So, you've got the itch — the itch to go out on your own. You're sick of big-company politics, rock-bottom bonuses, demoralizing scandals and miniscule payouts. You've been watching a steady stream of colleagues set up their own shop, and now, it's your turn.
True, the payouts enjoyed by independents are tantalizing, as is the allure of being your own boss. But look before you leap: There are a lot of factors to consider, many angles to contemplate.
For starters, it looks like going independent is not quite as popular as it was a few years ago. Independent advisors currently make up about 40 percent of the total advisory market. But the stampede to join them looks like it's slowing down — partly because of increased competition, partly because “a lot of the people who wanted to go independent have already done so,” says Dennis Gallant, director of intermediary research with Cerulli Associates, a Boston research and consulting firm specializing in the financial services industry.
The number of reps affiliated with broker/dealers will grow from 94,816 in 2001 to 96,484 in 2004, but should flatten to about 95,761 by 2006, according to Cerulli. And the number of registered investment advisors has been dropping, from 30,024 in 2001 to an estimated 27,139 in 2006.
The waning interest in independence is telling us something. Still, the vast majority of those who have gone independent have positive things to say about the experience. The fact that making the move is hard doesn't mean it's not worthwhile. So, for those of you who are contemplating joining the independent nation, here is a list of troublesome issues you're likely to have to wrestle en route.
A lawsuit from your former firm.
If you signed an employment contract with a non-compete clause, your employer can issue a temporary restraining order to stop you from taking existing clients with you when you leave. If you've been with your firm since you started and you received training, chances are good your contract included such a clause, even if you aren't aware of it, according to Christopher Stief, partner in the Philadelphia law office of Saul Ewing.
Typically such contracts forbid soliciting former clients for as long as a year. That means you'll have to spend the first few months of your life as an independent involved in legal negotiations — and you're likely to end up paying thousands of dollars in attorney's fees just for the privilege of reaching a settlement of 5 percent to 20 percent of trailing 12-month production, according to Stief.
That can happen even if you're leaving an independent to hang your own shingle. For instance, in January, Lynn Allen, a Stevensville, Md., advisor left the firm she had been with for eight years to strike out on her own. But because she had signed a contract that included a non-compete clause, the company sued her. After three months, they reached a settlement, with a list of clients she could approach and the fee she had to pay to exit her contract. (Allen declined to disclose the amount.) To pay for the $8,000 in legal fees, Allen tapped a $35,000 startup loan she got from her broker/dealer; the B/D also helped finance $10,000 of the settlement, which she's paying back in monthly installments. She now has about $13 million in assets under management, or most of the $20 million in assets represented by the clients on her approved list.
Such loans are often necessary, of course, but they should not be taken lightly. It's possible to end up in court if you signed a promissory note for a loan when you started at your firm. Generally these loans stipulate that if you stay at the firm for less than a certain period of time — say, five years — you can't solicit business from existing clients until you pay it back. “You really have to know what your contract obligations are,” says Stief.
Of course, a lawsuit isn't guaranteed. In many firms, the branch manager has a lot of discretion in whether or not to go after you. So, if you leave on good terms, you might not get hit at all. If you're generating under $500,000 or so in production, it also might not be worth the effort for the firm to pursue you. Then again, there's the matter of timing. “If you're one in a long series of departing reps, your firm may feel they have to take a stand,” says Stief. “If not, they might not care.”
Your firm stealing your clients.
Even if you have no employment contract, you aren't home free. You're still not allowed to contact existing clients about your plans until after you've left. In fact, you have to wait until your license has been approved by the NASD and the state. That won't happen until your old firm has sent your U4 along — and it might just decide to drag its feet. As a result, the process can take anywhere from a few days to a month. In the meantime, it's open season on your client base, as your old firm divvies up your accounts among remaining reps, who can then try to convince your people not to make a switch with you.
When Rob Wright left U.S. Bancorp Piper Jaffray two years ago to co-found Tucson, Ariz.-based Schannep Investment Advisors, he discovered that some of his former colleagues tried to scare clients into staying by suggesting he might go out of business. “A good friend apologized to me later, because he'd told some clients I was flunking out of the business,” he says. About 85 percent of his old accounts eventually made the switch to his new firm.
“There's an extreme urgency to contact and transfer hundreds of accounts all at once,” says Robert Hand, who recently left a regional brokerage after three years to become independent in New Orleans (for a related story, see page 112). “You have to contact all your clients first, explain why you're leaving and why it's in their interest to transfer their account, and get them all the right forms.” Hand hired an assistant to help him by mailing letters and making calls. Even so, it took him about a week to get it all done.
In some cases, the firm might not have to go after your clients in order to keep them. If you've serviced accounts jointly with other reps, for example, you probably won't be able to bring them with you. “The more people that touch a client relationship, the more the relationship stays with the firm,” says Philip Palaveev, a senior consultant with Moss Adams, a Seattle consulting firm specializing in financial advisors.
