#FASuccess Ep 044: Structuring A Successful Internal Succession Plan As A 25-Year-Old Buyer with Jake Kuebler

What You’ll Learn In This Podcast Episode

• How Bluestem built a niche focus serving college professors and administrators. [4:51]
• How Jake structures the firm’s annual retainer fee model, and how it changes from up-front to on-going. [7:50]
• How Bluestem’s retainer model structure allows them to grow the business serving young professionals as well as retirees. [16:28]
• What business management spreadsheet Jake uses to monitor the key performance metrics of his advisory firm. [20:27]
• Why Bluestem chose to include tax preparation as part of the annual service. [36:19]
• How Jake successfully agreed upon and executed a succession plan with the founder at the age of just 25. [56:03]
• Jake’s advice to other young advisors who want to buy into a firm and be part of a succession plan. [1:28:08]

Resources Featured In This Episode:

• Jake Kuebler
• Bluestem Financial
• University of Illinois
• Quickbooks
• ACP – Alliance of Comprehensive Planners
• NAPFA – National Association of Personal Financial Planners
• Succession Planning for Financial Advisors by David Grau
• Lacerte
• TD Ameritrade
• tRx – Total Rebalance Expert
• Morningstar
• Orion Advisor Services
• RedTail
• One Page Financial Plan by Carl Richards
• Matthew Jarvis Interview: Episode 007
• Angie Herber's Diamond Teams
• David Goad
• Bill Starnes’ Excel Spreadsheet For Managing Your Business

Full Transcript: Structuring A Successful Internal Succession Plan As A 25-Year-Old Buyer with Jake Kuebler

Michael: Welcome, everyone. Welcome to the 44th episode of the Financial Advisor Success Podcast. My guest on today's podcast is Jake Kuebler. Jake is the President of Bluestem Financial Advisors, and independent RIA based in Champaign, Illinois that provides a combination of financial planning, investment management, and tax preparation, with four staff members for nearly 100 clients, using a comprehensive annual retainer model.

What's really unique about Jake's business, though, is that he's actually the next generation successor of Bluestem, having spent the past five years buying out the founding owner, Karen Folk, while nearly doubling the size of the practice along the way. Oh, and he just turned 30, which means he actually started this internal succession plan as a buyer when he was just 25. In this episode we talk in depth about how Bluestem built a niche focus on serving college professors and administrators, as they are based in the hometown of the main University of Illinois campus, why they chose to include tax preparation as a part of their annual service offering, the structure of Bluestem's annual retainer fee model and how it changes from upfront to ongoing, and how their retainer model structure is allowing them to grow the business serving a substantial segment of young professionals in Champaign in addition to retirees, and the business management spreadsheet that Jake uses to monitor and track the key metrics of his advisory firm along the way.

From there we also talk about the details of the actual succession plan that Jake executed with the Founder, how they eventually came to terms on setting a price on a hard-to-value solo advisory practice for an internal succession plan, the way the purchase was structured and funded, and how it was balanced to share the upside for both Jake as the buyer and Karen as the seller, for any growth that happened after the terms of the deal were set.

And be certain to listen to the end, where Jake shares his own advice to other young advisors looking to buy into an advisory firm and be that succession plan, about how to push the conversation forward when the founder just doesn't seem to want to sell, and how to know when it's time to cut bait and leave, and find another opportunity instead. So with that introduction, I hope you enjoy this episode of the Financial Advisor Success Podcast, with Jake Kuebler. Welcome, Jake Kuebler, to the Financial Advisor Success Podcast.

Jacob: Thank you, Michael. I'm very excited to be with you today.

Michael: I'm psyched to have you on the episode, and it's funny, this was truly just sheer coincidence of timing and how people's schedules lined up, but our last episode was with Marty Kurtz, with The Planning Center in Moline, Illinois, who has lives succession planning as the successor, as the founder that has been selling shares of the business and transitioning ownership and transitioning management to the next generation. And you come at this from the exact opposite end. You were the successee that came into the practice, bought out a founder, and has now transitioned and taken over the practice. So I feel like we're going to end up with this sort of yin and yang balancing act, that Marty talked about what it was like to be a seller and you can talk about what it's going to be like to be a buyer. I wish we had master engineered it as well as it's turned out. It really was a sheer coincidence, but I'm excited to kind of tell these opposite sides of the same story, because there are so many succession plans out there that I see that try to come together and don't work out, and it's usually because of these gaps in perception and understanding of what founders and buyers come to the table with. So it's powerful to show both sides of the story, and you have, I think, a particularly successful succession plan story that you've actually lived through. You went through it and it worked. So I'm really excited to have you share it today.

Jacob: Well, I'm happy to bookend this ad hoc miniseries, and our plan now has been in place for almost seven years now, and in many ways been in the midst of the plan for so long that you almost forget because you kind of move through one phase and then you start making plans for the next phase of the business. So actually, given that our succession plan has sort of just come to the close within the last year, I think this is a great milestone for me to kind of reflect back on what's been happening as well as talk about what's coming up for the future for my business. So I'm happy to be here and looking forward to telling the story.

How Bluestem Built A Niche Serving College Professors And Administrators [4:51]

Michael: So maybe as a starting point just to paint the picture, can you tell us a little bit about Bluestem Financial Advisors as it exists today? What do you do, who do you do it for, what does that advisory business look like?

Jacob: Yeah, so we are a fee only financial planning firm in Champaign, Illinois. For those of you who are not familiar with Illinois, we are a couple hours south of Chicago. I know people think of Chicago when they think of Illinois first. We're the home of the University of Illinois. So we're a university town, metro area, probably 120,000 or so. So our clients, because of the university, that tends to be kind of our area of expertise. Two-thirds of our clients are university faculty, professors, as well as administrators. So kind of real quick background, I'm sure we'll dive into the details later, but it was started by my former business partner, now retired, Karen Folk. She was, herself, a professor, got her PhD here at the University of Illinois, taught in Consumer Sciences, decided academia wasn't quite for her, went off to do something more applied. She went and worked for the extension department, which essentially is a way for land grant universities to take research and apply it, give it out to the community and to the state.

So she would go out and teach consumer education, did that for a while, and then ultimately, given state budget issues, not just in Illinois, but nationwide, extension departments weren't getting the funding they needed. She saw the writing on the wall, left, and ended up working for another professor who had retired and started doing some planning work. When he retired, then she was kind of left to decide what to do, and started her own firm. That was in 1999. Fast-forward to 2008, I met her when I was a college student. That turned into a job, which turned into a succession plan, which turned into where we are today. So back to today, I currently have two other advisors. One is in a lead advisor role, the other's in an associate advisor role, and I have two additional fulltime support staff, my Director of Client Services, Mary Beth. So she kind of helps us around the office, and then I've got a Client and Financial Planning Support Specialist, which is a fancy term for paraplanner, though we've got grand ambitions for him as well.

Michael: Interesting. So your staffing is very advisor centric. You mentioned two advisors, a lead advisor and an associate, two fulltime support staff, a Director of Client Service and another financial planning support paraplanner role. So four total people in the firm besides you, and three of them are focused around advisory.

Jacob: So two additional advisors in addition to me. So three advisors total, and then two support staff.

How Bluestem Chose To Structure Their Retainer Fee [7:50]

Michael: So what does the business look like in terms of clients, how many clients, or I don't even know how you size the business. Do you look at AUM, do you look at number of clients, do you look at revenue?

Jacob: Yeah, so we're a retainer based model. So I don't tend to look at AUM too much, because it's really hard to define what's managed versus what's under advisement and so forth. So we're currently at, I think, 108 clients as of today. We've been growing at a rate of about 12 to 15 new clients per year, and that's been pretty steady since I joined the firm. I think when I joined Karen in 2008 we were about 35 clients, and it was just Karen and then myself as the first fulltime person. So quite a bit has changed in the past not even quite 10 years.

Michael: So what is a typical retainer fee in Bluestem? What do clients actually pay on average and then how do you set those fees?

Jacob: Yeah. So I'd say we really have two sets of clients that we work with. We have the more, what you would think of as, I guess, the traditional financial planning client, the person in the mid to late career, they're starting to build up some assets, they're starting to think about retirement, how to simplify their financial life, all those sort of questions that go around that. So when they come in, they come in with portfolios anywhere from $500,000 to usually $1.5 million, although we've got some higher than that. And their net worth is a little bit higher than that, with house and other assets and so forth. Then usually being in a university environment, they've also got pension, at least a pension if not multiple pensions from different universities that they've accumulated along the way.

So the first year of working with a client, we base the fee on primarily income and net worth, and we do some adjustments for other complexity factors that usually pop up along the way. For example, if they're self-employed, do a lot of consulting, writing books, things that add extra tax planning, we'll make some adjustments in there for that. If they've got a lot of pensions or other things that we're going to need to kind of work through and make decisions on, we might make some adjustments for the upfront work that's going to go on with that.

Michael: So how does that fee get, that income and net worth fee get based? Last week we talked to The Planning Center. They do a similar retainer fee based on income and net worth. Their formula is essentially 0.5% of net worth plus 1% of income, and then there are certain assets like a home that they exclude, because they're not actively giving any advice on the family residence you've been in, but structurally it's 0.5% of income plus 1% of net worth. So are you a similar style formula? Do you balance those percentages differently?

