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Growing Pains

It's never easy, but as a firm gets bigger it'll get better - if you know what your doing

Ever think of your practice as your baby? Well, you should. For one thing, it needs an awful lot of care and attention. For another, you can expect it to go through a number of fairly predictable stages of growth.

As with any modern parent, you're faced with challenges each step of the way, and as soon as you're hit by one phase, another one rushes up right behind it. Just look at the numbers.

In the past four years, the amount of assets managed by registered investment advisors' firms increased nearly 40 percent, to an estimated $2.2 trillion from $1.6 trillion, according to Celent, a Boston-based financial research and consulting company. “As these organizations grow, they're going from being small to much bigger very, very quickly,” says Doug Beck, a senior vice president with Schwab Institutional in San Francisco.

The way to deal with a practice as it develops, say many experts, is to know just what you're in for, the better to prepare yourself so you can adapt to the changes as quickly as possible. Here's a look at the key hallmarks of each stage and some of the challenges you may encounter on the way.

Going Solo

When you're managing less than $50 million or have revenues of under $500,000, you're just getting started. Most advisors launch their practices as solo endeavors, with, perhaps, an assistant to help them out. That puts a huge burden on the boss, leading to long hours and sleepless nights.

Frank Fantozzi, for example, started Planned Financial Services, his Cleveland practice, in 1994, and ran it without an assistant for six months. He calls the first five years in business “the dark years.” “I worked 70 hour weeks, doing stuff like seeing people at 10 o'clock at their homes,” he says. The stress and hours started affecting his marriage, as well.

If you're successful, however, at some point — anywhere from five to 10 years after starting up — you'll probably hit a wall. “One advisor can handle only so many clients,” says Philip Palaveev, a senior consultant with Moss Adams, a consulting and accounting firm specializing in financial-advisory practices. Generally, the limit is about 150 clients, although, says Palaveev, the occasional advisor can work with as many as 200. Whatever the magic number is, according to Palaveev, when it is reached, that's the point at which most advisors realize they have to make a decision about whether or not to continue as solo practitioners.

Fantozzi reached his limit eight years after launching his practice, when he experienced a typical epiphany. With 125 clients, he was overwhelmed. Plus, “I was a glorified employee,” he says. “Without me, the business stopped.” So, Fantozzi took a big step: He hired two employees — another financial advisor and a compliance officer. After that, he added two administrative staffers. Assets rose from under $20 million to the $75 million he has today. And he has been able to double the number of clients to 250.

Of course, some advisors choose to remain solo. That choice generally requires two moves: You have to stop taking any client who walks in the door. And you need to come to terms with the fact that you'll be making some key sacrifices — everything from long vacations to bringing in more money.

“You're always going to be struggling with the question of your capacity,” says Palaveev. Plus, since valuations of solo practices are tough to make, you'll have a harder time selling it. Remember: RIAs have to register with the SEC when they reach $25 million in assets under management. And, even if you remain solo, your compliance costs are likely to shoot up.

The Silo Practice

In passing the $50 million to $70 million in assets, you've gone beyond what Richard Steiny, president of AssetMark Investment Services in Pleasant Hill, Calif., calls “the ceiling of complexity.” That means you've reached the point where you can't nurture big client relationships without bringing in more help, specifically hiring more staff, outsourcing things like money management or doing both.

There's also a different tack advisors often take at this stage of the game. It involves teaming up with peers, sharing resources under one roof, like administrative help and computers, often operating under the same brand name without splitting revenues or clients. Palaveev calls it the “silo practice.”

When it works, the system pays off handsomely. Thanks to lower overhead, advisors in successful silos have twice as much income as advisors in solos, according to Palaveev. On the other hand, they're also ripe systems for conflict. You have to be able to get along with your comrades, of course, and figure out ways to share resources efficiently — something easier said than done. Indeed, according to Palaveev, many silos have higher overhead than solos, because the advisors can't agree on, say, what type of computers to buy and end up purchasing more than they need.

Palaveev points to one client, the member of a three-year-old six-person silo, who came to him seeking help in how to sort out the mess he and his colleagues were in. It seemed they couldn't agree on much of anything. As a result, they were using three software systems and a different administrative record-keeping process for each advisor. Plus, there was constant bickering over what resources to buy and how much to pay for them. Eventually, they were able to decide on one software choice and devise a single administrative system. But, says Palaveev, “It wasn't easy.” They also agreed to a different formula for determining how much each would contribute to expenses.

Partner to Partner

When advisors are managing between $100 million to $500 million in assets and pulling down $1 million to $5 million in revenues, they likely need to align with at least one or two other peers and form a real team — sharing revenues, clients and expenses — if they want to keep growing. Each partner will probably have a different strength, i.e., business development or operations management.

The crucial ingredient is successfully integrating the different practices. That requires a well thought-out common strategy. And you need to share the same investment philosophy. A year ago, for example, Rich Moran joined forces with an advisor, whom he had shared office space for 12 years, and a third person they both knew. Together the three advisors formed Moran Kimura & Heising in Torrance, Calif. What made it easier to integrate, among other things, was that over the years Moran and his colleague had traded investment advice and opinions and grown to see how in synch their thinking was on areas like diversification and cash-flow analysis. Combined assets under management are now about $200 million.

A year ago, J. Michael Fay, 69, was beginning to plan for retirement and wanted a home for his practice after he was gone. Fay, a partner with Claremont Financial Group in Claremont, Calif., was hoping to phase out completely over the next three to five years. So, he merged Claremont with SRS Private Asset Management, a neighboring firm run by two 30-something advisors, forming a practice with about $120 million in assets under management. He plans to sell his share to his new partners when he leaves.

Perhaps the toughest task facing advisors at this phase is the client pruning process. That's because efficient growth requires that you assess your client roster more strategically and cut those that don't fit. It's a difficult process for many advisors, who must cut loose clients they may have worked with for years. The best approach: sending something in writing, then following up with an in-person meeting.

For example, Bob Smith, a partner with Spiro Smith Investment Advisors, analyzed the costs of the Cleveland firm, which has $320 million in assets under management, last year and realized how out of whack client expenses were. The best way to improve the situation: Focus on bigger, more profitable accounts with a target size of at least $1 million. So, the firm wrote to 20 of its 290 clients explaining that it was raising its fees and offering to set them up with advisors who might be a better fit.

Strategy and Management

When you get really big, say, over $500 million in assets and $5 million in revenues, you face an entirely new world requiring a different level of expertise. You'll offer multiple services — estate planning, tax advice and so on-with a staff of 20 or 30 employees. And, like it or not, you may not work directly with clients anymore but, instead, manage and develop strategy.

Case in point is Michael Yoshikami, who heads YCMNet, a 20-year-old practice in Walnut Creek, Calif. Four years ago, he forged a new business plan and stepped back from client contact to devote his attention to strategic planning. During that time, he also added two advisors a year; he now has a total of eight, along with 30 other employees. Assets have grown from $250 million to $750 million in that time.

Chances are, however, not all your staff will be able to keep up. Indeed, it's likely that at least some of the employees who thrived when your practice was smaller might not be up to the requirements of a much bigger, more sophisticated organization. “As the firm grows, you need people whose skills can grow with you,” says Yoshikami. About eight staff members have left since he began his new push four years ago.

Ultimately, every phase of development tends to share at least one common challenge: increasing costs. Indeed, making each successive stage work successfully inevitably requires greater expenses. Yoshikami, for example, says costs have increased over 400 percent because of more office, staff and technology needs. But, just like that summer camp your third grader wants to attend or the orthodontic work your teenager needs, it's money well worth spending.

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