One of the “luxuries” of operating as a solo financial advisor is the simplicity of dealing with advisor compensation: the gross revenue of the business, minus your costs, is your net income as the advisor/owner. However, at some point in time, many advisors will consider launching a multi-advisor partnership – either as a means to share (and split) growing overhead costs, or perhaps to try to build a multi-advisor “ensemble” firm that is bigger than what any one advisor can create on his/her own. Yet in the process of shifting to a multi-advisor firm, especially when merging together multiple existing firms with varying numbers of existing clients and revenue, it’s necessary to navigate the messy process of determining how to split equity and partner compensation in the new business entity!
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we discuss ways in which financial advisors choose to split equity and partner compensation when forming a multi-advisor business, and why the structure of the arrangement depends on heavily what type of firm you’re ultimately trying to grow in the first place!
Historically, the most common reason to form a multi-advisor firm – whether as an RIA, or more often on an independent broker-dealer platform – was to share and split overhead costs (e.g., office rent, administrative staff, and perhaps gain some bargaining power to get a better payout rate as a group of advisors). In this context, all of the advisors still took their “own” revenue from their own clients, and the primary or sole purpose of the business was really just to split the costs. As a result, the “equity” split was really just a reflection of how to split the costs themselves, and all partners were compensated based on their own individual client revenue (reduced by those shared costs).
On the other hand, with some multi-advisor firms, the goal is actually to build a true standalone business, in which all the advisors contribute to the growth and success of the business (i.e., an “ensemble” firm) that is larger than any one of them alone. With this type of partnership, equity and compensation dynamics are different: the primary driver of value and wealth creation is not client revenue (less expenses), but net business profits and the (slice of) equity value of the aggregate business. Which means taking uniform salaries based on job descriptions (not revenue-based compensation from clients), plus perhaps a bonus for business development, and deriving most long-term value directly from the equity itself.
If the ensemble firm is being created from scratch, this typically results in an even equity split amongst all the partners. However, in most cases, at least some of the advisors already have existing clients and revenue, which may be uneven when they come to the table. Which means it’s necessary to either set the ownership percentages based on the relative amount of revenue that’s being brought to the table in the first place (e.g., if a partner brings 70% of the revenue they receive 70% of the equity), or to equalize ownership at the start through a buy-out (e.g., if one partner brings 70% of the revenue the other partner buys them out of 20% and each gets 50% equity). The advantage to the latter strategy is that if growth between partners is relatively equal going forward, then each partner has an equal incentive to grow the firm, and receives an equal benefit for doing so.
The key point in all of this, though, is simply to recognize that there’s a big difference between forming a “let’s share the overhead costs” multi-advisor partnership, where each advisor keeps their own client revenue and their goal and upside is to build their own client base, versus a true “ensemble practice” where you’re trying to build the shared equity value and the upside isn’t your client revenue but your participation in the bottom line profits of a growing business entity. Because if you want to build an ensemble business, and the other partners just thought of this as a cost-sharing partnership… the visions are so different that, regardless of how equity and compensation are split, this partnership isn’t likely to go well!
(Michael’s Note: The video below was recorded using Periscope, and announced via Twitter. If you want to participate in the next #OfficeHours live, please download the Periscope app on your mobile device, and follow @MichaelKitces on Twitter, so you get the announcement when the broadcast is starting, at/around 1PM EST every Tuesday! You can also submit your question in advance through our Contact page!)
Michael Kitces is a Partner and the Director of Wealth Management for Pinnacle Advisory Group, co-founder of the XY Planning Network, and publisher of a continuing education blog for financial planners, Nerd’s Eye View. You can follow him on Twitter at @MichaelKitces.