Shining a Bright Light on the High Costs of Breaking Away

Shining a Bright Light on the High Costs of Breaking Away

Once You Break Free of the Wirehouse, You Need to Run From the Platforms and Aggregators, Too!

There is always a dark side to success.  The RIA market has been booming for years, consistently taking assets away from the traditional bank/wirehouse community, and now manages nearly $3 trillion in assets.

As the overall assets under management has risen in the RIA community, a slew of opportunistic middlemen have put up their shingles, offering “platforms” or an “aggregator solution” to help captive advisors break away and remove the operational aspects of the transition to independence - a truly valuable service that is needed by breakaway teams who have never had to manage these critical issues before. 

The rub here is that these middlemen are using the lack of experience and knowledge of these advisors against them to extract exorbitant rents.   As a result, the high costs associated with the aggregators and platform providers is limiting and slowing down the breakaway movement, especially for the larger teams – a very unfortunate result for not only those advisors and their clients, but also the industry as a whole.

In many ways, the financial crisis of 2008 was the greatest thing to ever happen to the RIA industry.  High net worth clients began to value the open architecture, transparency, and conflict-free business models offered by independent advisors.  Once clients began asking for it, advisors began flocking in droves to the independent channel.  Most, if not all, of these advisors had never set up or run their own business before, so a cottage industry evolved helping these teams enter the independent channel.  The typical advisor thought, “I want to go independent, but I just want to focus on my clients.  I don’t want to worry about running my own business.”  They were flocking to plug-and-play solutions, regardless of the cost.  They just had to get out of the shackles of the wirehouse world, and they needed to do it quickly.

Fast-forward to today: the industry has continued to evolve and billion-dollar RIAs are no longer the rare unicorns that they once were.  In California alone, there are over 40 fee-only RIAs that manage over $1 billion in assets.  RIAs have lifted their heads from their client servicing responsibilities to realize they have built real businesses!  They have started hiring dedicated managers of their businesses to handle HR, IT, Compliance, and Business Development.   They have documented business plans, with specific revenue targets and growth strategies.  These aren’t lifestyle practices any longer, these are true sustainable business built for the future.

There is a lot at stake for a wirehouse team considering setting up their own RIA.  Following the 2008 financial crisis, it was enough to attract clients simply by saying “I’m an independent advisor conducting business under the Fiduciary Standard.”  As previously mentioned, there is now fierce competition of real businesses competing for RIA clients.  No one wants to figure out the transition experience on their own (See “A Breakaway Artist Confesses the Mistakes He Made Ushering PBIG’s Hou-Sear Team”) -- the fear of losing clients during transition is just too high.

Unfortunately, while the industry has evolved to become more sophisticated, the transition solutions for wirehouse advisors, particularly the billion-dollar teams, have not.

Currently, due to the lack of alternatives, these teams meet with the legacy opportunistic platform providers/aggregators that can offer the valuable startup services such as real estate, office setup, technology, branding, website, and even “swag” that they need to exit their current firm.  The sales pitch they receive is that by plugging into these larger organizations, they can provide teams economies of scale where they can negotiate great pricing with the various vendors and service providers on their behalf.  Here’s the fly in the ointment: for these services, the aggregators want a percentage of firm ownership (bottom-line earnings) and the platform providers charge expensive basis points on AUM.  

Breakaway advisors find themselves wondering where the promised value-add services are, now that they are established RIAS writing big checks every year to these middlemen.  Confirming this trend, we are now beginning to see high-profile stories of advisors who had joined the aggregator platforms, only to realize they can do better on their own, such as PagnatoKarp (See “After chats with Phyllis Borzi, a flagship HighTower team executes a ‘deliberate’ breakaway to for a $2.5-billion RIA”

As an example, consider a $2 billion team with $15 million in revenue and $10 million of bottom-line earnings.  If an aggregator wants 50% equity for their services, that would cost this team $5 million per year, in perpetuity.  If a platform provider wants to charge 5 bps for their services, that will cost this team $1 million per year for the length of the contract. 

These teams sit back and realize, “With $2 billion of AUM, I can get great pricing on IT, Compliance, and Custody all on my own.  I don’t need a long-term relationship, I really just need help setting up my RIA and transitioning clients.  This long-term contract seems awfully expensive just for transition services!” 

When running the numbers, teams realize that it is not economical to make the move to an expensive aggregator or platform provider solution, and as a result, end up staying with their wirehouse firm – a suboptimal outcome not only for their clients, but also for themselves and the industry as a whole.

For the truly entrepreneurial advisors, they realize very quickly that the equity and/or AUM pricing eliminates operating leverage – something they are trying to achieve by going independent.  Operating leverage is a simple, yet powerful business concept where every dollar of additional revenue is more profitable than the last, because operating expenses don’t grow at the same rate as revenue.  In the wirehouse world, an advisor’s payout percentage doesn’t change once they top out on the production grid, resulting in no operating leverage. 

