Surging upfront recruiting checks carry significant risks for independent advisers

It's crucial for advisers to kick the tires thoroughly on any potential transition, starting with questions about the firm's capabilities, products, support and financials

Dec 19, 2018 @ 11:24 am

By Jeff Nash

The recruiting wars are heating up, but this time, the primary battlefield is among independent firms rather than between wirehouses. Yet the more things change, the more they stay the same, especially when it comes to upfront checks for new recruits.

When the wirehouse recruiting wars were at their peak during the early 2000s, it wasn't unusual to see firms offering upfront checks totaling more than 300% of an adviser's trailing-12-month revenues.

Today, the independent financial advice industry has started to witness comparable dynamics, especially among the top 25 independent broker-dealers, as measured by total annual revenues. Indeed, since the start of this year, the industry's largest 25 firms have been issuing bigger and bigger upfront checks for new recruits, with valuations for independent practices comparable to wirehouse offerings 15 years ago.

On the surface, this seems like a terrific environment for switching firms. When is more upfront money bad?

But the devil is in the details, and this surge in upfront recruiting checks contains greater risks to advisers than might be obvious.

Private equity or publicly traded

To understand the risks, it's essential to first examine why independent firms are engaging in these practices.

Let's start by recognizing that many of the top 25 IBDs based on annual revenues and adviser head count are either under private-equity ownership or are publicly traded.

What private-equity-owned and publicly traded firms have in common is their top priority of increasing value for their owners, whether they're private-equity fund investors or public shareholders. And most of the time, value for equity holders in this context is driven by rapid growth, either through acquisitions or recruiting.

At first blush, acquisitions would seem to be the obvious path forward for rapid growth, but it's a strategy that has its limits. For starters, there are only so many mega NPH acquisition deals out there that can generate a one-time enormous boost to adviser head count and revenues.

(Full disclosure: I served as senior vice president for business development at LPL Financial until 2012. LPL acquired NPH in 2016.)

Moreover, as with any change-of-control transaction between firms, there is a significantly escalated risk that competitor firms will be very actively trying to poach as many advisers affiliated with the acquisition target as possible, pitching to these recruits the dangers presented to their business by uncertainty and a potential lack of service continuity.

And of course, there are the perennial issues of cultural fit and operational integration, which can be complicated, costly and time-consuming.

All of which explains why the top 25 IBDs, and especially firms that are either private-equity-owned or publicly traded, are intensifying their focus on recruiting advisers as the primary avenue for accelerated growth.

(More: Independent broker-dealers fastest-growing brokerage group)

Perils of forgivable loan structure

To round out this background, upfront recruiting checks are almost always delivered as forgivable loans. In a nutshell, advisers receive a sum of money in exchange for committing to remain with their new IBD for a set time frame, usually three to five years. In some instances, loan terms also demand that the adviser meet performance metrics such as average annual production.

If these terms and conditions are not met, and the adviser either exits the profession or switches firms before the terms of the loan, then the adviser usually must repay the forgivable loan, which can be a significant financial hit.

In today's environment, recruiters will pitch transitioning advisers by glossing over details because recruiters are incentivized to make these moves in large volumes and as quickly as possible.

If the adviser is unhappy after transitioning to the new firm, based on how the forgivable loan structure works, it's the firm — not the adviser — that has the upper hand.

(More: How to recruit top financial advisers and staff)

Questions and considerations

More than ever before, it's crucial for advisers to kick the tires thoroughly on any potential transition and assume that key details will be omitted as part of most proactive messaging from recruiters.

It's incumbent on the adviser to dive deep on a number of issues, starting with questions about a potential new firm's comparative capabilities, products, support and financials.

A very important point to clarify in this era of larger upfront checks is whether broker-dealer fees and payouts are negotiable. It's not just about what you get on the front end, but also about what you can keep on an ongoing basis out of your earnings.

It might work better for some advisers to go with a firm that demonstrates more flexibility on these items versus just going with the larger upfront checks.

Here's the bottom line: It's all about integrating feel, fit and financials rather than allowing the upfront check amount to drive the decision.

Both private-equity and publicly traded ownership create added growth pressures for firms and their recruiters, so it's incumbent on the adviser to go the extra mile in identifying key details recruiters might not want to address, while considering the overall fit of the new firm and the forgivable loan financial obligation details.

(More: Regional broker-dealers quietly making comeback now, but the future remains uncertain)

Jeff Nash is CEO of Bridgemark Strategies, a leading strategic consultancy for the independent financial advice industry.


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