Getting Funding To Launch An RIA And The Startup Costs Of Becoming A Financial Advisor

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#OfficeHours with @MichaelKitces Video Transcript

Starting an RIA and the cost to get set up, that's the topic for today, starting an RIA and getting launched.

Hello, everyone. So we're here talking today about launching an RIA, getting started. What does it take to get an advisory firm launched and underway? I get a lot of questions about this. As many of you know now, this Office Hours segment, I try to field the questions that come into me. One that I get often, I got another one of these this week so I figured it would be a good topic this week is, "How do I get funding to launch my firm? How do I get money to go out and start my advisory firm?"

Startup Funding To Become A Registered Investment Advisor?

I got a message this week from Clarissa. Clarissa said, "I'm reaching out for you about funding information. I'm on a quest to fund my financial planning firm. I've got a unique focus; a company I'm going to serve. I know who I want to reach." I'm going to read through her message here. "I think really given the uniqueness of what I want to do and the opportunity for it, it's an incredible opportunity. But," as she said, "basically I'm going out there to find funding, and left and right, I'm not finding anybody who has interest in funding me. What's the deal? What does it take to get started as an advisory firm, and how do you get funded for it?"

So I wanted to dive into this topic a little because I think there's a lot of misperceptions out there about both from the advisory firm perspective, like what does it really take and what does it really cost to start an advisory firm, and then from the flip side, if you're a lender, what would you even be looking for if you were going to loan money to someone to start an advisory firm. And when you actually look at it from the lender's perspective, frankly it gets pretty clear why there often isn't very much in terms of funding and what to do about it.

So what does it really cost to get started with an advisory firm? As I was trying to show you at the top of the show here, when we look at what it costs to start an advisory firm, I've had several guest posts now on the blog about this.

It's frankly a lot less than what most people think. A typical cost that I'll see for someone getting their advisory firm launched is less than $10,000 in the first year. Really that's probably no more than maybe $5,000 to $7,000 in true startup costs, getting off the ground, and then maybe a couple of thousand dollars that they rack up through the year for some ongoing costs to maintain the business.

RIA Startup Costs

So the true startup cost might be getting your compliance work done. You can do that by hand, although we typically recommend you outsource that to someone. It might cost you a few thousand dollars. You're going to set up your business entity. That might cost you a few hundred dollars or a little bit of filing fees.

You're going to need the core technology infrastructure that gets used to run an advisory firm. So this might include things you're going to need, like a CRM, a client relationship management software. You're probably going to want some kind of financial planning software. You'll need a computer itself. If you don't have one, you may want an electronic filing system, some tools like Dropbox or Worldox or whatever tools you want, E-signatures, online software scheduling.

So there's this constellation of software that you need, which frankly is not terribly expensive. You're talking about stuff that maybe people are running for no more than a couple of hundred dollars a month with all their software costs wrapped in. That's really about it. Maybe you'll get a website done. That might cost you $1,000 or $2,000. But it's really not much.

The truth of advisory firms is that this is a personal labor-intensive sort of business. That's really what drives advisory firms. So it's not as though we're starting a chef shop. I know someone who is recently going out to launch a restaurant where they're going to bake cakes and stuff. And they had to get an oven that cost more than $10,000, just for the oven unit thing so that they could bake the stuff. So his oven costs more than what I know most advisors spend on everything in the first year, at least if they don't have an office for overhead. That sometimes adds up a little more.

Because most of what we do as advisors, for better or worse, is the sweat of our brow. It's our personal labor. We're not a capital-intensive business being financial advisors because we just don't have a lot of machinery and equipment and such. Now, what that means from the flip side is when we look at what makes advisory firm businesses work, or viewed alternatively what makes them fail, basically virtually every advisor I know that ultimately doesn't succeed as an advisor for financial reasons, for business startup reasons, it's never the cost of running the business.

Financial Advisor Personal Expenses - Your Upkeep Will Be Your Downfall

It's the cost of their personal household. It's them. It's their personal overhead. It's paying your rent or your mortgage. It's putting food on your table. It's taking care of your family if you've got a spouse and kids. It's all of those expenses. It's your personal overhead that becomes the bottleneck and the constraining factor for an advisory firm, not the actual business costs. I see a lot of those tap tap hearts. So it sounds like this is definitely resonating for some of you.

It is the personal expenses. It is the personal overhead that ultimately becomes the constraining factor for making an advisory firm work. And frankly, this is one of the reasons why I see career changers who come into financial advising often have some of the biggest challenges breaking in because their lifestyle is accustomed to a certain income from their prior job, their prior career or profession and that salary or whatever they were taking off of it.

