Are You Starv­ing Your Firm?

If you want to sell your prac­tice for a big pay day, aim for an­nual growth of 15%. That means rein­vest­ing in­tel­li­gently.

Financial Planning - - CONTENTS - BY BRENT BRODESKI

If you want to sell your prac­tice for a big pay day, aim for an­nual growth of 15%. That means rein­vest­ing in­tel­li­gently.

Far too many ad­vi­sors naively think that their largest as­set — their busi­ness — has a lot of value and will some­day pro­vide them, and their fam­ily, a big pay­day. But year af­ter year, they un­der­in­vest in peo­ple, process, tech­nol­ogy, mar­ket­ing and brand­ing. In a sense, they are re­lent­lessly milk­ing their RIA cow (their busi­ness) for cur­rent cash so they can spend a lot on toys and an in­dul­gent life­style. Sadly, this means they may end up with lit­tle busi­ness value. In­stead hav­ing a fat­ted calf to sell at re­tire­ment, they will find them­selves with a skinny, mal­nour­ished cow. Ad­vi­sors point to the fact that their old clients are sticky, which is true. But the prob­lem is that five to 10 years from now, the ad­vi­sor will be that much older (and less en­er­getic) and their ag­ing clients even older (or maybe dead). The busi­ness will have stopped grow­ing, and they may have a firm that is shrink­ing or, at best, stag­nant. Why is this prob­lem­atic? A stag­nant or shrink­ing busi­ness with an old founder and older clients can­not at­tract, nor af­ford, next-gen­er­a­tion ad­vi­sory tal­ent. In turn, it won’t at­tract next-gen­er­a­tion clients. The re­al­ity is that the best and bright­est next-gen tal­ent will not want to work for a stag­nant RIA that fails to make the investments re­quired for long-term suc­cess. As a re­sult, top young tal­ent will mi­grate to RIAS that pro­vide real op­por­tu­ni­ties or hang their own shin­gle and take your clients. If you re­ally care about your busi­ness value, it may be time to stop milk­ing your busi­ness so ag­gres­sively. In­stead, you should rein­vest in your busi­ness. In fact, to at­tract the best clients and cre­ate sal­able en­ter­prise value, you need to in­vest to grow 15% an­nu­ally. So what’s re­quired to achieve 15% growth? It de­pends on the size, stage and na­ture of your busi­ness and on the num­ber of sig­nif­i­cant own­ers. But, if you’re tak­ing out more than 40% of your rev­enue (as owner’s com­pen­sa­tion, ben­e­fits, perks and profit dis­tri­bu­tions), you are prob­a­bly over­milk­ing. To pro­vide some rough guide­lines about how to bud­get for growth, here are the investments you should con­sider mak­ing to grow your RIA 15% per year. Peo­ple ex­pense. Without great young em­ploy­ees, your busi­ness may be a mar­ginal con­cern when you are gone. It will be un­likely to at­tract or re­tain great clients. Thus, you need to in­vest in your peo­ple. Peo­ple ex­penses in­clude nonowner wages, ben­e­fits (top tal­ent won’t stay if they don’t have ro­bust re­tire­ment and health care plans), pay­roll taxes, and em­ployee ed­u­ca­tion and train­ing costs. For your busi­ness to grow 15% an­nu­ally, you should be spend­ing 10% to 20% of an­nual rev­enue on your nonowner ad­vi­sors. These ju­nior ad­vi­sors can lever­age your time as lead ad­vi­sor, free­ing you to re­fo­cus on busi­ness de­vel­op­ment and ad­vis­ing the most im­por­tant clients. What’s

The cash you milked from your busi­ness in the past is mostly ir­rel­e­vant. Buy­ers want to un­der­stand its prospects for growth.