Jacob: Yeah, it's very similar inputs into the calculation. We just use different percentages. So we actually do quite a bit higher percentage of income in the first year. It is 3% of income, although we will cap that usually around $300,000 of income. And a big part of that is we're a very tax-focused firm. We are very heavy on the tax planning. Tax preparation is typically included in our retainer. So we're going to do a lot of legwork on the upfront around income and income tax planning. So we are a bit heavier on that. Then the net worth, at this point we do 0.5% on the first $750,000, and 25 basis points on any net worth above that, with usually a minimum in the first year of at least $4,000 for an initial retainer.

Then for our second years and beyond we actually have a slightly different system that's essentially just net worth based, and we again will have a few adjustments for some of those complexities that will continue on after that first year.

Michael: So can I ask what that looks like in future years if it's primarily net worth based? Do you just, instead of 0.5% up to $750,000 and 25 BP's above, it's just different percentages and different thresholds, and you drop out the income formula entirely?

Jacob: Yeah, so it's pretty much $3,000 ongoing plus 50 BP's over $500,000, 25 basis points over $1 million, and 15 basis points for anything over that. So anything about $3 million. And again, we have some of those adjustments. So we dropped the income component in renewal years because we found it was really hard to figure out exactly what income was. Do you use wages plus business income? What about rentals and consulting?

Michael: Do you do AGI, right? You get into weird issues with AGI, like if I tell my client to contribute to a pretax account, I get paid less, above the line deductions. So only give them advice on below the line deductions, and above the line deductions it makes you get paid less. So you really just migrate net worth based on an ongoing basis, and that way you don't have the awkwardness around giving them advice on tax strategies that reduce your income which would otherwise reduce your income based fee if you were basing it based on income or AGI.

Jacob: That's right, yeah. And sometimes I regret that, sometimes I'm grateful that we did that. I think at the end of the day what I learned is there's really no perfect way to charge your clients. There's always going to be issues around, are you entirely capturing the complexity and value of what you do? But at the end of the day, the system works for us, and it's about the best representation that we have currently of what we do for the clients, and all that really matters is, is the client okay with the fee, are we feeling like we're adequately compensated for what we do? And if everyone is happy, it doesn't really matter all that much how we arrived at it.

Michael: And ironically I feel like that's, indirectly that's part of the justification even for why AUM fees seems to actually stick and last as long as it has, because at the end of the day, it's not really about the portfolio, per se, even if you're doing financial planning and tying it to AUM fees. It's just a particular system and structure around how you arrive at a fee that either is or is not valued by the client, and fair compensation for you for the work that you do. The caveat to it is, if you're AUM-based, you can only do this for a subset of clients. If you're net worth based, you can work with a different set of folks, because you're not necessarily just tied to people that have liquid portfolios. But it's still not really about the formulas, necessarily. It's about do the formulas get you to a dollar amount that works for the client and works for you.

Jacob: Yeah, I think that's right. So us being net worth based, you would think that would sort of somewhat bias us towards higher net worth clients, but the reality is that our fees tier down much more quickly than an AUM fee would. So for example, a $3 million net worth client is going to pay us somewhere in the $10,000-11,000 range. Then it's about 15 BP's above $3 million. So it's not significantly fee increasing as the net worth climbs. So we do have a minimum fee for ongoing clients, which is $3,000, plus when we're starting with a new client we've got that income component. So what that allows us to do is to work with younger clients who have potential either for growth, clients with higher incomes, and so forth. So what typically happens is younger clients I'm charging much higher than an AUM advisor would. In fact, I can work with that young professional with student debt and a negative net worth and still charge them $5,000-10,000 for that upfront plan, because we're doing tax planning and we're getting them set up on all the things that need to happen in their early professional and family life. The fee will drop down in that subsequent renewal year, because usually we get it all in place, and then it's a lot less work ongoing. But then their fee is sort of gradually increasing year after year, which as a business model perspective is really nice to know that your clients are growing with you as opposed to your retiree clients, which tend to be a little bit more level fee once they come on.

How Bluestem's Retainer Allows Them To Serve Both Young Professionals And Retirees [16:28]

Michael: And I guess, when you flip off income and just go to net worth in subsequent years, if it's that classic high income, negative net worth, your percentage fee would be 50 BP's on a negative number kind of thing. But your $3,000 minimum fee I guess is what solves that. And if they're not at least comfortable paying out of income for what you're doing for them, then it's just not a good fit and they just don't work with you, and that's that.

Jacob: That's right, yeah. So I had mentioned we kind of have those two types of clientele that we work with. So the first one was the more traditional, and then the second is, I understand young clients is not a niche, but at this point there aren't a lot of other advisors that work with those high income new professionals. So the clients that we're working with at that stage are usually either new professors or just younger professionals, typically income in excess of $150,000. But the real thing that's going on is they're having kids. That tends to be that financial life event that draws them in. If we talk to someone prior to having kids, for whatever reason, they just don't see the value in the planning, but having kids makes it real. You've got to get your life together at that point. So that's about the point where they'll actually sign on.

Michael: Well, and I know you have a unique appreciation of that actually being a new father with a one-month old baby girl at home. So you now have a unique way to share that perspective with your young professional clients who are making that life transition.

Jacob: That's right. I can absolutely understand the value of delegation now. Time becomes a lot more precious.

Michael: Yes. So what is this kind of add up for clients overall? You've got a $3,000 minimum fee. Are most clients down toward the minimum? Or does an average client end up at about $5,000 for you or $10,000? Where does that ultimately tend to land as a typical client?

Jacob: Yeah, so right now I'd say we're kind of bar-belled where we've got quite a few at the higher end and quite a few at the lower end. We tend to take on a mix of those near retirees and younger professional clients. So our average fee right now, on a renewal basis, is probably around $7,500 as of the last time I checked.

Michael: I guess ironically you don't actually have very many paying $7,500. You have a whole bunch that pay $3,000 and a whole bunch that pay more than $10,000, and the average is $7,500 because that's the middle of the barbell.

Jacob: Right, exactly, but those clients at the younger end, some of them are sort of in that stage where their net worth is growing rapidly. So their fees go up quickly and the clients at the higher end, the interesting thing about working with universities professors is, because they have a pension, they don't usually spend their portfolios. So their fees aren't really declining, but they're getting older and they're not going to be with us forever. So it's kind of a nice model, again, me being young and being a young firm, we've got clients at the higher end that give us the revenue now, but we've got clients in the earlier stages that will grow with the firm over time.

Michael: So it's, not to be crass about it, but it's kind of a diversification for the firm overall. You've got older clients who are blue chip stocks that pay a steady dividend as you service them, and you've got young clients that are like small growth stocks. They don't pay a lot of dollars now, but they're rapidly appreciating and can become valuable as clients in the future, and you basically diversify between them?

Jacob: Yeah. I mean, you never want to think about one individual client in that manner, but that's exactly right, and it was intentional, knowing that you certainly want revenue and profitable clients now, but you also want to have future revenue growth to make it a viable business and something that's worth buying into.

The Spreadsheet Jacob Uses To Track Bluestem [20:27]

Michael: So I mean, do you track those kind of metrics on an ongoing basis of, you said you looked recently that your average fee was around $7,500. I mean, then do you know that your clients are distributed like a barbell. I think even that phenomenon, a lot of us, probably deep down if I said, "Do you actually know what percentage of clients are at various fee points on your schedule?" not a lot of advisors could actually answer that off the top of their heads, because we don't tend to keep that data handy. Are you data driven around that? Or are you just immersed enough in your numbers that you just know where everybody stands?

Jacob: Probably a little bit of both. So I do annual benchmarking. I've got a spreadsheet that tracks each year number of clients, number of new clients, revenue, all the major expenses on a major category level. And then that spreadsheet then breaks down different metrics on how are we doing in terms of overhead expenses, advisor costs, how are we doing on revenue per professional and revenue per staff member. And then we use that to sort of do a rough valuation based on the operating profit each year. So I've got that and then we've got various different data points, and we do track all of this. We do it both on a quarterly basis as we're meeting with our staff, we do it on an annual basis when we're doing our strategic planning. In addition to that I've got some of the numbers because we just recently put together some of it for our client advisory board just as sort of a status update, here's where we're at today, here's where we're going, and let's show you where we're at so you guys know what we're talking about.

Michael: So you dropped a lot of interesting stuff there I want to dive into a little bit further. So you track all of this on a spreadsheet. So you've made your own Excel spreadsheet that just tracks all these various business metrics, the ones that you want to be tracking and monitoring, and so you pull data from accounting, QuickBooks or whatever your accounting software is, and wherever else you can to populate it into this central dashboard spreadsheet of how the business is doing?

Jacob: Yeah. I wish I could take credit for it, because it really is a great spreadsheet. But I got it from another advisor, Bill Starnes. So Bill is the fellow member of The Alliance of Comprehensive Planners with me. He had posted this many years ago on the intranet for ACP and ended up doing a follow-up webinar on how he uses it. So we ended up grabbing it, and I think we started at probably around 2010, as we were getting ready to start talking about succession planning, used it to put together some historical numbers and start to give us some data as we started talking about valuation. But it's such a valuable tool that I make sure that we keep it going every year. So at the end of each year we'll pull it up, we'll put in the numbers. And in fact we rearranged our QuickBooks chart of accounts to sort of line up with the key data points that we were going to need. And really one of the genius things about the spreadsheet that we use is the expenses were even categorized to sort of mimic all the compensation and other surveys that we get asked to do as advisors. So whenever we're asked to participate in those various surveys, we've got the data, and it's really quite a breeze to fill them out and get a free compensation report back from whoever's running them nowadays.

