The Age-Old Debate: Profit vs. Growth – What’s More Valuable?
September 25, 2018, by Matt Sonnen
At the Echelon Deal and Deal Makers conference in Newport Beach earlier this month, several sessions tackled the big question: If I’m looking to sell my firm, what is more important to a buyer – my growth rate, or my bottom line profits?
From a deal makers’ perspective, I think the answer is probably both. A buyer will be more willing to pay for a firm that has a proven track record of growing top line revenue than a firm that has stagnated and/or is losing clients more quickly than they are gaining new ones. Likewise, a buyer will want to invest in a healthy stream of cash flows (bottom line profits) and will be more willing to apply a higher multiple on that profit than for a firm that burns through all of its revenue and has no earnings to report at the end of the year.
From a day-to-day operational perspective, however, if you are not looking to sell, I think profits outweigh growth, hands down. In fact, I would make the argument that without profits, your firm cannot experience any growth.
Most advisors running RIA businesses grew up in the wirehouse world as W2 employees of Merrill Lynch, Morgan Stanley, Wells Fargo, etc. When you are an employee-advisor being compensated off a payout grid, nothing matters but top line revenue. The more revenue and commissions you can produce for your employer, the more take-home compensation you will enjoy (setting aside the “golden handcuffs” concept of deferred comp, which more and more wirehouses are playing with these days, but that is another story altogether).
These advisors have been trained to think “Top Line, Top Line, Top Line…” and very rarely equate their headline production number to their take-home pay. “Million-dollar producers,” for example, do not take home anywhere near one million per year, but they all advertise their production numbers with little regard to how much is actually hitting their bank account each month.
When wirehouse advisors break away on their own and start RIAs, you can’t blame them for carrying forward this same top line mentality. They assume having more advisors at the firm leads to more clients, which leads to more revenue. More employees on payroll should mean more clients can be served, which should bring in more revenue. More AUM, regardless of the fee being charged, should mean more revenue. Then they wake up 10 years later and realize they have a profit margin well below 50% and lack the cash to reinvest in the business on updated technology, proper marketing, proper benefits for their employees, and they find that the business is shrinking. Many advisors are confused by this and are somewhat taken off guard. If they have been working so hard to increase revenue, what happened? Why are they struggling?
It is high time that the RIA community faced the fact that we are business owners. Employee advisors working for a larger organization are practitioners and only need to have a narrow focus on growing their top line revenue. A business owner is seeking a PROFIT, and must take into account not only revenue, but expenses and profit margin as well. This means actively monitoring and managing the ongoing cost of running the business, employing highly trained professionals, having a technology stack that delivers a top of the line client experience, etc.
There is nothing wrong with being an advisor-owner of an RIA who only wants to focus on the practice of being an advisor and who wants to remain focused on his/her clients rather than the day-to-day running of the business. However, these advisors should look to bring in professional management as soon as possible to focus on HR, Operations, Culture, and of course, Profitability. Whether you call this person a Partner, Chief Executive Officer, Chief Operating Officer, Director of Operations, or President makes no difference – but someone needs to take the reins and focus on the business, while the advisors do what they do best – provide quality service to their clients and continue to prospect for more.
If growth is your ultimate goal, you need to take a step back and understand that sustainable growth cannot be realized without first experiencing profitability. How does an RIA experience profitability? By becoming a balanced, cross-functional organization, one that delivers a unique, high-touch client experience in a robust and scalable fashion.