For many advisors, the thought of going independent is coupled with critical financial considerations—because unlike transitioning to a traditional firm, making the leap doesn’t come with the outsized check via a recruitment deal.
Whether funding is needed to pay back deferred comp, cover start-up costs or satisfy the desire to monetize in the short term, advisors making the leap often look at one of the most available sources on the Street—that is, investors who are eager to exchange capital for equity.
While it can be a real positive to align with an entity that can bring significant cash to the table as well as expertise and experience, there are also some good reasons not to do so—particularly when it’s early in the life cycle of the business. Here are five things to consider:
1. Selling a portion of the business while you’re still an employee would likely be at a lower valuation or a less advantageous deal structure than what it might be in the future.
In this case, the advisor doesn’t “own” anything at the time of sale, and since they are unable to take client data or pre-gauge who will move with them, there is greater risk to an investor. The increased risk translates to a structure that is weighted more on back-end earnouts than a traditional transaction of an already established independent business. And unless the sale of equity occurs 12 or more months after the transition, the proceeds will be taxed as ordinary income vs. long-term capital gains.
2. Selling a portion of the business could negatively impact your take-home economy.
A well-run independent firm most often nets in the vicinity of 60%–65% of revenue to the owners after all expenses. So even if you sell a minimum of 15%–20% of the business to an outside investor, net payout would be similar to or less than that you might be receiving as an employee of a traditional brokerage firm.
3. Selling a portion of the business can often be one of the most expensive forms of financing.
Once you sell equity, the transaction is most often permanent—which means even as the business grows and matures, the investor is still receiving dividend payments. While some advisors are resistant to take on debt or a forgivable note obligation, the cost of debt and the taxes/interest payments on a note in the long run are likely more affordable.
4. Selling a portion of the business too soon could cut into your future upside.
Most advisors who are interested in breaking away do so because they have long runways ahead of them and are bullish on their growth. Selling equity today directly diminishes the upside earning potential down the road, impacting optionality at a time when monetizing the business in its entirety—that is, closer to retirement—would be most desirable.
5. Selling a portion of the business too soon would limit the choice of investors.
This is the biggest reason to consider—because there will be greater choice in the way of investors once the independent business is up and running and demonstrating success. Many private equity firms, family offices and even clients (who might have an interest in becoming an investor) will have less desire to take a stake in a nascent business. Plus, the laws of supply and demand dictate that fewer bidders often equates to a lower sale price.
These reasons aside, there may be times when selling equity right out of the gate makes sense, such as:
- Your partner is considering your firm’s retire-in-place program. While selling equity isn’t ideal, it can help to incentivize the senior advisor to leave—and avoid the five- to eight-year lockup inherent in these programs.
- You’re trapped by the “golden handcuffs” of significant unvested deferred compensation. A sale of equity can more than make up for the deferred comp that is holding you captive—and allow you to get on with building your business and serving clients with freedom and control.
- You’re looking for a strategic partner. The right capital provider—one that shares your ethos and vision for growth—can become a true partner, providing expertise that may otherwise be lacking. While you may be opting for a lower take-home economy after selling a portion of your business, the right partner should help you grow faster and more than make up for what you’ve sold.
- You’re interested in accelerating growth. Leveraging additional capital could help you grow the business far faster than you might on your own. It also comes with the potential bonus of tapping into the deal-making expertise and M&A sourcing of the investor.
- You want to pocket some capital and make the move to independence less risky. If the only thing standing between you and your desire to go independent is upfront monetization—and you believe in your long-term upside—then it may be well worth selling some equity early on.
If it’s capital you’re after, there are many ways to access it without selling your future income—such as forgivable loans from broker/dealers and RIAs, lenders who specialize in providing capital to breakaway advisors, and supported independent platforms designed to offer services for breakaways that have creative solutions to help bridge the financial gap.
So are you selling yourself short by selling equity? Only if you don’t have clarity on your goals and haven’t explored all of your options. As the independent space has become more developed, there’s no shortage of capital solutions for advisors who are seeking to retain control and autonomy.
