An individual financial advisor can only ever work with so many clients before running out of any time and capacity to serve more. As a result, all advisory firms eventually hit a capacity wall, where they must either decide to stop growing or hire or partner with more advisors to increase capacity. When several advisors come together to create and build on such capacity, an “ensemble firm” emerges, where it’s no longer about growing any individual advisor’s practice, and instead is about growing “the firm” and clients of the firm (and hiring employee advisors as necessary to service those clients). The caveat, however, is that most advisors who come together to create such an ensemble firm are transitioning from existing individual practices, with separate expenses, separate revenue, and separate income. Which can make it especially hard to figure out how to actually transition advisor compensation from separate silos to a shared enterprise where all advisors are treated consistently… especially if there’s a large discrepancy in the revenues that each advisor brings to the table.
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1 PM EST broadcast via Periscope, we discuss the mindset shift that must occur to successfully grow an ensemble firm with shared clients, how partners in an emerging ensemble advisory firm can equalize compensation levels and get to work growing their business, and when advisors are best able to make the shift from revenue-based compensation to ensemble salaries and bonuses instead.
One of the first challenges that advisors face when transitioning into an ensemble practice is changing their mindset from being an individual advisor with his/her own clients, to being an advisor in a larger firm that is responsible for servicing the firm’s clients. Because ultimately, if the ensemble business is truly going to grow and scale to 10X its size or more… the firm will eventually be so large that it’s no longer about the clients and revenue of any founder/partner/owner, but the collective value of the firm’s clients. After all, the whole point of building an ensemble practice in the first place is to create value from a business that’s larger than and goes beyond what either partner could have built with their own individual client base.
Still, different advisors come to the table with different existing client bases and revenue, which can make it challenging to equalize (or at least standardize) compensation levels, especially if one partner is responsible for generating substantially more revenue than the other.
One way to approach the issue is simply to go ahead and equalize ownership and compensation and get on with the work of building the business, because if the goal really is to create a sizable advisory business in the long run, then the personal wealth that’s created from the long-term value of the firm will dwarf the small differences in compensation in the initial stages anyway.
The second approach that can work – especially if there’s a large discrepancy in revenue-generation – is to have the lower-revenue partner buy a percentage of the business from the larger-revenue partner. Doing so makes it easier to even out both partners’ compensation structures, with the check the lower-revenue partner writes mitigating the step-down in pay taken by the larger-revenue partner.
The third approach is to blend advisor compensation, with a salary base for the “executive” functions of being an owner of the firm, and a partial revenue-based compensation for the job of servicing the founder/advisor’s existing clients. With the caveat that, as compensation for servicing clients in the business, advisor partners need to be cognizant that whatever they pay themselves should be the same compensation structure they would offer to other employee advisors in the business as well (as the additional upside for the partner should come from equity profits, not compensation for the job of being a “partner” in addition to an advisor).
Regardless of which approach is chosen to make the transition, the question also remains: “When is it best to make the switch from revenue-based silos to ensemble salary compensation?” While there’s no hard and fast rule, the shift typically takes place somewhere between the $500,000 and $1,000,000 in firm revenues, because at that level, there’s enough to not only pay the partners an appropriate salary for their work in the business but to have enough left over at the bottom line so that the partners can begin split the income generated from the business itself.
The bottom line, though, is simply that building a multi-advisor ensemble business is all about separating out the value being created by the business itself – for which owners generate profits – from the work of servicing clients that’s being done in the business, for which compensation should reflect what the job itself is actually worth (i.e., what would be paid to any employee in that role, partner or otherwise). And by making the compensation transition, ensemble firm owners truly create the most effective incentive for themselves to focus not on their own clients and revenue but building the shared enterprise value of the business itself.
source https://www.kitces.com/blog/ensemble-practice-partner-income-conversion-revenue-based-to-salary-equalize/
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