This is the latest installment of a regular column to answer questions from advisors who are considering transitioning to an RIA model. To see Brad’s previous articles, click here. To submit your question, please email Brad here.
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Several variables go into a successful transition of a practice to the Registered Investment Advisor (“RIA”) model.
It starts with first determining if the RIA model is a fit for your practice. Will it achieve what you are hoping for?
If it is a fit, next is an understanding of the different RIA models from which to choose.
From there, you identify and perform due diligence on the solution providers supporting your chosen model.
Finally, you orchestrate a carefully crafted plan to navigate your departure from your current firm and the transition of your clients to your new setting.
This process typically takes six to nine months from start to finish.
The most carefully choreographed plans, though, can result in challenges or unnecessary stress if you haven’t calculated a cash cushion to traverse the transition.
A cash cushion is needed not just for initial startup costs but for peace of mind as you leave your firm, move clients over and reestablish revenue.
Unlike starting a McDonald’s, which takes a large upfront capital commitment before you can even open the doors and start business, the upfront costs of starting an RIA are relatively modest.
Most costs of an RIA are ongoing expenditures such as technology, office rent, staff, compliance support, etc. These are typically paid monthly or quarterly going forward.
Upfront hard costs are things such as the formation of the RIA itself, possible office buildout (depending on your office environment), and initial marketing resources such as a website.
Part of the preparation phase of planning a transition is identifying the upfront costs and tallying the capital needed to cover it.
What’s less easy to pencil is the additional capital you’d want on hand to provide peace of mind through the process.
I have heard various feedback from advisors on what rule of thumb they used or wished they had used regarding having peace of mind.
An answer I often share is from an advisor who left a wirehouse setting, moving to his own RIA.
In hindsight, after having made the transition and his practice returning to normal operation, he recommended that transitioning advisors have four months’ of expenses in reserve.
If, hypothetically, not a single dollar of revenue came in for the first four months, you’d have a cash cushion to cover office rent, staff salaries, tech costs, etc., for the four months.
This is an extremely conservative approach, as not only does revenue (from newly transitioned accounts) come back online well before four months into the transition, but you typically have all your desired clients moved over by then.
This was the framework he would have used to calculate his ultimate peace of mind cash cushion if he did it over again.
Your cushion could be different, but having a strategy that you’re comfortable with will help reduce anxiety throughout the process.
A cash cushion, however, does not have to be literal cash on hand in your account. While that should be part of it, you can also fill your cash cushion bucket by having readily available access to cash if needed.
Case in point: Knowing the four-months-of-no-revenue mindset is conservative, having access to draw on cash for that extreme scenario can satisfy the needed comfort level. An example would be having an available home equity line. The cash is there if needed, but you don’t need to draw it down unless circumstances justify it.
Establishing a line of credit, if desired, is a step that should be taken before the final transition process. If you are a W2 advisor, it is much easier to establish a line with a bank while still with your current (long-term) employer, versus the extra scrutiny a bank would undertake if you asked for a new line shortly after leaving to start your own independent practice/business.
Ultimately, a cash cushion for peace of mind is like insurance. You want it in hand but hope you don’t need to use it.
Starting an RIA requires a lot less cash than starting a McDonald’s franchise. Strategically planning for it is no less important, though.
Brad Wales is the founder of Transition To RIA, a consulting firm uniquely focused on helping established financial advisors understand everything there is to know about WHY and HOW to transition their practice to the RIA model. Brad utilizes his nearly 20 years of industry experience, including direct RIA related roles in compliance, finance and business development, to provide independent advice regarding how advisors can benefit from the advantages of the RIA model.
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Read more articles by Brad Wales
This is the latest installment of a regular column to answer questions from advisors who are considering transitioning to an RIA model. To see Brad’s previous articles, click here. To submit your question, please email Brad here.
