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This post is a summary of a session from the MMI 2011 Fall Solutions Conference.  It is part 2 of a 2 part series.  You can read part one by clicking here.

The speaker for this session was Mark Tibergien, Chief Executive Officer of Pershing Advisor Solutions, a BNY Mellon company.

6. Don’t Forget About Business Continuity and Succession Planning

When Mark was looking for an advisor to manage his own money, one thing he avoided was solo practitioners, since they often do not have succession plans. He knew that he didn’t want to be looking for his teeth and glasses at the same time he would be looking for a new advisor!

The average age of principals is increasing and succession is a huge challenge, Mark informed us. The advisor population is skewed towards the upper end of the age range. There are just as many advisors who are ten years away from retirement as there are advisors that are three years away, he reported.

Mark emphasized that the fiduciary relationship with clients must be maintained and all efforts should be made to do everything in the client’s best interest. Putting a succession plan in place is definitely in the client’s best interest! Succession planning is a growing need, he said.

A recent survey of over 500 RIAs by TD Ameritrade found that 62% of advisors say they have or are in the process of developing a succession plan, up from 43% in 2010:

Top reasons for creating a succession plan, the advisors said, are satisfying client expectations (66%), supporting the long-term viability of the firm (51%) and providing a smooth transition into the advisor’s retirement (49%). Advisors nearing retirement say difficulty identifying an internal successor (53%) and lack of time to develop a succession plan (21%) were top reasons they don’t have a plan in place.

Many advisors think that simply having a buy-sell agreement with someone means they’ve completed their succession planning! However, Mark emphasized that this doesn’t ensure the continuity of the business.

The typical advisor has a co-dependent relationship with their clients. As the clients get older, they trust their advisor more. But, if they don’t start providing for an orderly succession transition, they risk leaving their clients unprotected.  During a succession, an advisory firm owner must manage transitions of the clients, owner and management all at the same time!

Mark then described the four phases in the life cycle of an advisory firm:

  1. Wonder – advisors feel optimistic, are very hands on, but manage by the seat of their pants, have no profits or cash
  2. Blunder – period of high growth at mach speed, advisors are feeling stressed, and their management style is crisis, financial performance is more revenue, but less cash because you’re re-investing in the business.
  3. Thunder – peak period in an advisors career where everything is falling into place, they start wearing dark clothing, they generate profits and cash
  4. Plunder – the declining years, advisors cut back their hours, they’re caught between wisdom and obsolescence, their management style is indifferent, their profits are declining but their cash is increasing because they’re trying to extract as much as possible from the firm before they get out of the business

These stages are from a book by George Hartman titled, Blunder, Wonder, Thunder: Powering Your Practice to New Heights.  You can read a review of it here.

7. Remember to Rebuild the Value in your Firm

In order to drive cash flow up, you must mitigate uncertainty and maximize future growth opportunities, Mark explained. Firms that don’t have a process for driving new growth will have problems with their valuation when it comes time to sell, he said.

Mark presented this formula for business value:

Business Value = cash flow / (risk - growth)

Mark said that the challenge for advisors is to shift focus from retiring baby boomers and onto the new generation of accumulators.  He then referenced the following quote by Cam Marston, an author and lecturer on how generational demographics are changing the landscape of business, from an article in Investment News:

A recent Bank of America Merrill Lynch study predicted that the baby boomers will pass $41 trillion to the next generation, mostly Millennials.  That’s the good news. The not-so-good news is that 80% of those heirs will move to a new financial adviser or manage the inheritance themselves.  Thus the generation of advisers that has overseen one of the greatest accumulations of wealth in history is about to watch it walk out the door.  Should they stand idly by or is there something they can do about it?

Why are most advisory practices sold?  In the past few years, there was an average of only 40-50 transaction annually among advisory firms with more than $100 mm AUM, Mark reported.

Some trends that will drive the market in the near future are from a whitepaper by Pershing Advisor Solutions called Real Deals 2010: Definitive Information on Mergers and Acquisitions for Advisors:

8. Actively Manage Your Practice to Maximize Profit

There are many mistaken beliefs that advisors have about what drives profit, Mark observed.  In the past, advisors viewed their business as:

Revenue - Expenses = Owner's Income (which should be around 60% of revenue)

But the cost of labor required to generate the revenue must also be considered.  Therefore,

Gross Profit - Overhead Expense (target is 35% of profit) = Operating Profit (target is 25% of gross profit)

The captive space is different, Mark pointed out, because the broker dealers are receiving the benefit of the operating profit and covering their overhead.  However, in the independent space, the direct expense is the advisor’s reward for labor, he said.  The operating profit is their reward for risk and ownership.

It’s not just about generating more volume or doing a better job of control costs, Mark emphasized.  You need to ask yourself these questions:

The cost of running an advisory business is increasing, Mark commented.  The average firm has an average expense ratio of 45% of profit, but the target should be around 35%.  New regulatory and compliance issues are squeezing firm’s profit, he said.

The fees and costs of customer service over the life of the relationship peaks at 65 and goes below costs at 75.

In the beginning they make a marginal profit and then hit a spike in profits and then profits go into a long, slow decline until the advisor is eventually losing money on every long-term relationship. Advisors need to redefine the client service experience as they get older, but with fees tied to assets, it’s a challenge. 35% of all RIA advisors are charging a retainer or project fee in addition to an asset management fee.

The real question is “do they know the cost of delivering their services?”. Do they know the market for their services? Can they define their value in such a way to ensure they receive a reasonable price for what they’re delivering?

10. Advisory Firms Should Invest in Leadership

Mark discussed some concepts from a book by Daniel Pink call A Whole New Mind: Why Right-Brainers Will Rule the Future.  For example, American business has been run by lawyers, accountants and investment bankers, who can all be considered analytical, left-brained people.  There aren’t enough strategic and conceptually thinkers who can envision an out-of-the-box future.  It should cause advisors to evaluate their own firms and ask whether they have the right mix of thinkers among their employees, Mark recommended.

Leadership is not the same thing as management, Mark declared.  Here are questions that Mark suggested be asked by Do you even know what business you’re in?  Is your strategy still relevant?  Are you able to persuade people to follow you?  Are you creating the right kind of culture which enables motivated people to flourish?

One of the great unheralded career paths in advisory firms is management, Mark said.  Successful firms are the ones that are hiring dedicated managers.  Firms with dedicated management have higher revenue and profits, more clients and AUM than those without dedicated managers, he said.

What characteristics should you seek in leaders?

An interesting commentary on leadership in advisory firms was made in an article by Matt Oechsli on RegisteredRep.com:

Elite financial advisors are leaders. They take a leadership role within their practice, with their clients, centers of influence, referral alliance partners, and prospects. As for leadership within the practice, this involves having a vision for the practice, creating a business plan, establishing annual goals, defining areas of responsibility, effective delegation, communicating clearly, and consistently inspecting what is expected. In other words, leadership is hands-on work.

Don’t rely on rules of thumb to run your practice.  This is a flawed way of thinking, Mark said.

This post is a summary of a session from the MMI 2011 Fall Solutions Conference.  It is part 2 of a 2 part series.  You can read part one by clicking here.

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