Michael: Interesting. Maybe we'll reach out to Bill and see if he's willing to reshare a copy of the spreadsheet with our listeners here. I don't know if you've got a version you want to sanitize, because obviously you don't want to share your business numbers, but a clean version that you'd be willing to share. I think it's powerful that there's actually a surprising dearth of tools to just help us actually run our businesses effectively as businesses and be able to track the pertinent data.

Jacob: Yeah, Bill may be willing to share, and certainly if you're a member of ACP it's on the internet and there are plenty of resources to go with it.

Michael: And we'll include a link out there as well. So for people who aren't familiar, ACP is the Alliance of Comprehensive Planners. Do you want to talk about ACP for a minute, Jake, just to give people context as to what it is, since you've mentioned it a couple times here?

Jacob: Yeah, absolutely. So really I had mentioned earlier on that Karen Folk had been the original founder of our firm in her prior years as an academic and professor, not really a business owner or entrepreneur, and when she was looking to start a firm, she needed some resources to get herself launched. And at that time I believe it was Cambridge Advisors at that point, it was run by Burt Whitehead and it was essentially both a training platform as well as professional organization to join up, get trained on both how to be an advisor but also how to start and run your practice. And it's now been around for, gosh, quite a few years, over 20 years. So I'd kind of say where it's at today, it's sort of the professional organization for advisors who want to operate under the retainer model but also have a particular interest or expertise in taxes. So I'd say probably about 80% of the members of ACP do tax preparation as part of their services, and even those who don't do tax preparation, it's typically very tax-focused in the type of planning work. So it's kind of like a Garrett Planning Network or an XY Planning Network, just sort of a different flavor, I guess.

Michael: Right, so Garrett focuses hourly for the middle class. That's kind of where they put their stake in the ground. ACP focuses around retainer models and tax-centric financial planning or tax-heavy financial planning.

Jacob: That's right.

Michael: Interesting. So we'll maybe reach out to Bill and see if he's willing to share a version of the spreadsheet. For everyone who's listening, this is, again, episode 44, so if you go to Kitces.com/44, we'll see if we can post something there as a business management spreadsheet that folks can use and try out. I find there are a lot of important numbers there of just the key performance indicators, so KPI is the acronym, KPI's of an advisory firm that I find very few advisors actually really pay attention to. I mean the starting point is just things like average revenue per client. I mean, on average how much does a particular client pay you, because the single greatest driver for growth and profitability of really any business over time is, does your typical client pay you more over time? Because if not, eventually you're going to have a problem in your business, because your staff want raises, and if your clients aren't paying you more over time, eventually your profits get squeezed.

But also, in some of the other numbers that you mentioned, things like revenue per professional, revenue per staff member. If you have a business with $500,000 of revenue, are you servicing that with yourself plus one staff member, plus two, plus three? Because that's a fundamental marker of efficiency, and the bigger the business, the more that matters. If you can do this with one staff member plus yourself, your revenue per professional is $250,000. If it takes you three support folks, then your revenue per staff member is only $112,500. Well, if your revenue is $112,500 per staff member, you can only pay these people so much before there's going to be no profit left, because you're not generating a lot of revenue per staff member. And it's just a way of thinking about the business that I find not a lot of us tend to do in the advisory world, even though those benchmarking studies do report out those numbers. We just don't tend to spend a lot of time on them.

Jacob: Yeah, it's definitely one of the advantages of coming into a succession plan early in my career is, really get a sense as to what numbers drive the value of a business, and therefore you focus building your business around the numbers that you should be hitting.

Michael: There's nothing like buying in committing to a giant debt to make you really focused on what actually is going on in the business.

Jacob: Exactly.

Michael: So what do you look at as the primary pieces that you focus on? You mentioned a few like revenue per professional, revenue per staff member. I don't know if there are particular targets that you try to set for those, or what numbers do you pay attention to as a business owner, and what do you shoot for?

Jacob: Yeah, I mean I tend to be kind of the top down type person. So I want to see the big picture first. And therefore I tend to focus on, first, the high level percentages. So that would be things like, how do my revenues break down between direct expense, which is what does it cost to provide the financial planning services, i.e., advisor salary? So I call that kind of the direct expense, and if you look at almost any study or any article on succession planning, typically you want to be at about 40% of revenue there. And we've never had a problem there, and I think in the early years we tended to underpay ourselves.

Michael: So do you actually tag a portion of your compensation there as well? I mean you're the owner of the business at the end of the day. You keep all the dollars on the bottom line after everybody else gets paid, but do you actually take a portion of your compensation and say, "This is my salary, I'm going to classify it up here as opposed to the rest that I'm going to take as my profits off the bottom"?

Jacob: I do, yes. That was something that, when we partnered up, we had to pay ourselves a guaranteed partner stipend, and I just continued that afterwards. And in fact, as an advisor, we have an advisor compensation plan, I as an advisor am paid the exact same way as my staff. Now, granted I'm at a different level than them, and my compensation as an advisor is calculated in the very same way.

Michael: Because you tie their compensation to clients or revenue or something to that effect. So you've got more clients, which means you simply scale higher on your payments for that reason.

Jacob: Exactly, yeah. So then, of course, my second category I'm looking at is my overhead expenses. So that's everything else, my technology, my support staff, my office rent, and so forth. Again, typically a firm is going to look for overhead to be at about 35% or less. That's been an area that, you know, we've been in growth mode, we've been growing 15-25% a year for many years. That's been an area that we've never quite been under the 35% benchmark because every year we reinvest into something new, bigger offices, new furniture, new technology, new support staff and so forth. But we're close. So in an ideal realm, 25% profit margin is great for our business. We've been anywhere from probably more around 20%, which I feel very good about in a growth capacity.

Michael: Bear in mind that, again, as the owner, you participate in 20% of the bottom line, plus that's after you're taking your fair wage salary for what you're doing.

Jacob: That's right. And that's a number that I've always paid close attention to, because as I was buying into the firm and talking to other younger advisors, one of the things I heard from them is, "Very well paid and I love what I do. I don't see much reason to buy into the firm, because I'm already paid so well, there's not much profit left over." So I've always been very conscious of, if I want to bring on additional partners in the future, which I do, there needs to be some incentive beyond, "You get to put Partner next to your name on the business card."

Michael: Yeah, David Grau did a fantastic book about this a couple of years ago around the theme of succession planning in general, but in particular the dynamics and the problems that come up when basically firms pay their advisors, call it "too well." So his book was called "Succession Planning for Financial Advisors." We'll put a version of it in the show notes for people as well. But the point that he made is, so many firms compensate primarily or in some cases entirely as a percentage of the revenue that you manage, and that's your sole determinant of comp. It's sort of the typical model that we're all trained in. If you come out of an insurance company or broker dealer of years ago, everybody gets paid a percentage of the revenue. That's how it works. The house keeps some and the rest goes to the advisor. But the problem that creates is, if the advisor gets to a sizeable level of income, at some point they're like, "Wait, let me get this straight. I take this slice of revenue.

All I've got to do is hold onto my clients. I don't even have to get more of them, because if I just sit on my backside, the fact that the market's going to double in seven to 10 years means my income's going to double in seven to 10 years by doing nothing. Why would I take all the financial risk and the business stress and all the rest of buying into a practice and becoming a partner when I get basically all the secure upside now and I don't have to spend any time stressing about the business, because I'm not an owner, I just get my slice of the revenue and you can deal with making it profitable?" And there's that split that comes, whereas when you have a compensation system that's a little bit more tied to, maybe it can reflect your responsibilities in some way, but is at least a little bit more tied to salaries and fixed bonuses and the upside is the profits on the bottom line. Now you actually want to be a partner, because you want to get access to the profits that you don't get. But when everybody gets paid revenue based compensation as their sole driver, you end up with a whole lot of profits that end up just going to the revenue share, and then people don't want to buy in.

Jacob: Yeah, and we had to think long and hard about our compensation plan before we implemented it, and ultimately we ended up coming up with kind of a mixture of the different models, which is a generous base salary, because we are an ensemble, we are a team, and we want everyone to remember that ultimately you're a part of the firm, not, "These clients are mine and those clients are yours." But then we add on that an incentive component for the advisors who have control over workload and so forth. Then in addition to that we do profit sharing where essentially each year I say, "Here's what we're expecting, here are the places I'm reinvesting, and therefore a reasonable profit goal is X, based on the reinvestments and so forth that we're making. And if we exceed that, then I'm happy to share the profits that we get above what I should get as the owner." So essentially I get the first percentage of profit, and then anything above what I set as that target, I'll share as a profit sharing bonus.

Michael: And you just put all those numbers out there for the staff? Everybody kind of knows what the revenue of the firm is and what the profit target is of the firm and where their bonuses kick in?

