Common pitfalls
It is important to be aware of some of the pitfalls of the JV and authorised representative arrangements.
Compliance risk
We have already seen that in both arrangements, as licensee, the adviser carries the compliance risk for any financial services that the referrer provides, even if they are provided inadvertently. Both the referrer and the JV must be required to comply with your compliance requirements and must accept that non-compliance will result in termination of the authorisation.
Distribution of revenue
As the financial adviser, you need to be properly compensated for the risk to your AFSL and the contribution that you make in terms of your systems, processes and procedures. The referral partner may not fully appreciate this contribution and may seek a greater share of the revenue as the party providing the client base. Generally, the adviser would receive any plan fee/agreed percentage of a commission and the parties would then share in the profits of the JV company as dividends paid to shareholders.
No referrals
What if the referrer’s promise of a ready and willing client base does not eventuate? It is advisable to tie the referrer’s revenue share to client referrals – so the referrer has an incentive to bring profitable clients to the business.
Expenses
If you share offices and resources with the referral source, then agree the basis on which you will pay for those resources up-front and link it to market pricing. If you are dealing with accountants or lawyers, then predefine the basis on which they will contribute their services to the JV. Should they be entitled to do so at full (or even partially) commercial rates, when you are contributing your time, expertise and systems for a salary plus profit? Or should they be compensated on a cost recovery basis?
Avoid tying your contribution to expenses to the share of revenue that you generate for the firm. One client with this arrangement, who successfully developed the planning side of the business, ended up subsidising the rest of the referrer’s business.
Non-exclusivity
What if the referrer has other JVs with other financial services providers, such as general insurance brokers or life writers? Consider the potential exposure to your AFSL and your competitive position before agreeing to any cross endorsement arrangements.
Termination
Perhaps the biggest issue is: what happens when the relationship irretrievably breaks down, or even if it is happily terminated? For example, the referrer might decide to obtain his/her own AFSL or reach a potentially more profitable relationship with another financial adviser. Who will have the ongoing right to service the clients of the JV? Are you happy for the referrer to directly compete against you?
When initially entering a JV, it is easy to overlook the fact that over the life of the venture, just like a marriage, the relationship will become increasingly complex.
If we liken the end of a JV to a divorce, it is unusual to find a divorcee who has split amicably, without arguments about kids or property. Did they have to go through the Family Court? Were they happy with how much it cost them in legal fees? How much easier would it have been if they had a pre-nuptial agreement?
Business relationships are like marriages – easy to get into and hard to get out of.
Unless the rules are laid down in advance, when negotiations and discussions are easy because goodwill abounds, significant and sometimes irretrievable problems can occur after the relationship has broken down and communication is poor.
Shareholders’ agreements – the “business pre-nuptial”
A shareholders’ agreement sets out the pre-agreed rules which govern the manner in which a JV operates and the rights and obligations of both of the parties, both during and after the life of the JV. For less complex arrangements, a referral or authorised representative agreement can be used in a similar manner.
What business issues are covered?
A shareholders’ agreement can assist with the management of the following issues:
1. Services
The scope of the services that each party will provide should be clearly outlined, specifically: Who will provide financial planning advice? What remuneration will be received for this? Who will be responsible for the financial management of the JV? If there is an arrangement with an accountant, financial management might be within their expertise, but how will they be remunerated? At cost or at professional rates? If one party is supplying premises, what will the rent be? Is it marked to market and, if so, how?
2. Remuneration
How will the profits of the JV company be distributed?
3. Accounts
What financial accounts will be kept and when will they be prepared and tabled?
4. Intellectual property
Financial planning methodologies and systems are valuable intellectual property (IP). Think about the work involved in establishing an advice process, IT reporting system, compliance system, approved product list (APL) and building relationships with fund managers. The profitability of a financial planning business will often rely on how effectively these systems are operated.
If it includes appropriate confidentiality obligations and clauses defining who owns this IP, a shareholders’ agreement can protect these assets and prevent a JV partner using this IP outside of the agreement.
5. Liabilities and indemnities
Who will be liable for negligent acts or omissions, or even breaches of the Corporations Act and other legislation? Sometimes the line between the services provided by the JV and those provided by the referrer could be blurred, especially if they are an accountant or lawyer. Was it the investment advice or the accounting advice that caused the client to suffer a loss? Was it the structure proposed by the financial adviser that caused the loss or was it the execution of the suggested strategy by the lawyer; for example, a discretionary trust with inadequate investment or distribution powers, or a testamentary trust that fails? What if it was a little of both? How should liability be apportioned? The shareholders’ agreement can define this, so that neither party assumes liability for the actions of the other and indemnities are made to ensure that those ultimately responsible for any loss accept the blame.
