Twelve years after the financial crisis, advisors are looking at weathering another shock—not just to the markets and to their clients’ health and well-being, but also to their own balance sheets.
Revenue is likely going to take a serious hit this year, said Philip Palaveev, CEO of consulting firm the Ensemble Practice, in a webinar for the G2 Leadership Institute, his leadership coaching program.
Amid coronavirus pandemic fears, the stock market has erased most of the gains since Donald Trump took office in 2016. The S&P 500 by early this week had fallen 30% from its high earlier this year. That’s going to hit advisors’ projected revenues, and force them to look hard at their profit and loss statements. It will make for a lot of pain in a world where many expenses are fixed costs, and advisors are naturally going to have to start looking at staff cuts to protect their firms.
“Where most of the money goes … where most of the expenses of an advisory firm goes, are really in the direction of people; 75% of all our expenses are related to compensation,” Palaveev explained. The most obvious costs that advisors would otherwise try cutting are likely going to make up only 5% of costs in total, he added. That includes travel; training and education; consulting, legal and professional; marketing and client appreciation; and referral fees.
Advisors need to understand that there is a cost to jettisoning people. It can have a huge psychological impact on employee and firm morale.
“Whenever you do that you have to realize that the damage will be very significant. This is not a decision you can make lightly. Whenever you let even one person go because of economic conditions, what happens is you damage the sense of job security for everyone involved.”
He said now is the time to look at future cash flows—and stress-test them, “assuming that this turmoil continues, assuming that we continue to see lower than projected revenues for the rest of the year.”
Healthy firms that make it through crises, he said, will have profit margins of 25% or higher and relatively little debt, good capital and capital reserves. That’s because firms with 25% margins can take the hit for some of their discretionary expenses and gain another 5% or so. Moreover, the owners can take less from the dividend portion of their compensation. Some can cut bonuses. "In grand total, you can make those changes to a healthy P&L and even [survive] a 35% reduction in revenue without suffering any losses and without having to reduce the size of the team.
“Good firms [in 2008] weathered the storm relatively well, with relatively little damage,” he said. “Unfortunately, the opposite is true. Much like the virus, if someone has health issues, they are very vulnerable and perhaps they need to be looking ahead and taking even more precautions. And most of those are firms that have profitability of less than 25% and firms that are borrowing money [because] they’re making an acquisition and they’re making significant payments either to retire a founder or a number of founders. … Firms that have entered into equity transactions that require guaranteed payouts or preferred payments to a capital partner. Firms that have high-level income distributions to the owner and the owner can’t forgo those income distributions. Firms that have not maintained capital reserves or have used up their credit lines.”
Those firms with less than 25% profit margins thus have less room to wiggle without going to compensation reduction and layoffs, he continued.