Jacob: I do, yeah. I think transparency is good. They're going to talk about it whether or not I give it to them, and somebody's going to see it. So I might as well just be the one to share it and control the way the conversation goes, as opposed to the breakroom chatter.

Why Bluestem Chose To Do Tax Preparation [36:19]

Michael: So in terms of servicing these clients, you said you're doing financial planning for them, you said you're doing tax returns for them. Well, I guess you said you're doing tax planning. Are you literally doing annual tax preparation as well?

Jacob: For, I'd say 90% of our clients, the preparation part is included, yes. So effectively yes for almost every client.

Michael: Do you draw lines, like, "Look, we'll do your personal return, but we only do 1040's and simple Schedule C's. If you've got a zillion Schedule E's because you've got a ton of real estate, that's separate. If you've got business returns, we handle those separately and bill you for those separately"?

Jacob: Yeah, that's right. So we don't do any business. I don't do any corporate, S corps, I don't do any trusts, estates. You need someone who just does tax returns. Primarily we'll do 1040's, we'll do Schedule C's, you're right. If it gets more complicated than, "I've got a rental property or two that I've acquired along the way," you need to have someone that's doing your taxes who, again, that's all they do. And in that case, we've got a couple CPA's in town that we work with and we have a good relationship with. But we find that, in terms of doing the tax preparation, there are two pieces to it. First of all, with the level of tax planning that we want to be doing with each and every one of our clients, you almost need to go through the tax return line by line to understand where that number's coming from and how it's affecting the tax plan. And at that point you might as well just put the data into the tax software anyway.

Michael: What's your tax software of choice?

Jacob: We use Lacerte, which is an Intuit product, which, you know, the maker of QuickBooks and so forth. It's I'd say on the pricier end of the systems out there, but at the end of the day we want the Cadillac product. We don't want to spend our time second-guessing our software or trying to figure out where a number goes. We'd rather pay a premium and make sure the tax preparation process as smooth as possible.

Michael: So you try to make back the cost of the software on the savings of your time and staff time for not needing to deal with issues that crop up.

Jacob: Yeah. I mean I don't think there's a year that goes by where the tax software doesn't give us an alert that says, "Hey, we noticed this. There might be something wrong with your input," or, "Did you know about this tax rule which may affect the way that you report X, Y, and Z." And even one of those, if you catch one error on a tax return, that tax software has probably paid for itself.

Michael: Okay, interesting. So how messy does this make just the management of the business when every time late winter and spring roll around, you're buried in doing 90-100 individual tax returns? I mean, does that swing the whole business? Do you just deal with it and schedule fewer financial planning client meetings in that time period? Do you hire up a bunch of seasonal help? How do you deal with that in the context of the overall business?

Jacob: Yeah, well there's definitely a seasonality, I'd say, in terms of our client process. So historically we would try to do both the tax preparation and the planning all at the same time. And when we were smaller and had fewer clients per professional, that was manageable, but now that we're getting larger and our team is growing and we want to continue to scale, we're finding the deadline for taxes is not getting any farther out, and tax materials come later and later. So at this point I think we're going to have to move to a model of essentially, for our ongoing current clients the only thing we do from late February through early April is tax preparation, but recognizing that tax time is also when we bring on a majority of our new clients. So when I say majority I mean in terms of, if we bring on 50 new clients a year, half of them may come in from January to March because they're looking at their tax return, they're getting their tax information together, and they're realizing not only do I have questions on my taxes, I've got other things that need attended to. So it just tends to be a good time for them to call us up. So we'll have to always leave room in our calendar to meet with and onboard those newer clients at tax time.

Michael: And part of the reason you get these influxes is just because you're known for being a tax-centric firm. So if having new kids isn't the pressure point that makes them actually take the time to seek you out, tax season is?

Jacob: You know, we don't really market our tax preparation, because I wouldn't say that's our core value add. The tax planning is a big part of what we do, and we definitely emphasize that, but I think part of it is just, I think a lot of people probably start thinking about this at the same time that they're doing their return, and part of it may also have to do with the seasonality of universities. You know, spring break falls right in tax season. So people have got time then, they tend to want to work on getting things in order over the summer when they're teaching load might be a little less. So there's probably a lot of different factors, but it certainly doesn't hurt that, at the same time that they're feeling this pain point of, "I've got to get my return filed," that when they call us we're like, "Well, yeah, we can handle your tax return and we can do all these other things that you need to get done as well." So a lot of my colleagues who do tax preparation, they'll say the tax preparation is just a sticky item. Once they start working with you, they love that everything is done inhouse. They don't have to go coordinating between multiple professionals to get data from their advisor to take over to their CPA, and if they ever want to leave you, not only do they have to find a new person to do financial planning and manage their portfolio and so forth, but they have to go out and find a new tax advisor, a new tax preparer. And I think that's almost just as painful as having to find a new investment manager.

Michael: I guess just with the caveat that it's great to have clients that are stickier as long as you don't blow up your own practice trying to deal with the annual tax season, and just either have the capacity to do it or a plan about how you can do it.

Jacob: Right. Yeah, and I mean it's definitely in my field of vision that as we get larger, we may have to have a team that focuses on the tax preparation so that advisors aren't always dividing their time between the preparation season of the year and then the other planning and investment reviews that we need to do with our clients.

Michael: So was taxes your background as well? Were you an accounting student originally and came through as a CPA to be doing this work?

Jacob: I was not, no. I was a consumer economics and finance focus, which is a fancy way of saying consumer recon and family studies. I came out, got my CFP, started working for Karen, who did tax preparation. So I took the H&R Block tax course to figure out how to do it, and my first year out of school I had some extra time because I was used to working 20-30 hours a week and a fulltime college student. So I worked for Karen fulltime, and then I went ahead and prepared taxes for H&R Block season just to sit across from a client and get some experience. After I did that, I went ahead and continued on and got my Enrolled Agent just because I thought furthering my tax knowledge would be a good thing, and it's definitely paid off.

Michael: So you're signing off on returns as an EA at this point.

Jacob: That's right, yeah.

Michael: So what does the rest of the technology infrastructure of the business look like? I mean classically we've got some kind of CRM, some kind of planning software, some kind of investment management tools. I don't even know, you haven't said. Do you actually manage portfolios as well? Is that part of the service offering for the retainer fee? Or are you just doing financial planning and tax work, and then they can go find their own investment solution, or you'll recommend one, but they self-direct it?

Jacob: Yeah, so we include the investment management as part of what we do, and it's sort of one of those items that's in flux. Historically we did everything on a nondiscretionary basis, meaning we would set up custodial accounts if the clients wanted to or needed us to, everything was managed through Excel spreadsheets, so we would just plug in the custodial accounts plus the outside accounts and figure out a plan to rebalance, give the recommendation to the client, and if it was a custodial account, the client would tell us, "Yes, go ahead, rebalance the account." If it was a noncustodial account, we'd tell the client what to do, and usually the expectation was the client would do it.

As we started growing we realized it's better to be standardized. You don't want to have some clients doing this, some clients doing that, and have this whole spectrum of responsibility. So we've been really moving everyone towards, as much as possible, let's get you into our primary custodian, which is TD Ameritrade, because we work with so many universities professors who are also on the Fidelity platform and TIAA-CREF as well. So most of our client accounts are spread out among those three custodians, and we're moving all of those to a discretionary management, but because I'd say our firm was sort of born in this model of comprehensive and holistic, we've always felt like you can't build a good, tax-efficient, holistic portfolio without taking into account the client's entire financial picture. So we knew if we ever wanted to move toward a technology solution, we needed something that could pull in every account, not just the custodial accounts. So a few years ago when Sheryl Rowling of tRx was sort of expanding that product, she had bought out a portfolio accounting system that I can't even remember what the name of it was originally. She had rebranded it to tPx. So I think it was Total Portfolio-

Michael: Yeah, Total Portfolio Expert.

Jacob: Yeah, so we signed on as that transition was happening. So we used that in conjunction with By All Accounts to download the outside accounts, and then we used tRx as our rebalancing system. Subsequently after Sheryl had done all that, then Morningstar swooped in and bought up tRx, and then tPx then transitioned over to Power Advisor. Essentially one of their key employees bought out the company and continued the portfolio accounting system. So it's been a few transitions along the way, and it's not the slickest of systems in terms of, the user interface is not as fantastic as Orion, for example. But it does everything we need it to do, and because they're a small company, we know the owner very well, he's been extremely gracious in helping us set things up the way that we want and customizing everything to really make it do all the things that we want it to do.

Michael: And are you still on tRx for the rebalancing plus tPx for the portfolio reporting?

Jacob: That's right, yeah, so we just have to write two checks instead of one.

Michael: So that's on the portfolio side. Then what do you guys use for CRM and financial planning software?

Jacob: Our CRM is Redtail. We chose them many years ago, 2010 or so, when we were just kind of getting going on building up the business. I'm very process driven. I like workflows and I want to make sure that everything is systematized and organized and everyone knows who's responsible for what in the client process. So we spent many years building out the workflows and the checklists and all that. So we're sort of tied, or maybe even stuck is the right word, with Redtail for the time being. I think in terms of an out-of-box system it has a lot of functionality. We're also kind of getting to the point where I feel like I'd like to be able to customize and build custom reports and have more control over the ability to put in the data that we want and manipulate it in the ways that we would like to. But we're not quite big enough where I feel I can justify the cost of something like a Sales Force or an Accelerate, where we really built it out to our specifications. So we're kind of in this middle ground.

