A large percentage of advisory businesses use some form of revenue-sharing arrangements, or an eat-what-you-kill system that rewards sales and production tied to the top line, not the bottom line. This is true of small practices as well as larger businesses. “Fracture lines” are built into the practice model as individual books or practices are built in an environment that starts out collaboratively but most often ends up creating competitors.
It’s important that independent advisors move away from obsolete practices and improper building tools held over from experiences in the wirehouse world. Creating a sustainable and valuable business should be the goal of every advisor. Building efficiently and effectively takes the proper tools, the proper structure, and the proper team.
Advisors need to embrace the most powerful and lucrative tool they have: equity. Equity is the value of the business separate and apart from the cash flow and compensation paid for work performed.
Correctly structuring compensation at the ownership level is a critical element to building a sustainable business. The common mistake is to focus on the question of how much an owner should be paid, instead of how an owner should be paid.
The compensation system most commonly utilized in this industry is some form of a revenue-sharing or commission-splitting arrangement. On the surface, revenue sharing seems to be an easier and lower risk payment system than hiring a bookkeeper and setting up a payroll service to generate a W-2 wage and withholding system. But the risk and true cost of a revenue-sharing arrangement can become increasingly apparent the more successful a new advisor in the practice becomes; any value other than the agreed upon share of revenue typically belongs to the individual advisor responsible for building the book, regardless of which advisor is responsible for expenses and operations.
Instead of building businesses that evolve and improve from one generation to the next, advisors tend to build one-generational practices, and subsequently rebuild them from scratch with each new generation of owners largely because of these eat-what-you-kill compensation systems. For that reason, practices that last for just one generation of ownership are plentiful and multigenerational enterprises are rare. The goal of a practice owner is one of production, and production equates more directly with cash flow than it does with equity and the durability of a business.
If your goal is to build a valuable and enduring business, then your focus should be on a team of advisors working together, compensated for contributing to and supporting a single enterprise, rather than building individual books with clients and cash flow that moves with the individual advisor. Relying on a revenue-share arrangement destabilizes business value and encourages the creates of competitors rather than collaborators.
Download "Destabilizing Value with Revenue Sharing" here and learn more about building a strong team and preventing fracture lines within your business.