How to successfully transition to a fee-based practice

Brandon Grundy, CFP, a principal with Ridgeview Financial Planning in Sonoma County, California, was working 100 percent on commission when he started contemplating the fee-only model in 2008. He reviewed his client roster to project which clients would follow him. While he was optimistic about the long-term outlook for starting his own registered investment advisory (RIA), he anticipated his income would fall by about two-thirds in his first year and began building up his savings cushion.

He left his former employer in August 2014 and dropped his insurance licenses. His detailed financial projections proved to be accurate, as was his forecast of which clients would stay with him. The new business model allows him to offer hourly planning consultations, which he couldn't provide previously, and those engagements generate additional fee income and bring in new clients. Overall, he's very satisfied with his first 18 months' results.

Grundy left under an onerous noncompete clause that slowed his startup. In contrast, David Shotwell, CFP, a principal with Shotwell Rutter Baer Inc. in Lansing, Michigan, faced fewer restrictions and a smaller impact to his income from transitioning to fee-only. His noncompete restrictions covered roughly half his clients, and less than 20 percent of his income was from commissions. Like Grundy, he ranked clients' likelihood of following him and he projected the transition's impact on his personal finances. The results indicated he would have to cut back on personal spending for about six months, but after that his income would return to its prior level.

Shotwell left his former employer in February 2013 and says the projections were accurate. 

Don't overlook practical considerations

Grundy started a solo RIA; Shotwell joined another advisor. Going solo means taking on the myriad tasks of running an RIA as a business: marketing, compliance, administration, investment management and so on. Over time the advisor's skill at and enjoyment of those tasks will become clear, at which point he or she can decide which duties to retain. Another option is to join an existing RIA, as Shotwell did, and leverage that organization's resources. "You can choose to wear all those hats and figure out whether they fit or not and you'll only do that in time," says Shanks. "Or you could go to someone who has figured that out, does a better job than you probably would and then just lean on them for that (so) you can focus your attention on your clients. When we run the pro formas, usually the net income to the advisor is higher than if they were to create their own company."

Consider the hybrid option

Another issue is the retention or disposition of former commission-based clients. Garcia says the advisors and advisor teams coming to Pershing typically derive 70 percent of their income from fee-based sources. They must decide how to transition their remaining book of business to a fee-based model or how to retain it as commission business when retention is in the client's best interests, which can be the case with insurance products.

If retention is the best solution, Pershing helps advisors transitioning to RIA status affiliate with a broker-dealer that does not require advisors to become employees. That hybrid arrangement buys the advisor time to work out a transition for the commission business or to continue serving those clients. Combining both business models is often the most practical solution, Anderson maintains. "Very, very few people have ever just ripped the Band-Aid off, if you will, and say I'm going 100 percent fee today," he says. "Most of them do it over a longer period of time."

Reid agrees that a hybrid transition is often smoother for both the advisor and clients. It also gives advisors more flexibility for applying the right model to each client's situation. She cites the example of an older client with minimal trading needs in his account and consequently incurs modest commission expenses. "You don't necessarily want to change that person to fee-based if you're not providing other services and other benefits to them for that," she says. "Allowing you to have the option to keep them commission-only is for the benefit of the client."

Initially retaining commission-based clients can benefit future growth. Shanks notes that advisors' ability to grow their practice by acquiring or merging with other firms is linked to their firm's size. He cites the example of an advisor who had $100 million in total investable assets, of which about half were broker-dealer assets. The advisor's new custodian convinced him to leave the breaker-dealer assets behind so the advisor could adopt the fee-only model.

It would have been more advantageous to bring the entire $100 million, says Shanks. The larger amount would give the advisor more flexibility and clout when approaching potential partners or sellers. "I said if you're $100 million in total assets, you could get in front of someone $50 million, $60 million, $70 million, $80 million in assets and you could position yourself as a successor to them," says Shanks. "But if you're at $50 million as a foundation, you're going to position yourself to those folks with $10 million, $15 million, $20 million, $30 million in assets. Because if I've got $85 million in assets, I'm going to think twice about someone with $50 million having enough of a business construct to support that coming on top of what they already have."

Keep the bigger picture in mind

The transition from commissions to fees is a major decision for an advisor but it involves more than a compensation model change, says Garcia. Advisors need to understand that they're not only going from commission to fee, but they're going from product selling to service purchasing on behalf of their clients. "That's a big change for folks but one that could be very lucrative from a professional perspective, from a business perspective and from an economic perspective and, then, obviously for their clients that they're serving every day," he says.