Here are a couple observations on those numbers.
1. It’s not quite apples to apples because the data I’m using combines 5-year average growth rates with 2020’s profit margins, but it should be directionally correct.
2. The average advisory firm is quite profitable but slow growing.
The Mix Between Growth And Profit Margin
The key question now is what is the right mix between growth rate and profit margin for your business?
To answer that, here are several considerations.
• If you’re optimizing for current income and not too concerned about having a big liquidity event in the future, then the 30% (or more) profit margin and 5% to 7.5% annual organic growth rate should work fine.
• A high profit margin (40% or more) with little to negative revenue growth is a wasting asset. You won’t attract top talent and you should consider selling or regrouping to get back on a growth track.
• If you’re happy with your current income but want to build long-term equity value for a possible sale, then make a conscious decision to trade a lower profit margin for higher growth. Shoot for at least double-digit organic growth and if you want to get aggressive, complement the organic growth rate with a merger and acquisition strategy. But don’t let your operating margin drop below 15% if possible as that leaves little cushion during an extended bear market.
• If you think you’ll sell the business someday, start making it salable today. Even if your business isn’t for sale, it must be salable. That means you have clean and updated monthly financials, you’re tracking metrics, you have a solid team, you have a consistent record of organic growth, you have a nice mix of clients from an age standpoint, etc.
The Rule of 40% is a solid way to think about the mix between growth and profitability of your business. The key is to get clear on your business strategy—what are you trying to accomplish—and that will inform the strategy you develop to drive your arrival at the 40% (or above) number.
What is your Rule of 40% number?
Steve Sanduski, CFP, is a financial advisor business coach, the co-founder of ROL Advisor, a discovery process technology system, a New York Times bestselling author, and host of the Between Now and Success podcast.