Michael: Where would you go next? I guess the next step, pretty much, is Sales Force if you want to do that level of customization.

Jacob: Yeah. In my mind my end goal would be being able to build something a little bit more customized. But I don't want to be in the technology game, and I'm not sure we're quite big enough to have an inhouse person or outsource to the level that we'd need to, to have it really function the way that we'd like it to.

Michael: And then planning software?

Jacob: Yeah, so planning software, I'd say we're still mostly Excel-based. The reason for that is, so our model of working with clients is we're very modular and it's very conversation driven. So we don't do a lot of financial planning in the back office. What I mean by that is, I've got a back office staff, they help us get ready for meetings, but they're just getting the data ready so that the advisor can sit with the client and have a conversation about their financial life. So a tax planning meeting or a portfolio analysis meeting, we're kind of pulling things up, looking over it, with the client, explaining, "Here's where you're at. Based on where you want to get to, here's our analysis," and then it's just very conversational. I know some of the planning softwares are starting to move in that direction, where it's more of a conversation tool as opposed to spitting out pages and pages of reports, but we just haven't found one that quite fits the way that we want to have that conversation. We really don't want to spend hours and hours plugging in data to get super fancy reports, because our job is not to give the client the expectation of the future, but really just have a conversation about where you're at and what are the priorities. So we keep it pretty simple on that end right now, but we're looking.

Michael: Yeah, we did a recent article on the blog as well. I kind of griped about this, that planning software is generally almost always built for this giant buildup to The Plan, capital T, capital P. And granted, a lot of us kind of build up to comprehensive plans that way, but if you want to do it more modularly, if you want to do it in kind of pieces that build with a client over time, particularly with younger clients, you can't. It's not really built to be modular for conversations that feed into a whole. It's like, either you use really limited planning software that just does simple stuff, but then it doesn't have the detail for a tax-centric advisor like you, or it's so comprehensive you can't do it in pieces.

Jacob: Right, yeah, and one of our big projects this year is really to move more towards simplifying the outputs that we're giving our clients. We used to send them essentially the meeting recommendations where, "Here's what we did, here's what we talked about, here are the outcomes, here's an explanation of these concepts that we talked about," and it took us forever to type it all up and proofread it and make sure the client understood what was going on. Then when we asked them, they were like, "Well, it's great. It's nice to reference back to, but honestly we don't read it half the time or even probably 75% of the time we don't read all the information you're sending us." So that was kind of our lightbulb moment when they told us, "Really all we want from you is a scorecard. Are we doing what we need to do? And if not, what are the areas that we need to improve upon?" So we're really moving towards, okay, how can we, in one page or less, give you a snapshot of, "Here are the areas you're doing well in, here are the areas that need your immediate attention, and here are some things that we'll sort of put on the backburner and get to when the time comes?" So to sort of steal Carl Richards' "One-Page Financial Plan" idea, that's literally what we're trying to do is, here's a one-page snapshot of your financial life.

Michael: And we had a planner named Matthew Jarvis on the podcast as well. He was on episode seven, so Kitces.com/7, if anyone wants to go back and listen to it. Matthew has a similar thing. They just do basically an annual one-page plan. He's very focused around retirees, so it's kind of this update on what your distribution rate is and where it sits relative to what's prudent, and are you on the guardrails? And it's just a one-page plan update. His clients love it and he's got this hyper efficient practice where he has very limited staff and takes a whole lot of time off, and still drives a lot of revenue in the business all because he's gotten really efficient by doing things like not giving clients giant reports or massive plan updates that, eventually when he asked them, he realized no one was reading it anyway. So why do you keep taking all the time and effort to produce it?

Jacob: Yeah, and I listened to that episode, and I think the one thing that still resonates in my mind is, if the client doesn't ask for a copy of it, they probably don't want to see it.

Michael: Yeah, it's a good reminder. Just think of all the stuff you produce in a meeting. If the client doesn't say at the end, "Hey, can I have a copy of that to take with me?" they probably don't care that much. I mean maybe they care that you presented it to them in the meeting, but maybe that doesn't need to be a thing you're sending them.

Jacob: Right, yeah. There certainly is this proverbial issue of, clients want to know that you're taking care of the details, but they don't want to see it. They just want a summary.

Michael: It's one of the reasons why I've kind of maintained, there actually still is some value to that big upfront plan for those who do it, even if the client's never going to crack the spine on that thing once they leave your office, because part of them getting comfortable and trusting you in the first place was that you could demonstrate you really knew your stuff and did the work, because there was a giant plan there. They don't want to take the time to read it, but it is trust-affirming for them to see it there sometimes. So there is some balance to that of, it might be true that I could boil a lot of my clients' situations down to finance tips that I would write on an index card, and they might all be right, and I could just hand it to them after the first meeting on a 3x5, but it doesn't mean they would actually accept the advice or trust me, even if it's right, because there's still some parts of the trust-building process that involved actually demonstrating your capabilities and your expertise.

Jacob: Yeah, and it's nice to be able to look back and say, "You remember when we were at this point three years ago? Look at how much you've accomplished. Great job. Now what's the next big item that we need to tackle?" So you need to be able to tell the story of what's been going on and the progress that the client's made. So you want to have some documentation of what's happened in the past. You don't necessarily need to go through it all or show the client every single detail at every point along the way.

How Jacob Agreed Upon A Succession Plan At The Age Of 25 [56:03]

Michael: So I want to shift a little bit. You mentioned very briefly in passing that you were a student in college, you met Karen in 2008 while you were still in school and started working with her, and then you began the succession plan a few years later, in 2011. And I'm just kind of sitting here doing the math in my head. So you graduated at 21 or 22, and by 25 you're buying a firm. So can you talk to us a little bit about, I don't know, all of that, that transition? How do you get to the point where three years after you take a job, you're buying the owner out, or at least starting the process? Can you just take us through all of that?

Jacob: It was extremely fast. I'll point out to listeners, this is probably not the standard by which you want to judge your own progress. So right, I started interning for Karen in the summer of '08. I was on track to graduate that fall. Probably to my good fortune, not so much Karen's, she had two part-time administrative assistants. They both ended up leaving to pursue other careers, which sort of opened up this, "Hey, do you want to not only stay on and help me cover some of this additional administrative work, but also if things go well, this fall we'll talk about a job when you graduate in December." So Karen and I, during that period I'd say we got along very well. We share a lot of, I'd say, life values and so forth. So it was just a really natural fit, and probably by September of that year we had decided, "Let's give this a go and see how it might work."

So I had the benefit of coming into a practice that was very lifestyle focused in that Karen wasn't trying to grow this thing to the biggest it could be, and she really was more focused on, "I want to work the amount that I want to work, and I want to have time to spend with my family," and at that time her dad was still around and she'd take every Tuesday off to go hiking with him and so forth. So that also meant that she had a lot of time to devote to me. So I'd say she was really my first professional mentor, where not only was I getting a boss, but I was getting a paid mentor whose only focus and attention was on making sure that I developed, because in order to make it work, we were going to have to grow the firm to support paying me.

Michael: And just really fast, there is an important note in there that I think often gets lost, is just this recognition that if you want to make it work, particularly when you're and individual advisor, if you want to make it work as you're bringing on new advisors and younger staff, you need to grow to make it work. And not to knock anybody who wants to have a lifestyle practice and that balance. We've had a number of guests on the podcast that want that, but recognize the tradeoff that goes with that, that you're only ever going to feel like hiring people is a step backwards for you if your business isn't growing, because literally they're going to carve out a portion of your income. If you want hires to be accretive, you hire more people and you make more money and the business is more successful, you have to have growth along with that. That's how you pay for it, that's how the math has to, that's how you make the math work.

Jacob: Right, yeah. I think going into it, we were both taking on a risk. So Karen's risk was she's going to take a significant chunk of her revenue and use it to pay me in the hopes that I help grow the firm, and as the firm grows we both benefit. The risk that I was taking is, she couldn't afford to pay me very much. I think I started out somewhere in the $12 or $13 an hour range. So I'm coming out of a top tier university at a salary well under $30,000 a year, but I had the fortune that my parents lived close by, I could stay with them for a little while, while I got my financial footing. And Karen promised, she said, "As this thing grows, I'm going to compensate you for the value that you're adding." And she kept to that promise. Every six months I got generous pay raises as the firm started to grow. And one of the first projects she gave to me was, "Okay, let's put together a five year business plan. How are we going to make this work?" And I'm coming out of school, I really didn't have that much of a business focus.

So putting together a business plan was pretty new to me, and as I started to put numbers into a spreadsheet, I realized we were really going to have to grow, and not only do we have to grow, we've got to raise fees and we've got to have some staff to leverage our time, because eventually we're going to run out of time, that I can't be stuffing and folding and envelopes and so on and so forth. I think a lot of that impressed Karen. It showed her that I had the grit, I had the interest in making this work, and so that probably only furthered her willingness to devote time to me, to sort of mentor me. So pretty much from that point forward our primary goal was just to get new clients. So she had been in practice a little under 10 years at that point, plus been in the community for a long time. So we just started putting out the word, "We're accepting clients." She had been sort of in a maintain mode for so long that she had done a lot of projects for people who needed help that she didn't have capacity for. So we got some of those converted into retainer clients and started getting people that we knew, professionals and so forth, letting them know we are accepting new clients.

