Growing firms often prioritize the top line in the form of asset accumulation. This does lead to revenue growth and is an easy measure of success. But AUM-driven revenue paints an incomplete picture, experts say, since growing an advice practice requires investing in infrastructure.
Firms that instead make profitability the priority take steps that best position the practice for long-term health, they say. This is more than a mere shift in perspective or performance tracking. When advisors who focus on revenue growth want to upgrade software or staffing, they may find themselves low on resources. If that happens, future growth becomes harder to achieve and the firm may plateau.
By contrast, firms that prioritize profitability are more apt to cut unnecessary costs and spend strategically, according to Jim Pratt-Heaney of LLBH d/b/a Coastal Bridge Advisors. He’s a founding partner at the firm, which oversees $1.6 billion out of Westport, Conn. “It’s great to go from $1 billion to $2 billion, but if your margins drop as you do it, it affects the business,” Pratt-Heaney says. “If some firm has the same AUM as we do, but we’re more profitable, our people can be compensated better and we can offer clients more.”
That’s why LLBH d/b/a Coastal Bridge Advisors, which was founded in 2008, outsources services that lie beyond the firm’s core competencies — for example, bookkeeping and compliance. The firm also chooses technology vendors that improve advisors’ efficiency, wringing scale out of a lean staff. Meanwhile, LLBH d/b/a Coastal Bridge Advisors strives to hire and retain only top talent that the practice can afford to compensate competitively, Pratt-Heaney says.
Such investments enable the firm to attract ultra-wealthy clients with complex financial lives who are willing to pay for family-office-style services, he says. Healthy profitability also means LLBH d/b/a Coastal Bridge Advisors can afford to pass up on prospects who don’t fit its target profile.
To be sure, advice firms can grow both revenue and profit. The median RIA of the more than 1,100 firms participating in Schwab’s 2014 benchmarking study saw assets increase 67% and revenues rise 71% over the prior five years. During the same period, the median operating margin of participating firms rose 38 percentage points, to 25%, while median margins for top-performing firms hit 37%.
Client service can suffer when profit is the sole motive, warns Ken Robinson of KCR Wealth Management. He left a growing RIA team last year to start his own firm. The sole proprietor oversees $15 million in Reston, Va.
He says firms that automate their portfolio management to save money probably are not evaluating clients’ individual life circumstances. Although Robinson uses rebalancing software and thinks robo platforms have their place, he cautions against assuming they lead to prospecting success. Too much automation “often results in less than ideal trades being placed from the standpoint of taxes and transaction charges,” he says. “Putting profits first can hurt client relationships long-term, hurting the business overall.”
Bob Fragasso, founder of Fragasso Financial Advisors in Pittsburgh, agrees firms should manage for both revenues and profits. However, there are times when one factor trumps the other, he says. Profitability should be the priority if rising overhead starts eating into margins or if cash flow is drying up, according to Fragasso. In practical terms, a firm should be able to revamp its website without fretting that other bills will go unpaid.
A strong profit margin has allowed Fragasso to establish a couple of small locations in the suburbs besides his firm’s main office in Pittsburgh. Now he’s ready to expand deeper into those suburbs by acquiring established practices. With ample cash parked in three different banks and access to favorable loan rates, Fragasso has freedom to choose whom to buy out and how to craft his deals.
In fact, his eye toward profit is part of the reason he’s acquiring practices instead of opening new offices from the ground up. “If I start an office without any revenues, I have a heavy expense,” Fragasso says. “But if I buy the revenues and structure the purchase so it breaks even, then it does not impact the rest of our marketing and growth strategy — it’s an entity unto itself.”
By Chris Latham, March, 2015