On the road to growth and success in an advisory practice, there is a fork, and the direction you take as the owner will define the rest of your career. You could keep your one-on-one relationship with clients, creating strong personal connections and controlling your practice. But you will always feel a strain on your time and energy.

The other road will take you to a model where you have a professional team, a group with different talents to serve clients. This ensemble approach will allow you to develop a business with unlimited growth potential, high profitability and lasting equity value. But it will take away your control of the business and require you to transform yourself from an advisor into a CEO.

The choice is difficult, and most advisors defer it, consciously or not. But the decision has to be made sooner or later for the practice to be successful.

Both models are valid. Both can also lead to disaster. The team model can be mired in conflicts among partners and place seemingly endless demands on your time. Yet a personal practice can feel precarious. It relies on you alone to supply all the expertise and effort. There is likely no succession or continuity planning. This can make you feel like you’re adrift on a tiny boat like the character in The Life of Pi.

But again, you can’t put off the choice forever. Revenues will likely grow to the point that you can no longer operate without an associate. Sometimes you’re forced to for succession reasons, realizing you have very limited time to groom a replacement, sell the firm or create size and scale through a merger.

The Team Model
In a large firm today (one with more than $5 million in revenue), the service team (or engagement team) usually consists of a senior professional (a lead advisor) and an associate (a support or service advisor). These two work under the direction of an investment committee with general service guidelines set by a partner group or they work under a more formal client service committee.

In some of the largest firms, the teams may have additional levels, such as a support advisor and an analyst, and may also involve an investment specialist (a portfolio manager), a planning specialist or a tax expert. The power in this approach is that the team can use less experienced professionals to perform parts of the client process, people not ready to be the “lead” yet.

For example, let’s assume that a lead advisor, working on her own, can service only 80 client relationships because each requires 20 hours of work. Imagine we hire an an associate advisor who can perform 10 of those 20 hours of work. The team doubles in capacity and can now work 3,200 hours (2 x 1,600), serving 160 clients with 20 hours each.

The profit margins improve as well. Let’s assume the lead advisor makes $160,000, while the associate makes $100,000. The revenue from each client is $5,000 in advisory fees. Before there was a team structure, the advisor brought in revenue of $400,000 (80 clients x $5,000 = $400,000) and the profit margin was $400,000 less $160,000 in compensation. That equals $240,000, or 60%.

Now notice what happens with the team structure: The revenue is now $800,000 (160 relationships x $5,000) and the cost is now $260,000 ($160,000 for the lead advisor plus $100,000 for the associate). The profit is $540,000 and the profit margin is 68%. This is the power of leverage.

Before installing a team, the lead advisor might have been running out of capacity, running out of energy and lacking a succession plan. The associate, meanwhile, who couldn’t generate revenue on his own, may have been struggling in his career. Now he has a career track and the lead advisor has a growth plan (and perhaps a succession plan too). This is why large RIAs are hiring talented professionals and growing a strong cadre of future professionals while smaller firms are stuck trying to picture what succession would look like.

The team approach (or leveraged approach) is not a succession plan. It is most of all a growth plan. It offers natural succession options, but that’s not the main reason for it. The point is that the associates in this setup can grow into successful leads—and in turn replicate the model on their own, continuing the process and adding new associates.

Many firms wonder if they could use this strategy to double their clients or assets. This is where the entrepreneurial nature comes to play. Some firms will take the leap of faith and add the capacity and look to grow. Others will take the more conservative position and look to maximize existing capacity. Each is a viable strategy. But before you choose, consider this: Those firms that added associates between 2001 and 2007 have grown and prospered while those that waited to add have been stuck at the same size for the past five years.

You can certainly create a fairly large firm of multiple professionals without a team approach. That means each advisor or partner works with one client and the firm grows by simply adding more advisors. That’s called the “silo” model. It offers the same set of advantages as a solo firm, but also poses the same problems.

A Fact Of Life
The team model is a fact of life for firms with more than $1 billion in assets under management, or more than $5 million in revenue. These businesses understand the advantages of the model.

But no team means remaining an otherwise successful firms with $200 million to $800 million in assets that is struggling to grow. Leverage is easy to conceptualize but very difficult to create.

Still, let’s consider the financial ramifications by looking at the results of a 2012 Investment News/Moss Adams survey. If we take the ratio of owner compensation to non-owner professional compensation, plotted on the left-side vertical axis of the following chart, and the profit per owner, plotted on the right-side vertical axis, we can observe an almost perfect correlation. For example, a firm with $250,000 to $500,000 in revenue has six times more owner compensation than non-owner professional compensation. That’s a low level of leverage. Such a firm generates $189,000 in income to the owners. Now compare that with a firm that has $3 million to $5 million in revenue. This firm has only slightly more owner than non-owner professional compensation (a ratio of 0.98 on the left-hand side) but generates $784,000 in owner income. The more the firm leverages, the higher the owner income. (See Figure 1.)

