Financial advisors looking to grow often wonder whether a change in their RIA structure would give them an additional opportunity. They ask, “Do I need my own RIA?” They wonder whether it’s better to be an investment advisor representative of a corporate RIA or establish and run an independent RIA.
But I have discovered in dozens of conversations with financial advisors over the years that they don’t always clearly understand the many pros and cons, the costs and benefits, the responsibilities and time commitments of being either independent or corporate.
This realization prompted my firm, NFP Advisor Services Group, to commission research on the topic so advisors could make informed business decisions. The results surprised even us.
The white paper that emerged, The RIA Tipping Point: Corporate or Independent, is based on a survey of 161 financial advisors and interviews with advisors, evenly split between those affiliated with corporate and independent RIAs. (The research was conducted by Aite Group, an independent research firm focused on business, technology and regulatory issues. The study was limited to advisors who currently have, or once had, a broker-dealer affiliation.)
Independence is the leading reason for selecting an independent RIA over a corporate RIA, rated as “extremely important” or “very important” by 63% of survey respondents. Advisors also figure they’ll make more money in the independent RIA model and have more control over their business, which was reflected by the 37% of respondents who said their desire to “maximize economic proposition for the practice” was “extremely important” or “very important” in choosing that model.
This seems to work well for the largest, most efficiently run independent RIAs. But the survey results suggest that choosing that route doesn’t necessarily pay off with greater income for all advisors. They underestimate some of the drawbacks.
Independent RIAs Need Scale For Profits
If you’re out to maximize your income as an independent financial advisor, you’d better get big. Independent RIAs can start to tip the income scale in their favor only once they garner more than $200 million in assets under management—assuming they manage their business operations and expenses efficiently.
The tipping point could be even higher for advisors who lack expertise in business process and technology. By the same token, the bigger you get, the more you can create operational drag if you lack the expertise to leverage the scale you created.
Your business succession plans should also play a part in your choice. Practices with the greatest operational efficiency will have more value when it comes time to make succession plans, as we discovered in our earlier white paper, “The Efficient Frontier of Succession: Maximizing Practice Value.” While corporate RIAs have the advantage of turnkey support, independent RIAs must have the scale and expertise to build it themselves. Smaller RIAs can struggle economically and operationally, failing to reach the business maturity to reach higher valuations.
The survey showed that advisors with corporate RIAs generated roughly the same revenues as those with independent RIAs. Revenues for fee-only advisors with a corporate RIA averaged $1.2 million while they averaged $1.3 million with an independent RIA (Figure 1). Regardless of the model, fee-only advisors generated higher average revenues than hybrid RIAs. That’s likely because the fee-only world is populated by people who have exited the large wirehouses, while the hybrid model is more defined by small start-ups. The average revenues for hybrid RIAs favored those on the corporate side, who made $905,000 while independent RIAs recorded average revenues of $669,000. In all segments, about half of the practices generated less than $300,000 in revenues. (See Figure 1.)
Payouts And Income Favor Corporate RIAs
But revenues don’t tell the whole story. Advisors need to know what percentage of those revenues will flow to them (Figure 2). The payout ratio and income are important indicators.
Payout percentages fail to consider the expenses that advisors must pay themselves—for personnel, operations, compliance, technology, etc. To better understand the bottom line, we need to look at advisor income. (See Figure 2.)
When we compare the annual income of advisors who own all or part of their practices, it appears that corporate RIAs earn better income on their books of business, particularly those with books of more than $100 million but less than $1 billion. While the average annual income of both groups was comparable, $270,000 for corporate RIAs and $272,000 for independent RIAs, those with the corporate structure earned that income on a significantly smaller book of business (Figure 3). The corporate RIA needed a book of only $240 million to make that amount while the independent RIA needed $305 million. This gap reflects the often-underestimated costs associated with running an independent RIA. These costs aren’t just financial; they’re also measured in time and opportunity costs and even in risk management. (See Figure 3.)
Nonfinancial Costs Of Independence
The independent RIAs in the survey said they chose their model because it was important for them to keep operational control. But that control comes at a cost. They spend more time—and probably more money—on compliance, technology and other operational aspects of their businesses. These are opportunity costs: Because they are distracted by running their business, they lose time they could spend on prospecting and sales.
Independent RIAs also take full responsibility for compliance, unlike independent advisors who affiliate with a corporate RIA, 75% of whom rely on their broker/dealer for it. Independent RIAs may not appreciate the true cost of this until they run into a compliance problem or a lawsuit and find themselves without the legal and economic support they would get from a corporate RIA.
I’ve met some hybrid advisors who think that taking their RIA independent will free them from Finra scrutiny. But that simply isn’t true. Regulators will apply the most stringent set of rules for your licensing and affiliation. You cannot remove your Finra license hat when you’re acting as an RIA; if you have a Finra hat, you are always wearing it.
The need for technology can also create an economic burden for smaller independent RIAs, whereas corporate affiliates can rely on a broker/dealer for it. Independent RIAs with less than $200 million in assets under management should look for an integrated technology solution to support more aspects of their business. I always say, “If you’re not amazing at it, outsource it.”
Furthermore, operations tend to cost more in the independent RIA model, partly because of firms’ staffing requirements. The survey results showed that independent RIAs have higher head counts than corporate RIAs, which can offload some human capital and economic burdens by affiliating.
Not All Corporate RIAs Are Alike
Advisors tend to think that all corporate RIAs are the same when it comes to hampering their freedom. But these advisors should take a broader look. Some of those organizations understand that your clients belong to you. Some offer attractive payouts and let you control the way your business operates—letting you operate under your own brand, for example. And some of these firms provide more robust support than custodians.
But the bottom line is that either the corporate or independent RIA model can provide the right solution, depending on your firm’s size and business mix and your own personality and preferences. This is why we support both models for our advisors. The choice is yours.
Ask Yourself These Questions
To decide whether the corporate or independent approach is right for you, ask yourself these questions:
• How do I define independence?
• How do I like to spend my time? Do I want to focus on time with clients and prospects or do I enjoy managing operations, compliance, technology and other issues?
• What is the most effective use of my talents?
Your answers will help you make the best decision for your long-term success.
Your Next Steps
You’ll find more details about the corporate RIA or independent RIA decision in the white paper “The Tipping Point: Corporate or Independent RIA.” To obtain a free copy, or receive any of NFP Advisor Services Group’s other white papers, go to www.nfpasg.com/tippingpoint or call 800-966-9474.
James L. Poer is president of NFP Advisor Services Group, which provides a unique integration of service and technology for successful advisors to use with their clients in whatever capacity they choose.