Naturally, you'll have an easier time if you've moved firms already. Jeff Smith, a New York City advisor now affiliated with AIG/Royal Alliance, for example, recently left Smith Barney to go out on his own. But, six years before, he'd switched from Merrill Lynch. The upshot: Smith already had experience moving accounts — and his clients had experience with it, too. So, when he called to let them know his plans, many of them weren't taken by surprise. “It wasn't something I was doing for the first time,” he says. So far, Smith says, he's pleased with the number who have decided to come with him.
As with employment contracts, a good relationship with your manager also helps. Hand, for example, also had plenty of experience moving clients before he went out on his own; he'd already switched firms two times before. After leaving one wirehouse, the branch manager had copied all the data on his computer to see whether he'd been sending letters to clients about his plans while still at the firm. So, before his last move, Hand made sure to stay on good terms with his branch manager, even though he knew almost from the day he started that he would leave. The result: The firm went after him with considerably less vigor than the others had.
Clients declining to move with you.
“A significant reason clients at a wirehouse come to you is for the brand name,” says Moss Adams' Palaveev. Consequently, if you haven't established relationships of trust, based on providing sophisticated financial advice, as opposed to making trades, you might find many of your accounts would just as soon stay with the old firm.
Therefore, if you want to leave, it's best to rev up the service with key clients well before you depart. “Six months before, you should start aggressively holding reviews with top clients,” says Paul Largo, branch manager of the transition suite at AIG/Royal Alliance. “When you call to tell them your plans, it shouldn't be the first contact they've had from you in months.”
Choosing a broker/dealer.
If you're like most wirehouse refugees who go independent, you'll choose to affiliate with a broker/dealer. The selection is no small matter. B/Ds, of course, not only provide software, help with compliance and other services, but they also often have a team to help with the transition. (Some, like AIG/Royal Alliance, provide substantial help. It recently launched a new transition program, complete with office space and other facilities reps can use for the first six months or so after striking out on their own. Other B/Ds offer considerably less extensive assistance, or else aren't specifically wooing wirehouse refugees.)
Your B/D will also hold your license, so you will conduct your trades through its clearinghouse. And, if you so choose, many will let you do fee-based planning, as well.
The wrong selection can mean everything from research reports filled with errors to inconvenient reporting requirements and lengthy delays. But finding the right one means wading through the 650 or so B/Ds in operation and determining which one is the best for you — a Herculean task. Wright, for example, spent about three months investigating about 30 firms before choosing Round Hill Securities.
The main factor in the decision tends to be the payout, which ranges from about 80 percent to 100 percent — at least, that's the published number. In reality, a number of other charges can significantly reduce what your real net is.
Then there's the level of service and technology. Just because a firm promises top-of the-line software or round-the-clock customer service doesn't mean you'll get it. In fact, 39 percent of reps surveyed said the top reason for leaving their B/D was quality of home service, and 35 percent cited inadequate technology, according to Cerulli.
What's more, your choice might not want you. These days, B/Ds tend to scrutinize complaint records carefully. “If you have any type of complaint, it's going to hurt you,” says Cerulli's Gallant. “These firms are gun-shy.”
Plus, they often require minimum levels of revenues and experience. Roundhill Securities, for example, requires at least $200,000 gross revenues a year and five to 10 years experience. According to Bill McGovern, senior vice-president business development of Raymond James Financial Services, his firm turns away “several people” for every rep they accept.
Dealing with compliance hassles.
One of the nice things about affiliating with a B/D is that it will take care of most of your compliance requirements. But, that doesn't mean you're completely off the hook. What's more, some are easier to deal with than others.
Jim Butler, for example, who started Videre Asset Management in Exton, Pa., eight years ago, switched his B/D two years ago, because, he says, “I felt my first B/D's compliance department was not an ally, but a foe. It was like I was sitting down with the SEC.” Getting approval to submit an article to a newspaper, for example, involved so many forms and so much time, Butler decided it wasn't worth the effort.
If, on the other hand, you choose to become an RIA instead, working as a financial planner and aligning yourself with your own custody agent, you're in for a much tougher road, since you'll be responsible for everything, from setting up your system to day-in, day-out record-keeping. Typically, you'll have to hire an outside consulting firm to help you set up your books and record systems. After that, you can do anything from paying them once a year to help prepare for an SEC audit, to turning them into an outpost of your office, even doing your daily record-keeping, so you don't need to hire someone on staff to do that job. Costs can range from $5,000, for an initial set up fee, to $35,000, for soup-to-nuts service.
An avalanche of competition.