As each new client came in, that was an opportunity for Karen and I to work on them together. So it was a training opportunity for me, but then those were the perfect clients for Karen to then hand over to me when I was then ready to start working with clients on my own.

Michael: So what did that process look like? How do you know when you're ready, how did she hand things off to you?

Jacob: Yeah, so I'm not sure how you know when someone's ready. Sometimes you just eventually have got to let them try it out and fail and learn from their mistakes, but the way that we did it is, from the day I started with her I was sitting in client meetings on the computer taking notes, helping her run the software, and then just sort of incrementally I would take more and more responsibility both in preparing for the meeting, following up from the meeting, and then eventually running parts of the meeting. In fact, I ended up putting a timeline in place, both for myself and for Karen's sake that said, by such and such date I'm going to be doing this meeting. So no matter what, I'm going to be running an estate planning meeting with clients by fall.

Michael: So you would target it by meeting type, not necessarily like, "I'm going to have these 11 clients by the fall," but, "I'm going to be doing the estate planning meeting of our modular process by the fall."

Jacob: Exactly. Right. And it somewhat lined up with, I had to get my CFP because at the time the University of Illinois was not yet a board registered program. So I sort of lined it up with as I finish each course, I'm then ready to hold that meeting. But it sort of forced me to be ready, because you're not always confident as a new professional that you've got the skill sets. So it kind of forced me to do it. And again, Karen spent lots of time with me. We'd do mock appointments, she would give me feedback after each meeting, we'd talk about the next meeting coming up and we'd be talking about what's the goal of the meeting, what do I want to accomplish, and so forth. So it was a very interactive process, and that's something that we even try to do today with my younger advisors. That's the way we train them. You're in meetings from day one, your job is not only to support us, but to learn how to be an advisor yourself.

Michael: So you don't struggle with just the cost of it, the productivity of it. You're an experienced professional, you can take your own meeting notes. You don't really necessarily need someone else there to do it. Does that ever slow you up to say, "Why am I spending," when you're looking at margins that are not where you want them to be and you're saying, "We're doing double duty on every planning meeting that I could competently run solo," I mean do you get hit with that kind of second-guessing to yourself?

Jacob: I mean, we've been doing it for so long at this point, it's almost second nature. But yeah, in fact, we just had a meeting this morning about when do we need to hire our next advisor? And a big part of our capacity issue is, every meeting there's an advisor leading the meeting and an advisor sort of second chairing, and that commits a lot of man hours, which limits your capacity for number of clients per advisor.

Michael: Do you have a target on where you actually set that, of number of clients per advisor?

Jacob: It's still a work in progress. Our ultimate model is to do the diamond team. So if you're familiar with Angie Herbers' white paper on how to structure advisor teams, which again I highly recommend listeners go out and read her paper.

Michael: We'll put a link to it in the show notes for anyone who's interested.

Jacob: I think Angie's metrics are a bit ambitious for the type of service that we do. So I would say a fully formed diamond team, we're probably looking at servicing 150 clients. So that would be a senior advisor, two leads, and an associate.

Michael: So you're at kind of 50 clients per advisor.

Jacob: Right. In the future, if we continue to grow and we start to get more dedicated, not only have a back office, but have back office teams, I could certainly see that number inching up a little bit. But at the end of the day, it is a cost to have two people in those meetings, but the biggest barrier to growth for our firm is not finding clients. Our biggest barrier to growth is having the advisors to support the people who want to work with us. And therefore I've got to be willing to invest the time and money into training those people so that they can eventually serve clients.

Michael: And I think it's worth noting, even when you break down some of the numbers that you had, you said your average client is about $7,500 of revenue. So if there are 50 clients per advisor, there's $375,000 of revenue per advisor. If you're trying to keep your direct expense, the cost of advisors to service the clients, at 40% of the revenue, that means the advisor could make $150,000 serving those 50 clients at the typical size for your firm. It's a good number. I know plenty of people would be very happy if their job was, "Okay, you need to do awesome financial planning, make sure these 50 people stay around, we'll pay $150,000 a year." That's a sweet gig.

Jacob: Right, and if the firm gets big enough, you can really start to hone in and specialize. If you want to work with high net worth clients and have a higher per client average fee, that's great. Or if you want to work with simpler clients and just come in, do a great job, but it's up to each advisor the client base that they want to build.

Michael: Well, and to me that's one of the reasons why, as you were talking about earlier, why these business benchmarking metrics matter so much, why things like average revenue per client matter so much. If your average revenue per client was only $4,000, then a base of clients is only $200,000 of revenue. If an advisor is going to get paid 40% of that, you're down to $80,000, and that includes no other staff support. The math doesn't start to work very well. So now they have to service 75 clients or 100 clients so you can get the number back up. That phenomenon of, this is why numbers like the average revenue per client matter so much, because the average revenue per client and the number of clients you have per advisor is what ultimately drives to how much revenue does an advisor earn, what compensation are they going to earn as a percentage of that revenue, and can you still compensate the advisor and cover your overhead costs and then still have a profit as a business owner?

Jacob: Exactly, yeah.

Michael: So your process with Karen started with this, "I'm sitting in on meetings, I'm seeing how you do the meetings, and then at some point I get to run this type of meeting," and then I guess you added the meeting types over time until you were doing a lot of them. At what point did that shift from simply, you're an advisor working in Karen's practice because you're learning to be an advisor and she's paying you and you're trying to grow it together to make the numbers work for everyone, to, "Hey, I actually want to buy this"? Was I the plan from day one that you were coming in as a succession plan? Or were you simply coming in for a job, and then later it turned into a succession plan?

Jacob: It was a little bit of both. It was, I'm coming in for a job, but if this works out well, the ability to buy in was on the table. So it was pretty fast. I mean by 2010 I'm starting to not only take over the clients that Karen and I had worked on jointly, but I'm also starting to take on any of the new clients that the firm's bringing on as the lead advisor. It was at that point that Karen's like, "All right, things are going well, you're doing great. Let's talk about what a succession plan is going to look like." So this was really only two years into my professional life. A couple years working for Karen, I mean two to three, depending on if you count the internship or not, that we really started seriously talking about what would this thing look like going forward? And in 2011 we actually, in January, we said, "You know what, we're going to take a pause from bringing on new clients so that we have the time to have the conversations about what a succession plan is going to look like." And essentially what we did is we came up with an outline of, "Here's everything we need to talk about to put together a succession plan." So everything from what are the expectations on purchase price and the way we're going to structure the sale to what technology are we using, what are our expectations for future compensation and types of clients that we want to work with, to the conversations about, "What if one of us down the road has mental issues or becomes an alcoholic? How do we deal with-

Michael: Were you pushing these conversations? Was Karen pushing these conversations?

Jacob: It was driven by, so we ended up getting some information from David Goad, who's different than David Grau, but he's another succession planning expert. He had sort of this outline of, "Here are all the things you need to talk about before you can put together or put in action a succession plan." And at the time, he said we were too small, he wasn't going to work with us, but he'd give us some of these resources. So we took it, ran with it, and some of the conversations I definitely felt like we needed to have, and others were on the checklist, so we had them and it turned out it was a good thing, and others of them, I'm not sure how much they contributed to the conversation. But I think at the end of the day a partnership is really a professional marriage, and you've got to date before you can get married, and you've got to make sure expectations are clear. So the real value is just having the conversations about what we both want and what this thing is going to look like so that, before we sign on the dotted line, we make sure we can work together well.

Michael: I think it's a good way to frame it, that partnership basically is like a professional marriage, that you have to go through the dating process, you've got to take time to really get to know each other and get comfortable that you want to be in business together, because as with almost any marriage, disputes are going to come up, fights are going to come up from time to time. Either you're with someone that you're ready and willing and able to work through the arguments and disputes that are going to come up, or the business is going to fall apart. And as with getting divorced from a marriage, getting divorced from a business partner can also be quite spectacularly expensive.

Jacob: Right, and to sort of continue that analogy, one of the things I think that made it work so well was that Karen never came into this as, "This was my business, this was my baby, I started it, I got it off the ground, and therefore I need control." It was always, "We're going to be business partners. This has got to have your footprint on it as much as it has mine." And in fact, to even move away from the marriage analogy, she knew one day I was going to buy this firm from her, and in order for me to have an interest in it, it was in many ways going to have to eventually have both of our visions attached to it. But in many ways it would have to continue to evolve more towards my long-term vision in order for me to be willing to buy her out when she was ready to retire.

