Switching From Wirehouse To RIA – AUM And Revenue Requirements To Break Away, cont.
#OfficeHours with @MichaelKitces Video Transcript
Welcome, everyone! Welcome to Office Hours with Michael Kitces!
For today’s video, I want to talk about the ongoing trend of breakaway brokers – the label the industry has given to advisors at wirehouses who are breaking away to the independent RIA channel. The breakaway broker trend has really been underway for several years now. It got started… or really, gained momentum, in the aftermath of the financial crisis, where a lot of brokers were giving second thoughts to being affiliated with their wirehouses after all the anti-Wall Street headlines. But most wirehouses gave rather lucrative retention deals after the financial crisis in part to stem that outflow of brokers with seven to nine year terms attached to them, that are just now expiring. And because that expiration is queuing up, it seems to be leading to a fresh wave of interest in a lot of folks potentially breaking away from wirehouses. And especially now over the past few months, as Merrill Lynch, Morgan Stanley, and UBS have all been reigning in their signing bonuses, which means it’s not as lucrative as it once was to just switch wirehouses and going out to form an independent RIA you can someday sell, is getting at least, relatively speaking, a little bit more appealing for some brokers.
And so, today’s question is from Keith who asks,
“At what level of wirehouse revenue does it make sense for a team to switch to the RIA channel? Given all the time demands of running an RIA, whatever makes sense for a wirehouse solo practitioner to go RIA.”
This is a great question, Keith. And what I’m hearing more and more now. A lot of brokers are looking at other alternatives right now. Of course, it’s one thing to recognize that there’s a growing number of brokers in the aggregate are breaking away to become independent RIA, but it doesn’t mean it’s right for all teams to really consider a breakaway. So let’s talk a little bit about what it takes to make a transition and just how to think about your income and profit and loss on either side of the fence.
Wirehouse GDC Payouts Vs RIA Profit Margins [Time – 2:15]
Let’s start by looking at take home pay at a wirehouse versus an independent RIA. Now, at a wirehouse, brokers at the low end may be taking home something like 35% of your GDC. As your production grows, you may get up to 40-something percent. If you’re a big producer or on a big producing team, maybe you can get 50 to 55% at at least some wirehouses, depending which one you’re at, years of service to the firm, production bonuses, and so forth. Now, coming out of that, you have some miscellaneous fees and costs that go to the wirehouse, but the firm does absorb compliance costs, it gives you a platform, and it usually provides you office space. Basically, it absorbs a lot of the overhead you otherwise have to deal with as an independent.
If we look at this from the independent RIA side, it looks a little different. The good news is, you keep 100% of your revenue. Whatever is at that top line, that’s all yours. The bad news is, you have to pay all of your own expenses out of that 100% off the top line. We have a lot of benchmarking sites at this point that tell us what advisory firms typically spend in various categories (i.e., what their costs are and what their take home pay is across the board). And what you find for independent advisory firms is that they typically follow what’s called the 40-35-25 rule. That means out of their gross revenue, typically, 40% is to paying advisors and investment team in the firm. 35% is for overhead and administrative staff. And that leaves a 25% profit margin left over. So, 100% of your gross revenue minus 40% that’s paid to advisors and investment team, 35% for overhead and staff. Do the math. That leaves you with a 25% profit margin remaining at the end.
Now, if you’re a solo advisor, you usually actually take the pay of the advisor part and the profit part at the bottom, which means when you blend them together, you’re taking home about $0.65 cents on the dollar. Or in wirehouse terms, basically, it’s a 65% payout rate by the time you actually replace all the costs that the broker dealer platform is giving you. Now, if you’re a larger team, it’s a bit messier to reconstruct your income. You’re probably doing a lot of business under split rep codes, with split payouts, so you don’t necessarily get the full payouts and all revenue for your team. And so, if you’re trying to compare that to an independent RIA, frankly, you have to go a little bit deeper to allocate some of the revenue to the other advisors, some of the revenue to you for what you’re actually handling, what your income would be, what you’d recently pay yourself versus the other advisors, and then figure out what your profit margin is that comes down to the bottom line.
Broadly speaking though, what I find for a lot of advisors I’ve seen that go through this comparison is that, they end up keeping somewhere between about 10 to 20% more of their gross revenue after they make the switch. So, if you were walking away with 40 or 45%, you may see yourself walking away with closer to 60 to 65%. Although if you’re further down the grid, if you’re solo and you’re only getting 35 to 40% payouts in the wirehouse, you might see as much as a 30% lift in the amount of gross revenue that you get to keep.