more, they even­tu­ally learn to find their own clients, in the process pro­vid­ing mar­ginal growth. On top of the ex­pense of as­so­ciate ad­vi­sors, non­ad­vi­sor em­ploy­ees should cost 20% to 30% of an­nual rev­enue. Process de­vel­op­ment ex­pense. To grow your busi­ness, you need repli­ca­ble, scal­able pro­cesses that are ef­fi­cient, em­bed­ded in tech­nol­ogy and de­liver real and per­ceived value to clients. The goal is to ex­pand the value you of­fer without just run­ning faster or just throw­ing more bod­ies at your clients. Ef­fec­tive and de­lib­er­ate use of process al­lows you to ac­com­plish more with fewer peo­ple. This typ­i­cally means in­vest­ing in con­sul­tants and/or in-house staff who can for­mal­ize and con­tin­u­ally re­fine busi­ness pro­cesses. This should cost you 2% or 3% of rev­enue yearly. Tech­nol­ogy ex­pense. This cat­e­gory in­cludes hard­ware, soft­ware, li­cens­ing, con­sult­ing and/or in-house tech­nol­ogy staff. Gen­er­ally, this should cost you 7% to 10% of an­nual rev­enues. This in­cludes the ba­sics (like lap­tops, servers, cloud-based stor­age, Mi­crosoft Of­fice and video con­fer­enc­ing soft­ware), core en­ter­prise sys­tems (that is, port­fo­lio man­age­ment, CRM and fi­nan­cial plan­ning soft­ware) and fin-tech to make your team more ef­fi­cient in pro­vid­ing client de­liv­er­ables. Just 10 years ago, ad­vi­sory firms did not have a lot of soft­ware op­tions. To­day, the chal­lenge is se­lect­ing (and ac­tu­ally us­ing) the right tech­nol­ogy. But em­brac­ing tech­nol­ogy is non­nego­tiable if you are com­mit­ted to growth. Mar­ket­ing and brand­ing ex­pense. This in­cludes things like ad­ver­tis­ing, web­sites, col­lat­eral, spon­sor­ships, con­sul­tants and pos­si­bly ded­i­cated mar­ket­ing staff. While many RIAS spend al­most noth­ing here, in our ex­pe­ri­ence, this ex­pense needs to be at least 4 to 7% of an­nual rev­enues. Some of the fastest­grow­ing firms spend 10% or more an­nu­ally to gen­er­ate leads and at­tract new clients. By con­trast, RIA’S that do not in­vest for growth tend to just fall back on re­fer­rals and their in­creas­ingly de­pleted net­works of com­mu­nity re­la­tion­ships and cen­ters of in­flu­ence to gen­er­ate leads. You’re prob­a­bly think­ing how could my firm be valu­able if I spend all this money on peo­ple, process, tech­nol­ogy, mar­ket­ing and brand­ing? The re­al­ity is that your past prof­its are only one met­ric that a buyer con­sid­ers when cal­cu­lat­ing what to pay for your RIA. The cash flow you milked from your busi­ness in the past is mostly ir­rel­e­vant. Buy­ers want to un­der­stand your busi­ness’s fu­ture prof­itabil­ity, its prospects for growth, the like­li­hood your clients will stay when you’re gone and your busi­ness’ in­her­ent risk. Still not con­vinced you need to in­vest for the fu­ture? Con­sider what hap­pens if your RIA is not grow­ing, or if fu­ture growth is un­cer­tain. In this case, it is likely that your clients are at risk of de­fect­ing. In such a sit­u­a­tion, fu­ture buy­ers will prob­a­bly pay cents on the dol­lar at best. At worst, they won’t even want your cow. Hav­ing said this, it may ac­tu­ally be OK to choose to over­milk your RIA cow. If you re­ally want to work un­til you die, if you are not overly con­cerned about your em­ploy­ees and clients when you’re gone, and if you’re pri­mar­ily con­cerned with liv­ing large now (ver­sus cre­at­ing multi­gen­er­a­tional wealth for your fam­ily), then milk it like crazy. Just make sure that you do not drink all of the milk. Save some of it, just as you in­struct clients to save for their re­tire­ments. Then, if you de­cide you want to re­tire af­ter all or if your health does not per­mit you to work past age 90, you won’t have to re­tire on a park bench when your busi­ness does not pro­vide you a big pay­check.

If you take out more than 40% of the firm’s rev­enue as owner’s com­pen­sa­tion and perks, you are prob­a­bly over­milk­ing it.

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