Exactly how hard is it for a next-gen advisor unhappy with their firm to pack up and move elsewhere, clients in tow? It depends, and more than one would think.
Employment contracts vary wildly among RIAs, say the lawyers and recruiters who see large numbers of them on a regular basis. The details often depend on the origins and culture of the firm, its size, its ambition, and whether the advisor in question started their career there or joined from another firm with an existing book of business.
“Some firms surprisingly have no employment contracts and are very loose. There, the team can move whenever they want to,” says Louis Diamond, president of recruiting firm Diamond Consultants in Morristown, N.J., and a next-gen leader himself. “Others have a ridiculously aggressive employment agreement that takes their desire for control too far, and then you see everything in between.”
Brian Hamburger, chief counsel at Hamburger Law Firm in New York, agrees, adding that the structure and culture of a firm plays a huge role in whether restrictive covenants such as non-compete restrictions and non-solicit restrictions will appear in an employment contract at all.
“Many independent RIAs are really beginning to get serious about putting employment agreements that contain restrictive covenants in front of their employees. As RIAs are spending more money on things like training, helping people earlier in their career and investing in their brand, they have an asset that’s growing in value that they need to protect,” he says. The firms don’t feel as protected if they are overseeing nothing but a loose amalgamation of advisors who are just out to eat what they kill and have no loyalty to the firm, he says.
The question becomes more crucial for a next-gen advisor whose firm is thinking of selling out to private-equity backed consolidators. If the younger advisor would rather bolt than stay with the aggregator, their first step is to read their employment contracts and look for restrictive covenants. The second step—most likely with the help of a lawyer—is to figure out whether those covenants are enforceable.
The dreaded “non-compete clause,” for example, is both the most feared and the most contested covenant professionally and politically, so much so that many believe it’s headed for extinction.
Some U.S. states and the Federal Trade Com-mission have come to view non-compete clauses as antithetical to open competition. Currently, four states—California, Minnesota, North Dakota and Oklahoma—have banned non-compete clauses entirely, and New York will join that roster in 2024. Other states, including Colorado, Illinois, Maine, Maryland, New Hampshire, Oregon, Rhode Island, Virginia and Washington, have restricted non-competes, which are often tied to a compensation threshold. Iowa and Kentucky limit the use of non-competes to certain professions.
Meanwhile, the FTC may ban them nationally on the grounds that they stymie competition, are exploitative and coercive for employees and are unnecessary in light of other restrictions. The agency also thinks that industries from fast food to medicine would be more innovative and prosperous without them. Instead, it says, employers can protect themselves with the other robust tools they have at hand: non-disclosure agreements, trade secret laws, retention incentives for employees and employment contracts of fixed duration in which the employers can recoup their training costs.
The vote by the commission on a possible non-compete ban is scheduled for April 2024.
When firms continue to stand behind non-compete clauses that may not be enforceable, clients are essentially up for grabs, and that can lead all parties to sink to various levels of undignified behavior. If it’s an RIA and an employee advisor leaves, the firm is going to aggressively court those clients, says Jodie Papike, CEO of recruitment firm Cross-Search in Encinitas, Calif.
The firm doesn’t even have to sue the advisor. It could instead launch a massive outreach campaign to the advisor’s clients “saying who knows what,” Papike continues. The firm can’t legally say anything inaccurate to the clients, she says. “But there’s a lot of nuance in those conversations where they could raise doubt in the clients about where the advisor is going or what they’re doing or what happened and why they left. There’s all types of things that can happen to slow down an advisor taking their book with them if they don’t own it outright.”
All that campaigning, however, is expensive and disruptive, so it makes more sense for firms to build in procedures to let an advisor leave on good terms. That’s a trend Papike says she’s seeing more of.
Another way an RIA firm can handle the problem up front is by allowing a new advisor to leave with the same clients they arrived with, carving out that business so those relationships will never be contested. Or the firm can buy the advisor’s book of business outright in exchange for a non-compete or non-solicit provision. (Right now, books are selling for 1.5 times to three times revenue, Diamond says. Otherwise books can be valued on an EBITDA basis, and the advisor can receive that value in firm equity.)
Fixing the issue of client ownership after the fact is more difficult, though not impossible. According to Laurence Landsman, a financial services attorney and partner at Landsman Saldinger Carroll in Chicago, even if the jilted advisory sues the advisor, it’s always possible to hash out a settlement between the two parties, as long as the advisor had set the stage for this during the recruitment process.
“The new firm can pay the old firm a percentage of the revenue generated from those clients for some period of time to sort of grease the wheels and make it OK,” Landsman says. “The new firm is saying, ‘In recognition of the fact that there were restrictions, we’ll pay you a certain amount of money that’ll be based on the revenue that’s generated from the moving clients.’”
Whether or not the law comes down on non-compete clauses, some sources say the industry is meanwhile undergoing a cultural shift where, as next-gen advisors start their own firms, what’s acceptable in an employment contract might be changing anyway. “We tell firms now to really think about their non-competes and non-solicits,” says Leila Shaver, founder of My RIA Lawyer in Alpharetta, Ga. “If you want the really good people, the A players, you have to consider if you want those [contracts] at all.”
The founders of an RIA may feel more comfortable with restrictive covenants in place, she continues. But these do nothing to address what would actually make a next-gen advisor happy or otherwise prompt them to eye the exits.
“Don’t even bother giving equity. It complicates the business,” she says. While advisors want part of the profit, she says, “they don’t want to be putting in money if the business goes sideways.”
Achieving an advisor’s loyalty without putting them in handcuffs may seem like an elusive trick, but, as Shaver says, “it depends on the business and culture you want to create.” Offering strong salaries, bonus potential and profit potential is a great starting point.
“The clients belong to the firm, the marketing is all done by the firm, and that can be successful for both the firm and the advisor,” she says.
Despite the changing attitudes, how-ever, there are still enough old guard RIAs who will want to keep restrictive covenants in place for a while yet, as long as they’re legal. “Incentives only go so far when you’re in a labor market that’s so tight, and employers are increasingly concerned that there’s no end to those incentives,” Hamburger says. “You want people to be in their seat for the right reason, but just in case that reason isn’t enough, you want to have the legal remedies in place to protect your firm.”