Michael: I feel like that's one of the things that gets missed a lot in the succession planning conversation. As founders, most founders it's, "I made this thing, I built this thing, it's my baby, I'm very proud of it, I want to sell it to someone who's going to take care of it and continue this vision that I set for it." And the problem is that's not really actually what most buyers want to buy. Buyers don't want to buy a founder's vision. A buyer buys the advisory firm that they think it can become. And when founders try to shoehorn too much of the vision to the way they saw it originally and the way they wanted it, even if it's right and excellent and successful and profitable and all those wonderful things, it makes it less appealing to the buyer because at the end of the day most buyers, particularly in advisor businesses, we're not investor cash buyers where it's like, "Hey, you've got an awesome vision and it's profitable. Great, I want to plunk down some money and get a piece of that profit cashflow." That's how a private equity investor buys, but that's not how successors buy advisory firms. Successors buy advisory firms because you want to buy into what you think it can be, and if the successor doesn't have the opportunity to shape it, even during that process, then all you can see from the successor's end is, "I can't wait until the owner's out of the way so I can fix this thing the way that I want it to be." And the more you build up that tension, the less likely it is that the buyer wants to bother to follow through.

Jacob: Right. So speaking of buying what it could be, I mentioned we started putting together these benchmarking reports. We're looking at the business, and at that point it's a lifestyle practice and it's really not profitable. Karen's taking a salary, I'm getting paid, but there's really no profit left after that because it was run so lean and we weren't charging enough, and all these other factors. But I knew that we had 10 plus years in the community, we had great good will, we were growing, we both worked together well. So what I was buying was not the current profitability. What I was buying was the future potential of this business. So it was interesting, how do you put a value on something that's not yet profitable? At the end of the day we just had to pick a number that we were both comfortable with and that we thought the profits of our future growth would support payments for. So that's what I bought.

Michael: So how did you come to a number? Did you do some multiple of the revenue? Did you do some multiple of the profits, did you project the future growth and then calculate at a discounted cashflow back to present? How did you come to a number?

Jacob: Yeah, I mean it was sort of all of the above and also none of the above, in the sense of, we ran valuations for all those different methods, and one of the things that we found is, you can easily manipulate those numbers. If you want a higher valuation, you drop the advisor's salary a little bit. If you want a lower valuation, you tweak some other number in terms of estimating future cashflows and so forth. So I think what we found helpful was by running all the different variations, we got different numbers, we could average them together, we could go back and say what was the average of the past three and what was the average if you sort of project forward and do a rolling average? Then we also looked at what do we think cashflow is going to look like and how much would that support in terms of a purchase price. And at the end of the day we just picked a number that we were both comfortable with and said, "That's what we think it's worth today."

So we're getting ready to sign a contract, and what we're thinking at that point is, "Well, let's use the valuation that we're comfortable with today, and then every year going forward we'll revalue the firm based on the net operating profit, and we'll use a three year average for me to buy the remaining shares." So essentially I would pay up front for the first 50% so that we could be equal partners. I'll take on a note payable to Karen for the next five years, and then at the end of five years we'll revalue the firm based on some average of how the value of the firm has changed, and then I'll buy the remaining piece in increments at that new value every year. So that was kind of my expectation-

Michael: That's an interesting structure. I just want to make sure I understand. So you'd buy 50% up front with a five year note, and then you say at the end of the five year term, once the note is paid off, then you come back to the table to basically say, "Now we're going to buy the other 50% and we're going to reset the value to where we are now five years later." So Karen gets to participate in the upside for the 50% share that hasn't been sold yet?

Jacob: That's right. That was our original plan, and we were going to do an average where, instead of just saying five years later, "Here's the new value. This is what you pay for the next 10%," we were going to say, "Let's average the five year growth so that we both benefit from that valuation going up."

Michael: Okay, so you don't fully just re-anchor it on the new number five years from now. You were going to do it like on an average over the five year time horizon, which effectively means you kind of split the growth between you.

Jacob: Exactly, yeah. Now, what ended up actually happening is pretty much in the 11th hour Karen came back and said, "You know what, I'm comfortable with our original valuation. You pay me 50% now and I will give you an option to purchase the remaining 50% in year five, and you can buy at 10% a year from year five to year 10.

Michael: Just at whatever value it would be then? Or like anchored all the way back to the original value?

Jacob: So yeah, she pretty much just anchored it back to the original value. It's not that Karen isn't business minded, she just was financially independent, and her main goal was to make sure this thing runs smoothly. She was never trying to maximize value. So we ended up setting the valuation a little bit higher at the start because of that, but I certainly wasn't going to turn it down. And Karen was well aware that she would lose out on the potential growth of the value of the business. Now, if you talk to her, the way she says it is she benefited along the way. As the firm grew, her profit share grew. She got more profit than she ever would have if she had just stayed a solo lifestyle practice. But the reality is the firm grew along the way, and so an option that was essentially worth nothing in year one, at year five was worth quite a bit.

Michael: Right. So I mean that's an important piece to bear in mind. Even as she's selling 50% in the first five years, then you get to the second five years and you've got this option to buy the rest at the original price, you've also been growing the business along the way, and even by year five she still owns the other 50% and she's still getting profit distribution on the 50% that she hasn't let go of yet. So you're highly incentivized to grow the business because that implicitly makes your option more valuable, but if you grow the business, you are also growing her profit distributions for the next five to 10 years as she kind of weans down the size of the ownership share that she had.

Jacob: That's right, yeah.

Michael: So can I ask, how did you end up pegging a value at the end? Like you came up with this, "Hey, we were going to do two times revenue, but since we're including this option, we'll do it at 2.2 times revenue," and that's the number, and then off you went?

Jacob: Let's see. I actually have a spreadsheet pulled up from our old business. It looks like roughly the number that we came up with was about one times gross for the purchase price at the start, and that was the number that was pegged to for the entire purchase price. But again, remember, we're saying one times gross, but there was zero profit at that point. So the entire plan was based on the fact that we're going to continue to grow, at some point in the future there's going to be value as we move into a profitability phase.

Michael: Good news, you're buying at one times gross. Bad news is you have to pay all of that from your personal cashflow in your salary because there are no profits to fund it.

Jacob: Yeah. Looking at it at the start, there was certainly that potential. What ended up happening is we did grow quickly. So there were years where it was literally, you know, skin of your teeth, there's just enough profit to pay the note. But yeah. But eventually it got to the point where the revenue grew and the profits grew, and there was even some profit left over after the note payment, which was certainly nice.

Michael: Well, and that's the nature of why deals like this work, where you structure them over time and you sequence them over time, is the person who's buying in, once you take that note on, you are highly incentivized to make that thing grow to get a little more cashflow going. And as the seller, if you're not selling all of it at once, you've now truly incentivized your G2, your next generation advisor to grow the business, because they're trying to pay off the first half or whatever slice you bought, but they're also making your second half either more valuable or at least you're still participating in profits along the way, and in kind of the truest sense, that's how both people win on either side of the deal.

Jacob: Right. I think along the way Karen and I both certainly benefited from it, but neither of us, I think, went into it with the idea of how do we maximize profits? As the business grew, it was nice to have those profits there, but I think at the end of the day we both looked at our salaries are what we live on. The profit is just extra money that you can throw into retirement, you can throw it back in the business and continue to reinvest in new people, new technology, new overhead. And so I think that freedom on both of our ends allowed us to both take the risk, but also not get so hung up on the numbers that that becomes the reason why we couldn't make a succession plan work.

Michael: And did you have to go out to a bank to borrow money to make all of this work? Or did Karen kind of implicitly seller finance it and just said she's taking the risk and you're paying her directly over five years?

Jacob: Yeah, Karen just did 100% seller financed. My first note payment was not for a year after purchase, which was extremely generous, but I think she knew at the forefront that I was very committed to this. So she wasn't quite looking at this as a, "I've got to get my down payment to make sure he's got some skin in the game." So yeah, she seller financed, I paid her over five years, and then the end of five years would have been 2016.

Michael: I was going to say, so what happened when you got to the five year window?

Jacob: Yeah, so about a year out we started talking about what's the next step here, how are we doing this? And I think by that point we had been sort of going back and forth between Karen's going to scale down slowly versus is she ready to fully retire? And by that point she had been scaling back. So she had originally been at about 80% of fulltime equivalence in 2010-2011, and every year she was dropping back her time a little bit more and a little bit more. So that was both working less hours per week, plus taking more vacation. And by 2015 I think it was getting more and more clear that she was ready to retire. I definitely helped her make her decision when her husband, who also had his own company, he also decided to retire and identified his successor, and brought him in. So that, I think, was sort of the final piece that Karen needed to make her decision, and she decided, "Okay, 2016 is going to be my last year." And we had sort of decided up front that in order to be an owner you had to also be working in the business. And therefore if she was going to fully retire, then I would execute the remaining piece of my options. So instead of spreading that out where I would buy 10% a year for the next five years, I would go ahead and just buy the entire 50% on a new five year note.

Michael: And fortunately the good news is, because you'd powered forward growth in the meantime, I would imagine the second 50% was mathematically easier to buy and finance than the first 50%?

Jacob: That's right, yeah. So the second 50% was a no-brainer. It was essentially I'm buying cashflow because my note payment is already going to be less than the profit that I'm acquiring through this purchase. So that one was quite a bit easier of a decision to make. So in September she sort of fully stopped. We now call her an Emeritus Advisor, because she still has her office. She comes by from time to time. I have an employee agreement with her where she does, on an hourly basis, do some work, mostly mentoring of other people in the office, she does a few projects here and there. But she's mostly retired now.

Michael: So at this point, I guess, the note pays out over time, but you bought it, you're the full owner, this is functionally your practice now.

Jacob: Right, so effective January 1 I became sole owner.

