Equity Comp a Mixed Blessing for Independent RIAs

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According to a survey conducted by Schwab Advisory Services on RIA compensation practices released Wednesday, over three-quarters of registered investment advisors with $250 million or more in assets under management said they were looking to hire extra staff within the year, and many are planning on dangling equity in the firm as a lure.

Of the 42% of RIAs that said they plan on hiring from other RIA firms, be it financial advisors or administrative staff, 73% said that they share equity in their firms with nonfounders as part of their overall compensation package.

Equity ownership by senior client account managers grew by 21% over the past four years, according to Schwab’s study. Equity compensation on the part of operations directors or managers, largely administrative staff, increased by 18%, the survey said.

By and large, equity compensation in these still relatively small businesses is a good thing, observers say, as it aligns the incentives of the new hires with the firm. As valuations of RIA firms seem only to increase, so does the value of the employee’s compensation—on paper, anyway.

As advisory practices recruiting revenue producing advisors, with an eye toward succession planning, equity compensation makes sense. But as many of these RIA firms evolve from practices to enterprise businesses, the use of share ownership in compensation packages becomes more complicated. Bull markets don’t last forever, and some recruiting experts say equity compensation in the RIA industry could be a mixed blessing.

Louis Diamond, executive vice president of Morristown, N.J.-based Diamond Consultants, a consultant and recruiter for financial advisors, said that while there is “more good than bad” in the trend toward greater use of equity compensation, “there is more risk if the market takes a tumble or if the firm takes a hit.”

Diamond said his firm has seen situations where an advisor or employee finds there is little to no value in the equity received, because RIAs are by nature often private and closely held companies, which makes valuations difficult to measure. “It could be there is not a market to sell the equity, so you could be stuck with it without being able to see it monetized,” he said.

Consider too that employees with equity stakes, as opposed to principal owners, may not have a say about when or how those shares can be monetized.

Bill Willis, owner of Willis Consulting in Los Angeles, an industry recruiter, said that “if you take equity in part or in full there is going to be some risk; if you have to buy the equity or if you are offered equity in my experience, there is going to be some risk if you get into a terrible bear market, the operating income of the firm will drop and your income will drop just like anybody buying into business.”

Typically, equity is offered to a producing advisor who joins the firm, and that makes sense, says Michael Terrana, CEO of Chicago-based Terrana Group, which recruits breakaways from the wirehouses and banks. “It wouldn’t be just a staff role that they would offer equity to, although I’ve seen it done. It’s typically industry veterans who have come out of wires who have made that type of transition.”

In that sense, it’s not a bad thing. “You’re not depleting the cash of the firm as much as the wirehouses offering huge retention deals. That’s more of a danger if the market downturns. As a producer, it’s far more dangerous to give cash rather than equity.”

But Lisa Salvi, vice president of business consulting and education with Schwab Advisor Services, said it has become increasingly common for lower-level staff members to be offered equity in a growing RIA in addition to their compensation, as a means to gather top-level talent.

“Nowadays it can be anyone, especially the client-facing folks,” she said. “We spent a lot of time with students at the university level and even they are adept at long-term opportunities. They will go into a firm asking, ‘How will you invest in me? What will the next few years look like? Are there opportunities for equity ownership in your firm? This shows a pretty high level of sophistication, and those RIAs who have incorporated equity stakes into their practices stand out from the competition for talent.”

Ryan Shanks, CEO of FA Match, a recruiter based in Springfield, Mass., said that offering equity stakes “gives the folks who are running that firm a buy-in. If we see a downturn, and the firm is well-run and efficient and operating with a nice margin, no matter what happens you can maintain consistency in that valuation. But if you’re not methodical, those are the ones who are going to see discounting.”

He said equity is a good compensation incentive even as markets turn volatile, as it incentivizes employees to take the long-term view with the firm. Done right, even if markets fall, those employees could stick with the firm “for the next 10 to 15 years.”