If you choose to go independent now, you'll be jumping into the fray at a time when the market is still soft, and you're hardly the only kid on the block. Competitively speaking, you've got much more to worry about than just your fellow independents. Major wirehouses and regional brokerages have all started stealing their thunder, allowing reps to do fee-based planning, often with bonuses, and sell non-proprietary products. About 66.7 percent of wirehouse reps now refer to themselves as financial planners, according to Cerulli. “Differentiation among different channels will become increasingly difficult,” say Gallant of Cerulli.
You don't have what it takes.
One of the harsh truths of independence is this: You've got to be tough to make it.
For starters, since you can't contact clients until you leave, you can expect a period of one month to three months when you're doing nothing but transferring accounts and holding clients' hands, along with all the other chores associated with getting up and running.
“You have to learn a new computer system, a new way of inputting transactions, whom to call when the computer rejects a trade,” says Hand. The upshot: an immediate drop in income.
For that reason, you need to have at least a year's worth of expenses in the bank. More important, “If you make anything under $150,000 to $200,000 in gross revenue, you will probably struggle to maintain the level of income you were making before,” says Moss Adams' Palaveev. “Going on your own would probably not be the best choice.” That's largely because you won't be able to meet your fixed overhead expenses. For practices with about $300,000 in revenues, for example, overhead accounts for about 35 percent of revenues, or a whopping $110,000.
That overhead is mostly due to staff salaries. But, the hard reality is, you can't grow the business without adding staff. Advisories with $25 million to $50 million in assets under management have an average of three staff people, for example, while those with $100 million to $250 million have seven, according to Cerulli Associates. Even if big growth isn't your aim, in most cases, it's something you will have to contend with — if you want to increase your income. Pre-tax income per owner was $50,000 for firms with $150,000 in gross; that's compared to $130,000 in take-home for practices with $350,000 and $200,000 in income for advisories with $700,000. “The larger the practice, the more money you make,” says Palaveev. “You need a critical mass.”
Managing your own business.
It's probably the biggest stumbling block for any wirehouse refugee gone independent, and one of the main constraints on growth. You're no longer someone who provides financial counsel. You're someone who provides financial counsel, makes payroll, sees that the trash is collected, manages a staff, finds and furnishes an office, purchases a computer — all of the myriad tasks entrepreneurs must assume. Indeed, you can figure a substantial part of your time will be spent on non-financial activities — and that's true no matter what the size of your business. About 65 percent of firms with $25 million to $50 million in assets under management spend more than 20 percent of their time on such activities; those with $500 million or more spent 50 percent, according to Cerulli.
But, while those other tasks take up a lot of your time — and are crucial to success — it's likely you won't be that great at them, at least not at first. “A lot of reps are good as salespeople and advisors, but they're not so good as business owners,” says Moss Adams' Palaveev. In fact, 44 percent of practices affiliated with a B/D don't even have a business plan.
What some reps do to address the small-business dilemma is to go out in a group. That's what Wright of Schannep Investment Advisors did. He teamed up with two former colleagues, each of whom had complementary skills — one was a CPA and another had been a branch manager, while Wright had had experience working in a startup. Result: They started out with a combined total of about $55 million in assets under management. Or, you can set yourself up in a confederation of other advisors, sharing office space, copier machines, conference room facilities and the like, as well as drawing on each others' expertise when needed.
Jim Almond, with Financial Network in Dallas, for example, works out of a regional office of his B/D, along with about five other planners. While they don't share clients or work in the same practice, they do help each other out. Recently, for example, when he had a question about an interpretation of community property law, Almond asked one of his office mates, a Ph.D. in economics, for his opinion.
“There are a lot of advantages to being able to talk through situations with multiple planners,” Almond says. “It's better than being a lone wolf.”
Despite all the hassles, however, many advisors say going independent is worth the effort.
Take Thomas Dupree of Dupree Financial Group, a Lexington, Ky., firm affiliated with Raymond James Financial Services. Last August, fed up with the bureaucracy of his wirehouse, where he'd worked for 19 years, he struck out on his own. From the ability to experiment with new marketing approaches, to the chance to tithe 10 percent of his pretax revenue to charity, Dupree is thrilled with move.
About 100 of his 200 clients, many of them his bigger accounts, moved with him, and he expects to be profitable by second quarter of next year. “It's a big change, but a good one,” Dupree says. “I'm very happy.”
Percentage of principals who spent more than 20 percent of time on non-financial activities. (Dollars in millions.)
|Assets Under Management||Percent of Time|
|$25 to $50||65%|
|$50 to $100||57%|
|$100 to $250||53%|
|$250 to $500||51%|
|Source: Cerulli Associates|
The Bigger the Better
A quick guide to how much income can be derived from various gross-revenue totals.
|Gross Revenue||Pre-tax Income Per Owner||Income/Gross Ratio|
|Source: Moss Adams|
Projected number of independent broker/dealer reps.
|Source: Cerulli Associates, Nelson's|
Projected number of retail RIAs.
|Source: Cerulli Associates, Money Market Directories|