How an Equity Ownership Structure Supports Your Evolving Practice

As you plan for your firm’s continued growth, there are two questions you’ll want to consider:

While adding an associate advisor can drive long-term growth by building scale, reexamining your business model—more specifically, moving to an equity ownership structure—can provide the building blocks to help you create a sustainable, enduring firm with those young advisors.

Unlike the more traditional income model, where partners maintain an eat-what-you-kill (EWYK) approach through ownership of their individual books of business, equity structures are highly integrated businesses where the firm contractually owns all client relationships. This shift in client relationship ownership has profound implications for how your business operates going forward.

Let’s look at how it can benefit your practice and your associate advisors, the challenges you’ll face along the way, and the steps you can take to ease the transition.

How Equity Ownership Supports Your Growth Plan

The biggest benefit to an equity ownership structure is that it aligns everyone’s interests toward future growth and profitability. Advisors no longer work in silos focused on what’s best for their book of business—everyone works together to build firm value.

This collective focus can help you:

• Attract and retain top talent from the next generation. I’ve seen anecdotal evidence that new entrants to the industry prefer a more collaborative business structure and sometimes shy away from the EWYK model. Those advisors are drawn to financial planning but prefer a compensation structure that isn’t directly tied to building a book of business.

• Create a pathway to ownership for younger advisors. Telling potential and current employees that there is a mechanism for them to buy into ownership is a powerful motivator. And given that equity structures allow you to sell shares (or units) of the business instead of client relationships, the entrance and exit of partners is smoother. It’s also possible to sell small pieces of the business over time to make the buy-in more economically feasible.

• Build enterprise value as you grow your business. Because advisors in the income model retain ownership of the underlying asset (i.e., client relationships), the value remains in those individual books of business. Moving to an equity structure enables you to build collective enterprise value.

Challenges You’ll Need to Overcome

If it’s so beneficial, why hasn’t everyone adopted an equity ownership structure? Mainly because it requires a big mental shift and a lot of work. Having a collective focus means having a collective book of business. Some advisors may not want to give up control over systems, processes, or individual client ownership.

Here are some other things to consider:

• When clients belong to the firm, and an advisor decides to leave, there may be limitations on that advisor’s ability to take clients with them.

• Bringing on younger advisors means you’ll need to think more broadly about the core skills required. You’re training them not just to be advisors but potentially the future leaders and successors of the firm.

• As your firm grows, it becomes more valuable, which can make it more difficult for younger advisors to buy in.

• It’s a shift in how finances are structured and can result in tax implications.

• If you run personal expenses through the firm, you’ll need to separate your business and personal finances.

Next Steps When You’re Ready to Get Started

If bringing on younger advisors is part of your growth plan and you project an internal succession, the long-term benefits of equity ownership will likely outweigh the challenges. Once your team is on board, start thinking of your firm as a collective entity rather than a siloed environment.

Then, follow these five steps to move forward (which will also help with that mental shift):

1. Create standardized systems. To foster that shared vision, you’ll want to be consistent across all areas of the business. This includes everything from client onboarding and paperwork processing to investment management and financial planning. By creating standardized systems, you’ll ensure that every client has the same experience, no matter which advisor they work with.

2. Professionalize your P&L. By adopting professional accounting practices within the firm, you can centralize financial management. This will help move the firm’s focus from top- to bottom-line performance and give you a clearer picture of what’s driving success so you can think more like an entrepreneur. That, in turn, will help drive the firm’s long-term growth. Additionally, having a clean P&L is critical since the valuation of an equity firm is commonly based on a multiple of earnings as opposed to revenue.

3. Formalize your advisor compensation system. By establishing a transparent pay structure, everyone will know what to expect in terms of compensation and profit distributions.

4. Establish partnership criteria. This will provide an incentive to new advisors by articulating the path forward and allowing them to recognize the economic value of buying in.

5. Consult with your CPA and attorney. They will help determine the best tax structure for the entity and draft the necessary paperwork to put your governance structure in place.There’s more flexibility here than you may think, so consider your firm’s purpose and values when setting up this structure. For instance:

6. What kind of ownership do you want? Some firms hold onto ownership as the “ultimate carrot” and limit the number of partners to the core leadership team. Others prefer wide and thin ownership, where many people are allowed to buy small amounts of equity, often after they’ve passed a specific tenure.

7. How are you defining ownership? It’s possible to create either a single class or multiple classes of partnership, which can impact decision-making regarding who has a seat at the table and how voting takes place.

8. How will the buy-in happen? If one of your goals is to make it easier for younger advisors to join, you may want to put internal financing options in place, such as structuring the first buy-in entirely through profit distribution or discounting internal purchases.

Associate Advisors and Equity Ownership: The Keys to Long-Term Success

If your future growth plans include hiring an associate advisor (and they should!), shifting your business model to an equity ownership structure can help position your firm and incoming advisors for long-term success. Not only will it help you attract top talent, but it should also help you retain those advisors as they develop into the next leaders of your firm.

When everyone is aligned with where the firm is headed, there’s no limit to how far you can take it.

FREE DOWNLOAD

What your business needs to thrive now—and for many years to come.

Whether you’re just starting out or looking to take your practice to the next level, having a clear plan to grow is vital.

Commonwealth Financial Network® does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.

Editor’s note: This post was originally published in August 2022, but we’ve updated it to bring you more relevant and timely information.