And when they come into financial advising it's like, hey, great news, you can start your business for less than $10,000. Bad news, your salary is also going to zero until you get some clients. What blows them up is not the $10,000 in startup costs. What blows them up is the $50,000 or $75,000 or $100,000 of salary, of income that they used to get from their old job that goes away while they've still got personal bills to handle.

And so because of that, one of the things I cannot emphasize enough for anybody looking to come in and start their own advisory firm, you've got to have a plan on how you're going to deal with that personal expense overhead of putting food on your table and keeping your bills paid, while you're trying to go out there and get enough clients.

So are your personal expenses low and manageable? Think twice about buying that bigger house or getting that car, I mean just in general, because I think that's good financial advice, but in particular when you're looking at going out to start an advisory firm, keep that personal overhead and the expenses low.

Watch out for debt. This is another issue why debt becomes such a challenge. Yeah, I get the whole dynamic, "Hey, if I keep my portfolio invested and my debt costs are low and I grow more than my debt, I can make money." The problem is you lose all flexibility to make career changes like this. Hey, great news, you can make a whole lot more money in three years. Unfortunately, you default on all your mortgage and car payments in the meantime. So you lose your ability to launch an advisory firm because something looked great in the long run, but gave you no flexibility in the short run.

Filling The Income Gap As A New Financial Advisor

And likewise, you see a lot of people that ultimately do what are now variously called side gigs, side hustles, ways to make money on the side to fill what basically is an income gap between where you were, where you dipped down to on income when you launched your advisory firm, and then what you can ultimately get up to after you recover and get clients and get going again.

But you've got that big gap in the middle, that giant income gap where you come down from where you were before you get back to where you were. And that gap and the ability to pay your personal expenses while you're crossing through that gap becomes the killer for most advisory firm businesses.

Now, when you look at it that way, here's the challenge that crops up when you say, "I want to go out there and get funding." When you go out there and say, "I want to get funding," the lender is going to come to you and say, "Funding for what exactly?" Like, "Okay, if you need to borrow $5,000 to get your website launched and do your compliance filings, I guess we can have that conversation. And maybe if you've got good credit, you might be able to get that loan, but it's still ultimately going to be a personal loan. There's no collateral."

My friend who launched the restaurant, at least when he went to get a $15,000 loan for his fancy oven, the lender knew that there was an oven as collateral for the loan. So if the business didn't work out, the lender's going to take the oven, sell it, replace their $15,000, plus or minus a little depreciation.

When we go out there and launch our advisory firms, there's no asset. There's no collateral. There's nothing to foreclose on. There's nothing to protect the lender. It's really just a personal loan to you.

And frankly, that's what we see. To the extent that anybody gets any kind of funding as a financial advisory startup, basically you're getting a personal loan. Maybe you're going to a bank. I've seen one or two people now that just went to peer-to-peer lending platforms, to Prosper or Lending Club or one of those. In order to get funding for their business, they basically just get a personal loan to cover some of their personal expenses while their income takes a hit, and they try to build back to it by adding clients.

So just recognize that dynamic. There's a reason why there's a gap for funding for advisory firms. It's because all they're really going to be doing at the end of the day is giving you a loan for your personal household expenses, because there's not really that much in business expenses that are there. Some lenders will give you a loan for your personal household expenses, but it's a personal loan.

Frankly, the most common way that I see most advisory firms get started at the end of the day, credit card debt for their personal expenses until they make enough to get there. I don't necessarily recommend that. I'm not a huge fan of credit card debt. But just recognize this phenomenon. It's crucial to understand. It's not the costs of starting the business that's really the killer, it's your personal expenses.

And I see a comment there. Maybe you could even ask a senior advisor or another advisor for a loan. Certainly I think that's a possibility. When you look historically how the industry has helped to start advisors, even when you go back to the brokerage firms, the commission business of old, well, still kind of current but not for much longer, when we look at those sales businesses, frankly they all recognized the same thing.

They would bring in tons of young people to the business because it doesn't actually cost much to get them started. A little bit of compliance costs, not a big deal. They'd set them all up to do their cold calling or beat the streets or whatever they're going to do to get clients.

Big Firm Financial Advisor Salary, Or A Draw Against Commissions?

And the firms would give people what often would get called a salary, but it really was nothing more than a draw against your future commissions. They might say, "We'll pay your $10,000 a quarter," but in order to get the $10,000 a quarter, first of all the, the first $10,000 of commissions you earn this quarter are just going to repay your salary. So really all you're doing is you're getting an advance, a draw against your commissions in the form of a salary. It's not a real salary because you're going to replace it with your own income anyways.

