Understanding the hidden economics of independence: More than payout: How independence can build wealth

Whether or not they’re independent, today’s advisers understand the basic economics of independence: greater payout in exchange for the adviser assuming more of the expenses of running his or her own business. But there’s more to the equation than that, and it’s worth exploring one aspect of what we call “the hidden economics” of independence to understand how shifting the model of one’s business can add significantly to wealth and personal assets.

As we explained earlier, in the first article of a three-part series providing a different perspective on the costs, financial benefits and non-financial rewards of independence called “Understanding the hidden economics of independence: How smaller can be more cost-efficient than bigger,” the independent model liberates the adviser from subsidizing a retail brokerage operation that is based on the employee model. The employee adviser’s subsidy equates to a lower payouts to cover a firm’s local expenses. These expenses are shifted back to the adviser when the adviser runs his or her own business. We’ve seen, too, that the costs of operating one’s own business as an independent adviser can be significantly lower than the costs allocated to advisers in an employee-based operation.

Now, let’s look at how advisers can use the savings inherent in the independent business model to expand their business, build a practical succession plan and eventually sell or transition the business to realize its enterprise value — and thereby create true wealth for themselves and their families.

Once operating independently, many advisers recognize that their business generates sufficient additional income to several tax-advantaged savings vehicles that are not available to salaried employees such as SEP IRAs and even defined benefit plans, which most private employers no longer provide.

For independent advisers with teenage children, having a business that can offer employment during summer vacation and school breaks provides a way for young people to establish and fund Roth IRA accounts, which through the power of compounding can provide a great foundation for a youngster’s future retirement.

Also, with their businesses operating as separate legal entities, many advisers have found it advantageous to buy a property personally and then lease office space to the business. This affords many tax advantages along with an opportunity for capital gains through real estate ownership.

The key and often hidden wealth-building advantage of independence, however, is the ability to create an ongoing, viable business whose enterprise value can be realized through a sale or a transition to internal buyers.

Investing a portion of an independent’s higher income in technology and people to systematize business processes — including marketing —can play a significant role in creating an efficient enterprise whose value becomes less and less dependent on the income-generating ability of its principal. Many independent advisers have found that independence has given them the freedom and financial wherewithal to concentrate on a particular niche or submarket that they can serve well and which gives them greater personal satisfaction.

Independence also enables advisers to choose who they hire as employees. While the cost of such talent may be higher, the gain in productivity and fit within a practice translates into greater enterprise value and more than compensates for the expense. Importantly, independence gives advisers the flexibility to plan for and structure the financial arrangements that will support a future liquidity event when the adviser plans to retire.

Depending on the adviser’s goals, retirement might mean selling the business to an outside adviser, transitioning ownership to designated employees, or gradually winding the business down. Whatever the path, independence allows an adviser to structure compensation and transition terms in ways that support those long-term goals.

Finally, many employee advisers believe that they can enjoy the wealth-building advantages of independence through the long-term equity ownership programs their employers provide. While these “golden handcuff” plans can be attractive, their chief drawback is that an adviser’s long-term wealth becomes dependent not only on the market cycle but also on the performance of other aspects of the parent company’s business — trading, investment banking and commercial banking, for example — which often have greater impact on share price than wealth management.

For advisers who wish to have control of their own financial future, therefore, independence provides advantages that the employee model simply cannot match.

For more detail, download Wells Fargo Advisors Financial Network (FiNet) white paper, “Independence Simplified” or read the first article in a three-part series providing a different perspective on the costs, financial benefits and non-financial rewards of independence called “Understanding the hidden economics of independence: How smaller can be more cost-efficient than bigger.”