn they still have to pay them; of course, you could try to pass this on to the client) and total overhead works out to at least $55,500 annually. Still, the rep is left with a net of $214,500 each year. After five years, you're looking at $1,072,500. That's about a 71 percent net annual payout, according to Papike's example.
Few independents offer upfront compensation; when they do, it's small, rarely exceeding 20 percent of production, according to Philip Palaveev, senior analyst for Moss Adams. That pales by comparison to wirehouse offers, but it may not matter anyway. Bill McGovern, president of B/D Search, a consulting and recruiting firm based in St. Petersburg, Fla., says the upfront checks offered by wirehouses are usually not worth the money, literally. “What wirehouses are doing is offering advisors some incentive to move their business based on the advisor's current level of business, and they're banking on him growing. If he does grow, then the firm benefits more than the advisor,” he says.
Going independent is especially good for brokers in a growth mode. “He could end up making much more money on the independent side than in the wirehouse scenario,” McGovern says. “The higher payout gives an advantage over time,” he says
For those considering going the registered investment advisory route (RIA), Palaveev says the value of your business will be much higher than on the wirehouse side. (But wirehouses now offer succession packages that pay a trail to the retiring rep.) Take, for example, a wirehouse rep who grosses $1 million a year. Assume 90 percent of his book comes with him, and he might still be better off than he would at a wirehouse.
Assume his expenses are typical (about 35 percent of revenue, or $315,000 in this case). That means the RIA owner will net $585,000 — about 65 percent of the gross revenue. Palaveev estimates that in this scenario the owner/principal would take $360,000 as a salary. The remaining $225,000 would be profit of the firm, or EBITDA (earnings before interest, taxes, depreciation and amortization). “The firm will be worth eight to 10 times EBITDA if sold, or $1.8 million to $2.25 million,” Palaveev says.
That's a nice multiple. Even so, there are still plenty of brokers out there who seem to have no desire to make the jump to independence — only 1,000 go indie a year, Palaveev says. In short, there is something to be said for having a big firm provide an office, computer and investment platform.
And then there are advisors like Andy Brawly. A fresh face to the independent world, Brawly left Morgan Stanley after six years in August to join Raymond James Financial Services. A $350,000 producer with $120 million in assets under management, Brawly says his decision to make the switch was more philosophically motivated than financial. He says Morgan Stanley, his old firm, wasn't an asset anymore.
“You have to look and ask, ‘Is the firm giving me the value for the money that I'm giving it? The firm is taking 60 cents for every dollar, what are you getting back for that?’” Brawly, 36, says a great majority of his business is fee-based (more than 90 percent) and, because of his consultative approach to his practice, he says he was constantly told that his practice fit the independent model. He admits he wasn't sure what the independent model was all about. “I didn't know if it meant going to my own island and being alone,” he says with a laugh.
Jacobs and Brawly also had very different experiences when it came time to bring over their books of business. “Morgan didn't come after me at all. I've taken all of my clients with me so far, except one that I expect to come over eventually,” says Brawly.
On the other hand, Jacobs's departing team faced some hurdles. Merrill went after his clients, took him to court and threatened him with NASD arbitration, he says. (Since he was trained at Merrill, it's understandable why Merrill objected to his leaving.)
The obstacles to making the switch to independence will, of course, vary. For their part, independent firms are doing what they can to make the switch easier, including the odd upfront payments used to help the rep start up (usually referred to as transition-assistance packages). “It provides money for account termination fees, office rent, furniture and fixtures,” McGovern says.
Besides the financial benefits, Jacobs says there is an emotional side to owning his own business. “In a social situation, out on a golf course maybe, when someone asks what I do and I say I own my own financial-planning company, they start talking to me and are interested in my work,” he says, “I'm making a lot more money than I ever made [at a wirehouse], but you also just work a lot harder, smarter and you have a lot more pride because it's yours.”