And the companies will often have requirements that say, "And if you don't do a certain amount of sales this quarter, you'll get kicked off the salary deal and you're out of here." Why? Because they basically said, "We're going to advance you your commissions, and then if you don't earn enough to replace the commissions, we're just going to kick you out of here." So again, all they were really doing was mini loans, one month or one quarter at a time. If they gave you your $10,000 draw and you only sold $7000 worth of stuff, they would lose a couple thousand dollars on you, but it wasn't much.

Even now, advisory firm companies or brokerage firms historically have really held it close to the vest and not made very significant personal loans in this regard. They've hedged their own exposure for the same reason that it's a personal loan expense and your outcomes can be driven by your ability to get clients if you're actually going to launch your own advisory firm.

Start Your Financial Advisor Career Track By Working For Someone Else First

Now, often, many people will choose an alternative path, which frankly is the one I recommend anyways. They go and work for another advisory firm first. They get a job. They get a good old-fashioned job in a support position in an existing advisory firm.

Maybe you're a client service manager. Maybe you're a para-planner. You work within a company environment, especially if this is your first entry into the industry. It gets you some experience. You're going to learn more about what's going on in the industry so you'll be better prepared to launch faster. You're going to get a job that gets a real salary that gets paid while you're doing this.

It's an opportunity to even build up enough savings or cash reserves so that you can do the real launch later and step away from your income for a while. And you might even find with the firm you're working with that you like them so much that you actually just stick with them and say, "You know what? I'm going to build my business here because I like working under this company. And maybe we'll do a blend of salary plus client fees that they pay me over time as I build my practice."

So for a lot of people, I see that. And what I primarily recommend most, if you're coming into this industry cold, I think you're crazy to go get your own client style advisory gig from scratch, building your firm from scratch. There's just too much to learn. There's too much to take in.

Go work somewhere else. Get a little experience first. Then come out and either find a platform that helps you build your business, find another advisory firm to work with, grow within the advisory firm that you've already joined, or maybe go out on your own, as Clarissa is looking to do here and get started.

Becoming An RIA Requires Getting Your Own Financial House In Order First

But recognize that even when you do that transition, it's not the startup costs that are going to be your challenge. It's your personal expenses and what you're going to live on while your income dips down and you're waiting to recover through that income gap by getting clients and growing your business, going forward. So be prepared for that.

That means while you're getting ready for your launch, recognize that managing family costs is a big deal – your rent, your mortgage, your car payments, your other debts. What are your committed payments that you might not be able to scale back on while you're making this endeavor?

A lot of advisors I know that have had the most success starting, married couples, two incomes, lived on one person's income, saved the rest, so that when one of them stepped out to go start this advisory firm and that second income stream went away, it didn't blow up the family because they were already living on one person's income.

This is why fiscal prudence matters. We preach this to our clients. Well, hopefully we're not preachy. We talk about this to our clients, the importance of managing your expenses and managing your personal overhead so that you've got room to save. But it's not just about the room to save. It's also about the room to make changes in your career trajectory, including going out and starting a business.

And when you manage your debt loads, when you manage your household expenses, and when you keep them down, that's what makes it feasible to do this transition. Recognizing that, yeah, I guess at the end of the day, you can take out a personal loan, a P2P loan, a credit card loan, maybe you can even get a bank loan to cover your personal expenses while you go and start your business.

But that's generally going to be a high interest rate, not very appealing loan term, because at the end of the day, the lender knows there's no collateral here. There's not much assurance that the business is going to survive, because the hard reality is most advisors don't succeed going out to be their own advisors. And the lenders kind of hedge their bets as well or at least charge you a very high rate for it.

So if you really want to get an appealing startup funding, manage your costs down, build your own cash reserves and you're going to do it at a much, much better deal than what you are going to find from any kind of startup funding, startup lender out there.

So just recognize this dynamic. Step back to take two steps forward. I think that's true about a lot that we go through in life. It certainly applies for starting an advisory firm, when you've got to deal with that huge income gap when you make the transition until you earn your way back again.

And recognize, the startup costs are not really what are going to bury you, it's your personal overhead while you're doing it. So have a plan for that about how you're going to manage your expenses while you're building your client base. And that's really the key to getting started successfully as an advisor.

So I don't know if there are any questions here. I'm happy to take a few. I see a number of you are tap tap tapping your heart, so thank you for the love here. And thank you to Andy and Austin and those of you who are sharing the broadcast out as well. If you're listening in on Periscope, on the desktop, sorry you can't actually share from there. You've got to listen on the Periscope app. That's not me trying to sell Periscope. That's just the reality of how the technology works on Periscope. You've got to use the app to actually ask questions or share out or do any of that.

I'm not hearing many questions from you guys. You're very quiet today. All right. Well, hearing no more questions, I will...oh, all right, here's one. So we see a question. "Any interesting ideas on underserved niches in the financial planning world?"