RIAs, however, enjoy economies of scale and own 100% of their revenues, and do gain leverage from each incremental revenue dollar.  That is, unless they’ve sold a percentage of bottom-line earnings, or have agreed to pay a fixed rate based on AUM.  In those scenarios, the payment to these service providers continues to rise as earnings and/or AUM increase, effectively wiping out precious operating leverage.

What billion-dollar teams need today to transition out of the wirehouse world and start their own RIA is to use their inherent economies of scale to obtain the resources and preferred pricing promised by the platforms and aggregators. 

To get up and running, teams only need to work with experienced consultants who operate on a fee-based, project basis for the RIA business’ startup needs (full disclosure:  I am the Founder & CEO of one of these firms, PFI Advisors).  Once the clients have transitioned out of the wirehouse and the RIA infrastructure is in place, advisors quickly realize that they are a self-contained business, easily capable of handling the day-to-day operations of their own firm.

There is no need to pay for these services through the aggregators or platform providers by giving up valuable equity or paying steep ongoing basis points on a multi-year contract.  Rather, by tapping into the deep expertise and knowledge of industry transition experts – those that are independent and not tied to a specific platform – advisors can achieve a quick start up with the latest transition needs.

Teams can pursue their RIA dreams in confidence, knowing that they have the right advice and support to build their dream firm the right way, without having to give up a significant portion of their firm.

This article is based upon a recent white paper, “Pursuing the RIA Dream: New Transition Models for Billion-Dollar Breakaway Advisor Teams.” To obtain a copy, click here.

Matt Sonnen
Advisors in Transition
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Prior to founding PFI Advisors, Matt Sonnen learned the ins and outs of the wirehouse model at Merrill Lynch in the late 1990s. After leaving Merrill in 2005, he was introduce ... Click for full bio

Retirement Planning Has Its Limits: How to Prepare

Retirement Planning Has Its Limits: How to Prepare

Retirement planning is one of the issues that commonly leads clients to consult financial advisers. One of its essential aspects is creating a plan to save and invest in order to provide a comfortable retirement income. Ideally, this starts many years ahead of retirement, even as early as your first paycheck.

As retirement comes closer, planning for it expands to take in a host of other considerations, such as deciding when to retire, where to live, and what kind of lifestyle you hope to have. When retirement becomes a reality, the focus shifts to carrying out the plan.

All of this planning is crucial. Yet, for both financial advisers and clients, it's good to keep in mind that planning has its limits. In the post-retirement years, it may be helpful to think in terms of preparing for old age rather than planning for it.

The older we get, the more important this distinction between planning and preparing becomes. Too many life-changing things can happen without regard to our best-laid plans. Often they occur unexpectedly, resulting in emergency situations where urgent decisions have to be made. A stroke or a fall, a diagnosis of terminal illness, a broken hip that leaves someone unable to go back to independent living—and suddenly, right now, the family needs to find an assisted living facility, arrange for live-in help, or sell a home.

What are some of the ways to prepare for these contingencies?

  • Explore housing options well ahead of time. Find out what assisted living, home care, and nursing home services and facilities are available where you live and whether they have waiting lists. Have family conversations about possibilities like relocating or sharing households.
  • Research the financial side of these options. Investigate the cost of hiring help at home, assisted living facilities, and nursing care centers. Find out what is and is not covered by Medicare and long-term care insurance. For example, people are sometimes surprised to learn that Medicare does not pay for nursing home care other than short-term medical stays.
  • Designate someone to take over decision-making, and do the paperwork. Execute documents like a living will, medical power of attorney, and contingent power of attorney. Update them as necessary, and give copies to your doctors, your financial planner, and appropriate family members.  
  • Start relatively early to downsize. Well before you're ready to let go of possessions or move into smaller housing, start considering what to do with your "stuff." Focus on the decisions rather than the distribution. There's no need to get rid of possessions prematurely, but decide what you want to do with them—and put in writing. Do this while it's still your choice, rather than something your family members do while you're in the hospital or nursing home
  • Do your best to practice flexibility and acceptance. No matter how strongly you want to live in your own home until the end of your life, for example, it may not be possible. The physical limitations of aging can limit our choices, and even the best options available may not be what we would like them to be. It is a profound gift to yourself and your family members to accept these realities with as much grace as you can muster.

Finally, please don't underestimate the importance of planning financially for retirement. Because the bottom line is that you can't plan for all the things that might happen as you age, but you can prepare to deal with them. One of the most useful tools to cope with those contingencies is having enough money.

Rick Kahler
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Rick Kahler, MSFP, ChFC, CFP is a fee-only financial planner, speaker, educator, author, and columnist.  Rick is a pioneer in integrating financial planning and psycholog ... Click for full bio