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Will Equity Answer Wealth Management’s "Compensation Conundrum?"
Charles Paikert
5 October 2020
What keeps owners of wealth management firms up at night? Compensation, recruiting, retention and equity certainly top most lists. Advantages of equity And not every firm should make equity available, she warned.
According to Schwab’s most recent Compensation Report, median compensation costs are 70 per cent of revenues for firms with over $100 million in AuM.
The advisory industry is also grappling with a severe shortage of quality talent. Accordingly, 76 per cent of firms are planning to hire from external sources in the next 12 months, and close to half of those hires will come from other RIAs, according to the Schwab report.
And to attract new talent, nearly three-quarters of RIAs surveyed by Schwab who are recruiting staff from other independent advisory firms say they plan to share equity with non-founders.
But hard-earned - and increasingly valuable - equity is literally an owner’s most significant asset, and some are understandably loathe to relinquish it.
As a result, many fast-growing RIAs face what valuation firm Mercer Capital calls a “compensation conundrum.” Firms that aren’t ready to bring on an equity partner need to figure out how to structure employee compensation to be able to recruit and retain quality advisors. And those firms which are ready to offer equity must be able to carefully structure compensation and their P&L statement.
Make employees "income partners"
It’s not difficult for employees at a wealth management firm to figure out the company’s profits based on its assets under management and the fees it charges clients.
The employee can then compare their compensation with the firms’ profits as well as with what the owners are taking home. Even if their salary is paying them well, an RIA employee of a growing firm may feel that they are not being adequately rewarded for contributing to the firm’s growth and resulting profits.
But if the company’s principals aren’t ready to dilute their ownership and offer equity, what can they do to keep their advisors happy, as well attract new ones?
Mercer suggests structuring compensation so that employees become “income partners” by offering a base salary and a bonus that is determined as a percentage of company profits.
That way “employees have the opportunity to participate directly in the upside of the business without diluting ownership positions,” according to Mercer vice president Brooks Hamner, a co-author of the company’s recent blog on the subject.
To ensure that the practice isn’t too costly for the firm, Mercer advises partners who are shareholders to pay themselves a more competitive salary and bonus and take out less money in the form of distributions.
Balancing compensation and distributions
Wealth management firms that are ready to bring on equity partners but have paid out their entire EBOC in bonuses to minimize reported profitability also need to reconsider how both owners and employees are paid, according to Mercer.
“It is key to balance returns on labor and returns on investment ,” Mercer told clients in a recent RIA Valuation Insights. “Owners should consider compensation levels commensurate with job responsibilities and revenue productions…think about what it would cost to replace yourself if you decided to step away from the business.”
After determining the appropriate compensation structure that aligns with pre-tax margins based on industry norms, firms should begin offering equity as soon as possible, Hamner said.
“Firms can be reluctant to offer equity because it’s very valuable,” he explained. “But firms that offer equity can include it in a compensation package that competitors can’t match and attract advisors with an opportunity to share in the upside of a firm’s growth. But if they wait too long to share equity ownership, the value of an equity stake is too expensive for the next generation of leadership to afford.”
RIAs that do offer a path to equity say it’s a competitive advantage.
RegentAtlantic, a $5 billion RIA based in Morristown, New Jersey, sells 4 per cent of its equity annually to employees and is already on its second generation of ownership.
Offering recruits a path to ownership is a “huge” plus in the fiercely competitive market for attracting quality wealth managers, according to Chris Cordaro, a RegentAtlantic partner and its chief investment officer.
“We’re able to get new hires from competitive firms,” Cordaro said. “We find that many of them promise equity, but don’t come through. There are also a lot of RIAs who do not complete a succession plan. That leaves a lot of good next generation folk in those firms who would like a better opportunity.”
New partners are selected based on qualities such as leadership and metrics including business development and value creation. They also have to pass the firm’s “canoe test,” Cordero said: “The current partners have to be happy to spend a day in a canoe with them.”
Brightworth, a $4 billion advisory firm in Atlanta, began offering equity to non-founders in 2007. The RIA now has 20 partners and the founders have less than 50 per cent ownership, said CEO Ray Padron.
The ability to eventually buy shares in the company has been “a huge differentiator” when recruiting both college graduates who are just beginning their careers and established advisors who come with a book of business, Padron said.
Shares are valued annually by both an internal formula and an outside appraisal, and Brightworth provides financing assistance to those employees who need it, Padrone said.
Ownership isn’t for everyone
But not all wealth managers feel compelled to offer equity.
The most important thing many advisors are looking for is control of the client, said Jonathan Straub, a principal at AdvicePeriod, a $3.5 billion wealth manager based in Los Angeles.
Advisors who join the firm keep 70 per cent of their gross revenue and return 30 per cent to AdvicePeriod. They must pay salaries and other costs from their share but are given complete control of the client and can take clients with them if they decide to leave the firm, Straub said.
“These are advisors who want to bet on themselves and see value in running their own business versus investing in other advisors that they don’t have control over,” Straub said.
There are also plenty of advisors who aren’t interested in equity in an RIA because they want to minimize risk, recognizing there is a downside to ownership as well as an upside, according to Barbara Herman, senior vice president for the executive recruiting firm Diamond Consulting.
Established advisors who have worked for wirehouses and been paid on a grid are especially reluctant to move to an RIA’s salary and bonus structure, Herman said.
What’s more, in many cases equity ownership isn’t enticing enough to get a top breakaway advisor to join an RIA because there are so many turnkey solutions available for firms to set up their own RIAs, Herman pointed out.
“There are so many options now for advisors who don’t want to become an employee,” she said.
Which firms should - and shouldn’t - offer shares?
Nonetheless, allocating equity to key employees or critical new hires remains “one of the best tools RIAs have to attract and retain talent over the long term,” Jennifer Souza, managing director and head of Affiliate Management & Strategic Development for Emigrant Partners, which has minority stakes in six advisory firms, including RegentAtlantic and Brightworth.
But owners should only offer equity “when their firm is in a position to use it effectively,” Souza cautioned. “Firms that are good candidates are those with an established growth plan, a clear philosophy around the path to partnership, and sound equity plan mechanics that are understood by current and future equity holders.”
What should wealth managers avoid doing if they offer equity?
“Lack of transparency around who receives equity, how and why,” Souza answered. “Also avoid frequent changing of equity provisions and creating a siloed culture that demotivates non-partners.”
“Firms that need to rework strategy, structure or leadership should focus first on addressing those issues before tackling equity,” Souza said.