Breaking Away Is About Independence And Control [Time – 5:17]
That being said, there’s a really important caveat with this comparison. When you’re at a wirehouse, a lot of those cost decisions, staffing, overhead, compliance, office leases, technology tools, on and on and on, are made for you. The bad news with this is that sometimes when they decide, they don’t actually pick something that’s a great match for you. That waste, that not everything that’s in the wirehouse platform is necessarily used by every wirehouse broker, is part of what creates that gap as to why you can sometimes generate a little more take home compensation on the independent side. But they make those decisions for you, and if you become an independent RIA, those are your decisions to make.
Now, the flexibility of being able to make those decisions, again, is part of what lets you get a little more operational leverage from your revenue. You can have the office space that’s right for you, maybe you prefer a little bit of a less expensive space than the premier location that a lot of wirehouses tend to rent. You only need to hire the staff you need for your business. It’s a little bit more lean. You don’t need as much overhead infrastructure some times. You can choose the right technology for you, skip what you don’t need. But it’s on your shoulders, and that’s really the double edged sword of going independent. The good news is, you have more control over your destiny; but the bad news is, you have more control over your destiny. And because of that, the truth is that most advisors who break away from wirehouses in the end, don’t do it for the money. They don’t do it because, “Maybe I can take home 10 or 15% more of my revenue”, because it’s a lot of work.
You can try to get your clients to come with you by following the broker protocol, but at best, it’s a huge distraction for months leading up in preparation. A lot of stress when you tender your resignation and immediately start making 100 – 200 phone calls in about 48 hours, to try to reach all of your clients to start the switchover process, before the broker dealer sends other brokers to calling your clients.
Now, if you’re independently minded, you want to control your own destiny, you want to be the owner of your own business, and you want to make all the decisions about the office space, the staff, technology, and the marketing… as well as own your own brand and not be part of the wirehouse’s brand and all the rest, then that transition is usually a small sacrifice to make in the long run. But if you’re happy to have the firm make those decisions and handle that stuff for you, so you can just focus on your clients and growing your revenue, then honestly, I’m not sure you’re going to be that much happier in your business by going through all that effort to make a switch, just to try to get a few more points of take home off your GDC.
Breaking Away – Large Teams Vs Solo Advisors [Time – 7:52]
That being said, it’s worth noting that there are more and more options these days for brokers who are breaking away and want some transition assistance for this. There are platforms like HighTower Advisors and Dynasty Financial, who can actually recreate a lot of the structure you’re used to for the wirehouse, but ultimately, still have the flexibility of being an independent RIA. So, they will provide a lot of guidance about your infrastructure, even provide some of the technology platform and the back office support. You don’t have to make as many of those decisions. And while they do have a cost that’s not trivial, it’s still less than the slice of GDC your wirehouse is taking off your grid. Now, for larger teams that want to break away and really want to control their destiny from the start, there are also standalone consulting firms. Folks like Matt Sonnen at PFI Advisors that work with breakaways and help you to get your office set up and handle the transition directly.
And the truth is, if you’re a larger team (e.g., $5 million or more in revenue) then you have the dollars to hire the depth of staff and infrastructure around you. You can spend on the compliance consultants, the operations manager (or a full on COO), and the management team infrastructure that you need to execute successfully as an independent.
Because again, bear in mind that the typical independent RIA is spending about 35% of its revenue on overhead. So, if you’re a team with $5 million of production and you spend $1.5 million to rent your office, buy the furniture, get the technology, and hire the staff that you need to support you, run the firm, and replace what the wirehouse did – you are actually incredibly profitable. Because spending $1.5 million for that stuff on $5 million of revenue is only 30% of your revenue and cost, and the typical firm is close to 35%. Even as a $2 million team, where you’re probably lucky to keep 50% of your current payout, if you “just” spend $700,000 hiring multiple operations staff members, compliance, consulting, technology, office space, and all the rest of your overhead, you’re still coming out well ahead and probably keeping another 15 to 20% of your revenue, with an actual business entity that you own and that you can sell some day.
And it’s worth noting, because overhead costs scale down the line, breakaways really are not unique to the large team environment. So, Keith had asked as well about solos breaking away, and I actually find that a lot of solo brokers are some of the most successful in making the transition to break away, especially those folks that are sitting around maybe 50 or 100 million of AUM or even a little bit lower. You’re probably getting maybe a 40% payout on your revenue, when successful solo RIAs are taking home 65% of revenue, and the top solo RIAs are taking home as much as 85% of their revenue. There really are solo RIAs out there that are bringing in more than $500,000 of revenue and they keep more than 400 of it.
