Building an independent advisory firm is like running a marathon–it takes a long time, it is painful and it drains you of every resource and ounce of mental energy you had. It is competitive but it's more of a competition with yourself, a test of your plan and your will, than it is a race against others. It tests your limits but it gives you a sense of achievement like no other. For many owners of advisory firms, surviving the financial crisis has felt like running their first marathon–long, hard and draining, but ultimately rewarding.
It is hard to imagine when you finish your first marathon that you might find yourself at the starting line of another. Unfortunately, that may be what happens to every firm–we (the independent financial advisory industry) may have to go through another test. I have no insight into the market or the economy, but I believe most advisors would agree that the probability of a double-dip recession is higher than 0%. As daunting and scary as it may seem, we may have to prepare for another marathon. Still, this time we have the lessons of the first one and we know how to prepare better. The time to prepare, though, is now–not when we are in the middle of it. If we prove too cautious and the market surges ahead, then the most we risk is spending too much time on improving our business–how can that be bad?
The possibility of a double-dip recession is very frightening because so many of the business plans, so much of the emotional energy, and the credibility of almost every firm in the industry is heavily invested in the notion of recovery and return to prosperity. Another period of defending client relationships, reducing employment and compensation and having low profitability is not just disappointing–it might change the nature of many firms, threaten their existence, cause them to sell, prompt their people to change careers and undermine the credibility of the industry. I am not trying to be alarmist in my prediction but I remember vividly how many of those decisions were on the table in February and March of 2009. And that was just the first one–the easy one.
Running your second marathon is nothing like running the first one. When you run your first one everyone is cheering for you and all your family and friends line up along the course to support you. When you run your second one everyone is just wondering
what is wrong with you–why do you keep doing this? There is no one cheering from the sidelines, but the bar is set higher because now you have to run faster. Worst of all, you know exactly how bad it is going to be.
The 2008 and 2009 crisis was all about survival–just staying in business felt like an achievement; after all, it was the worst crisis since the Great Depression. What is more, the owners of advisory firms had the full support of their staff–employees were very understanding when their compensation had to be reduced and when some of their colleagues had to be let go. Employees not only cooperated with the owners and the measures they had to take to save the firm, but they also put a lot of extra time and effort to cover the shortage of staff and increased workload. In most firms there were no bonuses in 2008 and 2009 and no salary increases; nonetheless the camaraderie and sense of purpose preserved the culture of the firm and the morale of its people.
According to the 2010 Top Wealth Manager Survey published by WealthManagerWeb.com, 28.7% of all firms in the industry cancelled their bonus plans in 2009 and another 38.2% only paid token discretionary amounts. Salaries were similarly frozen throughout the industry, and the typical firm did not hire any new staff—and most likely reduced staff. Still, employees were there on the sidelines cheering for us—the business owners who were trying to survive this ordeal. They bought into the notion of persevering through this together because they believed that the firm will, in return, help them to grow in their career and would not let them go like others were doing. Unfortunately, if we suffer another recession our employees may no longer be as supportive, and we may have to run this marathon alone.
Financial concerns and employee issues are going to be the primary areas that firms have to shore up. Ultimately though, it will come down to being able to preserve a sense of opportunity and purpose in the firm—a reason to run your second marathon:
Stress-test your cash flow and balance sheet—Pretend you are a big bank for a moment (except, no government bailouts) and apply a similar strategy to your finances. First prepare a projection for 2011 where you increase your payroll by 10%, your other expenses by 5% and reduce your revenue by 10%. The result will typically be 40% to 50% reduction in profits. For some firms this may be an acceptable result, but for other this could be the brink of disaster. Firms that have to make payments to acquirers or buyouts of retired partners, or firms where the partners need to draw high levels of income, have to be particularly careful.
As many advisors realized in early 2009, profit and cash flow are not the same. For most firms, the cash arrives once a quarter but bills arrive daily. Creating a cash-flow budget, and looking at significant cash-flow outlays, such as taxes and estimated tax payments, significant purchases and other liabilities, is prudent and highly recommended. The cash-flow budget should be built off the projection above, but detailing the actual timing of payments. This step will either give you peace of mind or a signal that something has to be done. Keep in mind that reserving three to six months of expenses as capital reserve is a good practice. My concern is that many firms have
depleted their reserve down to nothing or may be about to distribute all of the reserve as dividends at the end of the year.
Work individually with each employee—More than 70% of all expenses in an advisory firm are employee related—salaries, bonuses, benefits, etc. The reality is harsh—if revenues go down and expenses have to remain the same and go down, employee compensation will be affected. There is no way of significantly reducing the expenses of an advisory firm outside of changing the number of staff, staff salaries and/or owner compensation. Usually all three, and typically owner compensation goes first. While employees are normally understanding of temporary changes in compensation, ultimately they still expect growth in their careers. At some point "temporary" starts to feel like "long-term" and at that point you as the business owner may find yourself in charge of a ship in mutiny.
If we really have to go through another period of declining market, or even just a flat market, it is important to understand that employees need to reestablish a sense of direction and purpose in their careers. If a firm goes two or three years without promotions and salary increases, employees would want to know what the ultimate prize is; why should they run in this marathon with you? Owners have symmetrical risk—we lose much on the downside but we win a lot on the upside. Employees lack the upside—they can only see the compensation they have lost. It has been my experience that camaraderie and culture can sustain motivation and contribution at least as well, if not better, than compensation. That said, prolonged compensation issues can undermine even the most cohesive culture.
The last recession was a time of panic and massive lay-offs where employees did not see alternatives if they left their advisory firm. Currently, staff counts are relatively low in our industry and throughout the country. While a recession by definition will not present our employees with many alternatives, there might be more than we think. Many of the larger advisory firm are upgrading their staff and continue to cherry-pick employees that they can lure away from competitors. Larger corporate employers, including those outside of the investment industry also continue to selectively add talent even if they are not hiring in large numbers. In other words, employees may have more choice than you realize. When trying to convince employees to stay with you firm, you are also asking them to dedicate their career to this industry—and that may be difficult to do in the middle of a crisis.
You can't answer the doubts that your staff have about their future and their careers through bonus plans or memos. The best method in my mind is to treat each employee individually. Each person has different expectations of where their career should be and what their goals are. If employees have the sense that the firm is committed to their career, they will make the same commitment back—and the opposite is also true, they will not make a commitment if they sense a lack of commitment from their employer. Now is the time to reinforce or rebuild the trust
