4 Incompatible Objectives With the Independent Broker-Dealer World

One advisor learns that there’s more to independence than what he had in the IBD world.

Independent broker-dealers (IBDs) serve a great purpose within the marketplace. By allowing advisors to own their business, self-brand and take control of their financial destiny, IBDs are often a breath of fresh air for breakaway brokers and entrepreneurial spirits. Further, IBDs serve as “incubators” for startup businesses that fall below the minimum requirements for wirehouses or are too commission oriented for the RIA space. Advisors are all the happier to share a percentage of their revenues with their broker-dealer in exchange for support in compliance, operations, technology, investments and practice management.

Yet while there are MANY multi-million dollar businesses within IBDs, there are often instances where a business has outgrown this model in favor of the registered investment advisor (RIA) hybrid space.

The RIA space has undergone a rapid expansion over the last number of years as advisors exiting the brokerage space have sought greater autonomy, flexibility and control over their businesses. In an RIA model, fee-based assets are held at an institutional custodian (i.e., Schwab, Fidelity, Pershing, TD, Raymond James) and commission assets (and securities licenses) are held at a friendly broker-dealer which is only compensated for the business which runs through it.

Take Will for example: A 20 year veteran of his IBD, managing over $400mm on behalf of his 600 relationships. Will began his career at his broker-dealer and found great support and empowerment throughout his years at the firm. For the last few years though, as the regulatory environment has changed, tough markets have stymied organic growth and more and more of his peers left the firm, Will started to think long and hard about whether he was in the best place for the sustained health of his business. After thought and consideration, Will decided that the RIA space was the best place for him and his clients based on his 4 primary objectives that he saw as incompatible with the IBD world:

1) Serve as true fiduciary

By definition, advisors sitting under a broker-dealer operate in accordance with the suitability standard as opposed to the fiduciary standard in RIA space. While most IBD advisors already act in the fiduciary mindset, a true fiduciary separates product manufacturing, advice and safe asset custody—three mandates that can only be satisfied as an RIA.

2) Customize Infrastructure

IBDs provide technology, compliance support, operations and many other value-add services. They do so, however, for hundreds or thousands of advisors, making customization and evolution quite difficult. Many are perfectly happy paying a few bps for a “plug and play” environment, but those who value the ultimate freedom, flexibility and control may find the RIA space to be a better fit. For example, Will wanted to implement the latest versions of Salesforce, E-money and ORION; however, these systems were incompatible with his BD’s proprietary technology stack. Additionally, although Will ran a clean and compliant business, he had to follow policies meant to corral a few bad apples. Like Will, many advisors look to the RIA space to build a custom compliance organization (with a dedicated or outsourced CCO) that best suits their business. For some, optionality and compliance control isn’t a plus, though, because it requires a lot of effort and responsibility.

3) Recruit and acquire

Quite possibly the greatest benefit of being independent is the ability to recruit and acquire advisors or practices based on the premise of operating leverage. As fixed costs stay relatively stable, each incremental dollar of cash flow hits the bottom-line. While there were thousands of targets within Will’s IBD, there was intense competition from larger and well capitalized OSJs and independent businesses. Additionally, Will’s efforts to attract top advisors from other IBDs, wirehouses and RIAs came up short as this would require prospects to change their BD affiliation or move back into IBD land from the RIA space—a generally unattractive proposition. As an RIA, however, the pool of recruits and M&A targets instantly grows to include all IBDs, existing RIAs and captive firm advisors.

4) Maximize enterprise value

By leveraging an existing infrastructure and effectively sharing services, independent reps (especially those under an OSJ) save time, frustration and capital. This is done, however, at the expense of creating a sustainable business that can operate without the support of an IBD. While Will was in his early 40s and had no intention of selling his business, he was a savvy businessman who would one day want to take some chips off the table at a maximum enterprise valuation. Will also knew from industry colleagues that sophisticated buyers from the private equity, RIA and hybrid-RIA worlds typically looked outside an IBD thus limiting the pool of prospective buyers and suppressing market valuation. Bottom-line, when Will goes to sell his business down the line a buyer will pay more as an RIA.

While the RIA space was the best choice for Will based on his long term goals, for many, an IBD provides the perfect backdrop to grow a business and leave a legacy. Truth be told, Will wouldn’t have been able to build the business he has today without the support and resources of his IBD. Yet it didn’t provide him with what he needed to grow his business into the real enterprise he envisioned for the future. So the real question for independent advisors remains: Just how entrepreneurial and motivated are you to build an enterprise that will meet your goals not just for now, but for your future as well?