Because the technology and the platforms, the RIA custodians, frankly have gotten pretty competitive with the wirehouses, particularly if you’re simply doing managed portfolios with what I’ll call traditional investments, mutual funds, ETFs, stocks, and bonds. Because on the independent side, you may not quite have the same kind of access to lending products, company proprietary products, private fund offerings that you had at the wirehouse. But if you’re simply doing fairly traditional market traded portfolios, you can leverage the technology and independent platforms, be incredibly efficient as a solo in offering up a portfolio and then providing the financial planning advice and the wisdom that’s the value add on top.
And it’s worth noting, another option for solo advisors or teams even up to about a million or two in revenue, is to do what’s called a tuck in, where you join an existing RIA that already has the staff, infrastructure, management, and the operations in place, and you tuck into their platform and you get to leverage their platform. But you don’t do it for a grid payout. In most tuck ins, you bring the revenue and you get some equity. So, you’re a partner now in an independent firm. You’ll get paid something for your client revenue and you’ll participate in the profits, the bottom line of the firm, and own some equity some day that you can sell. And so, it’s different than just moving to join another team where someone else takes a slice of your revenue, it’s moving into an independent world where you’re tucking into a firm, but actually taking equity to be part of something larger.
Or alternatively, there are solos that break away and just go entirely on their own, particularly those that want to form what are often called lifestyle practices. Because one of the other benefits to being independent and being your own boss is that, you get to decide what you’re building toward. So, if you’re happy with your income, especially if you could keep 65 or 75% of your gross revenue, and you don’t want to grow anymore and you’d rather just gain more efficiency so that you can take more vacation, you can do that. There’s no sales manager grieving you for not growing or hitting bigger numbers. Your numbers are whatever you want them to be, including not growing if you’re happy with your income where it is.
Why Do You Want To Break Away, Really? [Time – 12:50]
But again, if there’s one thing that you take away from this discussion it’s just that you need a clear picture in your head of why you’re breaking away and just trying to make a few points on your revenue is honestly not the best reason. It may work out okay for you, especially if you tuck in or look at platforms like HighTower and Dynasty that you can just keep serving your clients, maybe bring your cost structure down a little while you clear a couple more points in the future. But the biggest success stories I see amongst the breakaways who do go to the independent channel are the ones who want to be independent. They want to make those decisions. They want to control their destiny. The fact that can also be more profitable is a wonderful perk and a benefit, and part of the excitement of being an entrepreneur is that, you actually truly own your advisory business.
But if all that sounds scary to you, then you may just want to stick it out where you are, where you don’t have to deal with the responsibility of all those decisions, and you can focus on serving your clients and going to get more. But at the same time, I do think it’s crucial to recognize that breaking away isn’t really just like a revenue requirement or AUM requirement thing. Large teams do it because they want to build their own structure. Medium sized teams do it, and maybe they want to build their own or maybe they want to tuck in. Small solos do it, and sometimes they just want to take home more pay, sometimes they want to go lifestyle, or sometimes they want to tuck into a larger firm. Lots of different reasons and the economics are a little bit different for each, but any of them can do it up and down the line because overhead and cost scale to the size of a business. It’s a question of whether you want the weight of the responsibility and the upside opportunity of doing so.
But the good news is there are a lot more support services out there now. The technology in the independent channel has gotten very strong. There are a lot of benchmarking studies to help guide you on what to spend and consultants to help. Plenty of compliance consulting firms that will help you do the transition and comply with broker protocol.
It does take time to do the transition and a big burst of energy and focus during the transition itself and to get your new firm set up on the other side, but don’t make the decision just based on the fear of the time it will take or the few points you could try to make on the other side. Make the decision based on what you want to do you as an advisor and a business owner. How you want to build a career, what kind of control you want, and whether you want the responsibility that comes with the control of independence. And if not, hang on where you are, keep serving your clients well because the truth is that’s still what most advisors do. As much as we talk about the breakaway broker trend, most estimates are that, it’s still maybe 1% or 2% of brokers that are making a transition to an RIA. That’s not about the math of take home pay. That’s about the subset of advisors that are driven towards independence.
I hope that helps a little as food for thought. This is Michael Kitces. Office Hours with Michael Kitces. We’re normally 1 p.m. East Coast time on Tuesdays. Obviously, this week, we had to record on Wednesday morning here. But thanks for joining us and have a great day everyone.
So what do you think? Are breakaway brokers driven by a desire to keep more of their GDC? Do they breakaway over something else? Will we see an uptick in breakaways as post-financial crisis retention deals expire? Please share your thoughts in the comments below!