Developing A Firm Identity
There are two types of changes necessary for a firm that wants to create leverage with a team.

The first change is “mechanical,” and this may be the easiest to achieve: The firm needs to break down the client service process into component parts and identify things that can be performed by the associates. These usually include much of the plan drafting, the portfolio analytics, a lot of the product research and much of the investment analysis. Associates can also take over many routine questions.

The more the firm has standardized its processes and streamlined the delivery, the easier this is to do. The less experienced the musician, the more he needs sheet music. In this case, the standardized process is the sheet music.

But one common mistake many firms make is to delegate the smallest client relationships to the associates. Theoretically, this allows the lead advisors to develop more “A” clients while giving the associates training with lower level clients. This may be easier to implement, but the strategy of delegating the “unwanted” does little to prepare the associates for their work with premier clients. Instead, it is often discouraging and even leads to turnover. The “minor leagues” can be a good training ground, but they can also teach minor league habits. You can’t learn to hit 95-mile-per-hour fastballs by practicing on 60-mile-per-hour fastballs.

The second big change a firm has to make is cultural, and while this is harder it has much greater impact. It means creating a firm identity that clients can relate to and associates can “wear” for credibility.

Consider the patients in the neurosurgery unit of a hospital. They will likely have no problem with interns directing their treatment if the hospital is greatly respected. Nor do the guests of a great restaurant protest if the sous-chef cooks most of the meal while the celebrity chef mingles with guests. This is the power of a brand—clients accept that it extends beyond the person who created it.

This transformation is extremely difficult and not scientific, but the principles are very clear. To begin with, an advisor must involve and promote people. Give them a meaningful role in the relationship, challenge them to do better and promote them to clients. Advisors must resist the urge to rush in and help their underlings. They must learn to use “we” instead of “I,” and hire talented people who can grow quickly. It’s important to spend time with these people and train them. (I’ve written a whole book about this process: The Ensemble Practice: A Team-Based Approach To Building A Superior Wealth Management Firm.)

Where And When To Begin
Much as you would find while skiing a very steep slope, the first couple of turns are the hardest. Once you begin and find success, it becomes easier to adjust, adapt and repeat. The right time to begin this process is as soon as the firm reaches $1 million in revenue, simply because the financial resources are then available to compensate associates and there are likely enough client relationships to create scale.

Another threshold to consider is the size of client relationships. If these relationships are smaller than $5,000 a year, a firm will likely struggle to leverage them. The smallest tasks will be easier to execute with just one person. There is a certain “overhead” with teams, so if a client relationship is too small, it may be more practical to just handle it one on one. It could be the firm never has enough size advantage. And that’s one reason to be very careful with client selection.

Finally, a team approach requires that the firm can attract and train talented people. That can never be taken for granted. A “top of the class” Wharton or Stanford MBA holder cannot be easily persuaded to join a small firm. The competition is fierce and advisory firms must position themselves as good employers, not just good client service managers. There are many MBAs and even PhDs, as well as graduates from the top undergraduate programs and top postgraduate science schools. But they disproportionately join the largest firms in the industry. The ability to recruit talent is perhaps the most important and least understood advantage of the largest firms. This is another self-fulfilling prophecy—firms that leverage well tend to attract better talent and grow faster and, as a result, leverage even more. Firms that don’t tend to struggle with the first step of the process. The key, again, is to begin the shift and pursue it with persistence.

A Team Approach, Or Not
The fork in the road is critical for the future of any advisory firm. Once you choose a team approach and use multiple levels of professionals, there is no going back. The approach tends to replicate itself and requires the firm to grow in order to provide opportunities for its best professionals. It becomes a chain reaction.

It takes the firm to higher levels of growth—but also to higher levels of management complexity.

A personal practice, by contrast, can be simple and rewarding in its family-like culture and your sense of control. Much like a small town, it can be very endearing. But it is also very limiting.

The fork in the road is ahead for most firms—the vast majority of the industry still holds under $1 billion in assets under management and practices a one-on-one model. Still, while the choices are clear, that does not make them any easier.

(Please consider participating in this year’s edition of the Investment News/Moss Adams survey by visiting http://ensemblepractice.com.) 

Philip Palaveev is the CEO of the Ensemble Practice LLC. Palaveev is an industry consultant, author of the book The Ensemble Practice and the lead faculty for the Ensemble Institutes. More information about the institute and the book can be found on the Web site for the Ensemble Practice (www.ensemblepractice.com).