Michael: And all of this in your, you said you were finishing school in 2008. So you're nine years out from school, early 30's, and owning your advisory firm for the long run from here.

Jacob: Yeah, 30 years old was the full purchase, 25 was the initial purchase. So very young. And again, probably a little faster than what I would expect even internally with future staff.

The Advice Jacob Would Give Young Advisors Looking At Succession Plans [1:28:08]

Michael: Yeah, so as you look at it, I mean you've seen a lot of the industry, you've seen a lot of succession plans that struggle as well. I'm wondering, what advice would you give to younger advisors looking at succession plans that maybe are not going as well and as smoothly as yours did? Do you have advice for others that have gone through at least what they need to be thinking from the buyer's end in looking at these deals?

Jacob: I think at the end of the day, its's what's not going well. Is this a problem of expectations are not aligned? And if that's the case, then you can't force a bad fit. So I think I looked out in the sense of, the first firm I worked for was such a great fit that the succession plan worked. But if values aren't there or expectations just aren't lining up, it's never going to work. You can't force it. So the sad truth of it is you've just got to move on. We've had employees, we've had other advisors that have worked with us, and over time we figured out, "Hey, this isn't working out like we thought it was going to." Karen had people before me that she worked with, and it just wasn't a good fit. So I think coming to that realization and being willing to have the conversation of, "This just isn't meeting expectations." Sometimes you just have to have those hard conversations and move on. But I think the reality is a lot of the succession plans I see that aren't working, it's usually not necessarily that expectations aren't aligned. It's just people aren't communicating. You get so busy in the day to day, getting the next client, I've got this work, I've got emails, I've got to do this and that. You've just got to set aside time and make it happen. We put time on the calendar every single week to sit down and have the conversations that we needed to hammer out the details.

Michael: So literally just, while you were going through negotiating, you and Karen had a standing one hour meeting of just talk more about the deal, figure out more details?

Jacob: Yeah, it wasn't a standing meeting, but it would be, at each meeting we'd have a conversation, and before we left we would put on the calendar the next time we're talking, and ideally it would be within the next week. And then usually what would happen is I would go type up a summary of what we discussed and what the decisions made were, and then Karen would review it and make comments. And the next time we'd pick up and continue the conversation until eventually we had this sort of living document that we put together over time about all the decisions we were making and all the expectations, and that helped us write both an operating agreement and put together everything we needed in terms of a sales agreement and an installment note and so forth.

Michael: How long did that take?

Jacob: Like I said, we stopped taking clients in January 2011, and I think we signed everything in around June or July to be effective September 1, 2011. So again, it was fast, but we put a lot of time aside to make sure it would happen.

Michael: Interesting. So any other tips or thoughts for advisors coming in who maybe are struggling with this beyond the, what I think truly is great advice as a starting point, which is, if you can't find a values alignment, realistically this isn't going to work. You can't force a values change at that point. And make sure you're taking the steps to communicate. If the communication is not coming to you, bring the communication to the founder, if you have to. So other thoughts, other ideas and comments?

Jacob: I think the second point, and you sort of alluded to this earlier on, which is, as a 20-something signing a note for a business that was well larger than my mortgage was a little scary. So I think there was definitely this mental hurdle of, you're making an investment, this is all banked upon the fact that this business plan has to work out and the business has to grow. That was a hurdle, but I also knew I was early in my career, I was young, I had lots of time to figure it out, and was very confident in the partnership at that time. So I felt like it was a worthwhile risk to take, to sort of make that, not quite leap of faith, because we were a business, we had projections, we had estimates and so forth, but sometimes you've got to take the risk to be a business owner, and if you're not willing to take those kinds of risks, then you're probably not cut out to own a business.

Michael: So where does the business go from here? You said you're at 108 clients, growing at 12-15% a year, up to four staff members, I guess continuing to build with the university staff and professors. Do you view yourselves as a niche for you working with U of I university staff members and you're all in on that niche and you want to grow from here in that niche? How do you view it going forward?

Jacob: Yeah, so I always knew going in I didn't want to be a solo entrepreneur. I figured I like having a team, I like having other people to count on and give advice and have back and forth. So it's always been my goal to build an ensemble, something with multiple advisors, multiple partners. So that's the reason why we're at where we're at today, is because in order for me to be ready for Karen to retire, I wanted to have a team to work with me after that transition. So our next step is, I've got a team of employees, but I really want to now focus on getting that next person ready for partnership. What that means is not only do I have to get a partner, but I also need to have a team to support that person, because in reality, most of the times additional partners means another senior advisor on the team, which means they have a support staff of their own.

So kind of where we're at today is I've got, like I said, two other advisors. One of them, my advisor, Josh, we're ready to start having our conversations about where do we take it from here. We've been so busy planning for Karen's exit and getting Josh into the lead role that, now the next step is, okay, we need to start those conversations about what partnership looks like. So I'd say probably in the next couple months is really when we're going to start diving into those conversations. Like you mentioned, I have a new baby. So I've been a little bit focused on that the past couple months, getting ready for and then going through that transition, but I'd say 2018 that's going to be our project, is starting to have the conversation between Josh and I, but also sort of laying the foundations for, what does it take to be a partner at Bluestem? So that means that we're probably looking at in the next 12 months we're going to be hiring another advisor onto the team so that we have the capacity to keep growing, but also have people that can support as we move Josh up into a senior role.

Michael: You have a CFP program there at University of Illinois in Champaign to hire from?

Jacob: Yeah, so one of my advisors is from the University of Illinois, Emily. And then Josh came from another CFP program at a nearby university, Eastern Illinois University. So we haven't quite nailed down when that hire's going to happen, exactly. We're trying to decide do we want to target early 2018 or are we going to wait until the summer?

Michael: We'll make sure we've got a link out to Bluestem in the show notes as well, so if anyone's gearing up for graduation or a job change next year and wants to lurk you job opportunities, we'll make sure they can find their way over to you.

Jacob: Yeah, absolutely. We'll just put a little thing on our website you can submit your email address, and then when we have the job posting ready, we can just shoot it out to anyone who might be interested.

Michael: So what about just the focus on the growth of the firm from here? You mentioned a few times you're in a university town, you've got a whole lot of university professor and administrator clients. Do you view this as your niche and you're going deeper in it? Or does it just happen to be where a bunch of your clients are now, but you'll grow in other directions from here? How do you look at the growth of the firm going forward? You're 30. You look at this with a really long time horizon over what you can build towards and what you want it to be.

Jacob: Yeah, so the university is something I'd definitely like to continue to expand upon, just because we've got a natural knowledge base. And it's not just the U of I. It's a profession that tends to be very transitory. So we've worked with clients that have started at the U of I, but then branched out to universities across the U.S. and even some international. We plan on continuing to market that expertise and working with clients not only at the U of I, but nationwide. But I also imagine that as we grow and start to form additional diamond teams under the umbrella of Bluestem, that that would allow other partners to develop other interests and specializations that maybe they can grow within the umbrella of our organization. So I don't really know what that looks like at this point. I think at some point in the future I would definitely be interested in having the ability to serve clients in situations that, right now, we don't have the time and expertise to do. So if that could be both kind of the XY model of servicing people who are brand new and just starting their careers, it would be nice to build in some sort of pro bono system to help those who are more needy but don't have the resources to pay. But I could also see expanding into other sort of specializations as advisors have interests and the talents to develop out.

Michael: So as we wrap up, this is a show about financial advisor success, and one of the things that always comes up is that success means different things to different people. So you've had phenomenal start to the career and you're now sitting at 30 and you're owning your business with four employees and building from here with a great base and a long time horizon. So I'm wondering how, just for yourself as you look forward, how do you define success?

Jacob: Wow, I feel like I should have been prepared for this question. I think looking back to when I first started on this, I would have defined success a lot differently than I would today. I think it's one of those things that evolves over time. Like I said, I have a new baby at home. So I think my definition of success is probably going to continue to evolve as I start to get a better grasp as to what it means to be a father and have a family at home and so forth. I think right now to me success is not so much focused on the monetary side, but really just up to this point success has been the joy and the fun of building something and knowing that it's impactful both to our clients, but also comparing ourselves against other firms and realizing that we're hitting benchmarks where a few years ago we were barely more than just this little lifestyle firm.

Today we're an ensemble that people are interested in and asking questions about. So even just being invited here today to talk about the firm, to me, is sort of validation and recognition that we're doing things right. I think probably the next thing I need to do, for myself, is figure out, as we start to grow, at this point growth is not for the sake of more monetary reward. I mean I'm already at a point where I'm pretty happy, but it's growing a firm of additional partners both to share in that process, but also just having a team to kind of feel like I'm supported. So I think I need to decide what do I want out of this. Do I want more monetary reward? Do I want more flexibility? Do I want more freedom? Am I just doing this for the sheer intellectual fun of facing new challenges every day? But I think that's kind of where I'm at. I'm growing it because I want to see what I can do and it's fun to challenge and push myself.

Michael: Well, very cool. I'm excited to see where you build it from here. I hope we can have you back on again at some point down the road to share how this growth cycle has evolved and changed for you further over the next couple of years.

Jacob: Well, that sounds great. So thank you very much for having me on today, Michael.

Michael: Thank you, thank you for joining us on the Financial Advisor Success Podcast.