The traditional path to growing an advisory firm – or any business – is fairly straightforward: craft a product or service that you can deliver profitably, and then deliver it profitably to more and more people. The greater the number of clients or customers who are paying for the solution, the more total revenue the business generates, and the more in profits that accrue to the owners (assuming a reasonable profit margin in the first place).

In the early years in particular, when a financial adviser still has a lot of capacity (i.e., time) and not a lot of clients, adding more clients and the revenue they bring can quickly ramp up the income of the financial adviser themselves.

But only up to a point: the individual capacity of a financial adviser is typically no more than 100 clients in an ongoing advisory relationship.

As once the adviser’s individual capacity is reached, the only way to continue to add more clients is to add more staff to service them, including another adviser to work with them. Which suddenly makes the next 100 clients not nearly as profitable to the adviser as the first 100 might have been.

Because the reality is that for a financial adviser’s first 100 clients, the adviser is actually paid in two ways: part of the revenue compensates the adviser for the work he/she does in the business, while the (smaller) remainder is compensation as profits for being the owner of a successful advisory business. While for the next 100 clients, the next adviser is paid for doing the advisory work in the business, while the advisory firm owner is “only” compensated with the profits of growing the business larger. Which means in practice that an advisory firm owner might take home 70% to 80% of the revenue from the first 100 clients in combined profits… but only 20% to 30% of the revenue for the next 100.

Of course, continuing to grow an advisory firm, and participate in the profits, is still a goal of the business (and the income of the owner), for those who have a goal to grow further. But it also means that for many advisers, it may actually be far easier and more efficient to grow not by adding another 100 clients, but trying to replace the existing 100 clients with others who are more affluent and can pay higher fees; effectively generating more revenue for the firm not from more clients in total, but revenue per client instead. All of which drops to the bottom line take-home pay of an adviser-owner with fixed overhead costs.

At a minimum, though, the key point is simply to recognise that what it takes to generate more income, once an adviser reaches capacity, is very different depending on whether the adviser tries to grow a larger business with more clients, or simply via more revenue from each client.

Not that there is necessarily a “right” or “wrong” path, but growing the firm with more clients does mean added staff, overhead, and risk, in an effort to grow a larger business with less incremental profit that comes with it. Which means if advisers are going to go the path of growth through more clients, it should at least be done with eyes wide open… and an awareness that there are (potentially more efficient) alternatives to growth instead.

 

*Note this article is an executive summary on the Kitces.com website and is published with permission. To read the full article, click here.

Michael Kitces is an American financial planner, commentator, speaker, and educator. He frequently contributes to industry publications, publishes a blog and newsletter for advisors, is the practitioner editor of the Journal of Financial Planning, and is a partner in a financial advisory firm.
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