Finding A Financial Advisor Niche

Holy crap, underserved niches in the financial planning world. All of them? I say that kind of tongue-in-cheek, but just look out there at the advisor landscape. How many people say they're focused into a particular niche, and then how many people say, "Oh, well, I'm a generalist that serves anyone and everyone who ever comes in the door because I provide customized, personalized financial planning advice based on the individual needs of my particular clients," which is a nice B.S. way of saying I do anything for everyone. Almost everybody does that.

The financial advisor niches are so endless, it's hard to name them. You can go into a profession. You can work with attorneys. You can work with doctors. You can work with architects. You can work with real estate professionals. You can work with software developers. You can work with startup folks. You can work with engineers.

You could go company-specific. If there's a big company in your area, you could build an entire business. I know many have done this, just working with employees from a particular industry, a particular company, one large corporation in your area that just has a large base of people where you learn all their employee benefits and their executive comp, and you advise all the executives of the company, and you work with most of the senior management as well.

You can even go into detailed niches within that. I've seen people that are starting a business, not even just working with attorneys, but working with partnership track attorneys that are trying to figure out how to do the transition from coming out of law school with a giant pile of debt, getting themselves started financially, climbing the ladder at their law firm, and then trying to make partner.

And that kind of tenure trajectory of a lawyer, which starts with massive debt, then goes towards massive income, then towards massive buy in for a partnership track, and then ultimately emerges with a very high income on the other end, a whole slew of income issues that crop up.

Oh, and by the way, when you're going through that, you're probably in your 20s and 30s and dealing with first car, first house, first mortgage, first marriage, first child, possibly first divorce, a huge number of financial issues that come at you. So frankly, you can go incredibly focused in what sort of niche you really want to pick as a financial advisor.

The reality for most of us is that we'll have wonderfully successful businesses with no more than maybe 75 to 125 top, A-level clients. That is what I find for most advisors. Some are successful with even fewer. So you need a thing that's a problem to any 100 people on the planet out of 7 billion. So if I take 7 billion people and divide it by 100 possible clients each, you get hundreds of millions of possible niches that could be out there. Well, I guess 7 billion divided by 100 is 70 million possible niches. So that's the landscape, 70 million possible niches.

You only need one. You're only competing with about 300,000 other financial advisors, so there's going to be 69.7 million niches left over that no one has, even if everybody claims a niche. The opportunities are that plentiful, and I think completely underappreciated and misunderstood by advisors who feel like they have to keep being generalists, even though specificity is what creates connections with people, that ultimately builds a good business. So I hope that helps a little for perspective on niches.

Starting Finding Your Financial Advisor Niche Before You Start Becoming An RIA

And frankly, for many, you can start down the road of those niches even while you're still working or getting ready to launch. You can't solicit clients yet, but you can start to talk to those people. You can find out what their needs are. You can begin crafting a business that's relevant for them, getting the expertise you need to answer their questions and problems. Taking them out to lunch, learning more about their situation. All of that formulation of what would a good business be and how are you going to serve them, you can do that before you actually launch your business.

Don't solicit them. Client solicitation requires investment advisor registration. But you can talk to them. You can figure out what you're going to offer them, what business you're going to provide, how you're going to charge for it, what services you're going to create for them. All of that can be done in the pre-launch phase as well, so that at least when you actually do hit the transition, you kind of hit that ground running as the race is on to bring in clients, bring in revenue and try to earn your way back to where you were before, or at least before your personal overhead buries you.

So I hope that helps a little as some food for thought about just the landscape of getting started as an advisor, what it really costs to get started. The answer –not actually that much. But what really becomes a financial constraint for getting going, which is your personal overhead, your ability to put food on your table, roof over your head, clothes on your back for you and your family, while you're trying to get your clients up to the point where it pays your expenses and eventually builds a great business – that is the constraining factor.

And so as you come into this, don't view it for most of you as a funding problem per se. View it as a personal expense management problem. And the lower you can get those expenses and commitments, and the more you can build your cash reserves and savings, the more of a runway you get to be able to do this transition.

Particularly for what I see in the real world, which is it's going to take you at least two or three years to get back to where you were. Even advisors that do well, I find it's two to three years to get back to where you were. Some I see even the path is slower and it might be four years or even five years for them to get all the way back.

Now, it's great in 10. It's great in 15. It's amazing in 20. Advisory firms tend to build and compound over time. But recognize how long that transition is, how much of a runway you need, what kind of reserves you need to get there, how you need to bring your expenses down in order to make that work.

So I hope that's helpful food for thought. Thanks again for joining us today. And have a good day, everyone.

So what do you think? Did you get any "startup" funding for your advisory firm? What was your strategy to fill the income gap while you brought on your first clients? Please share your experience in the comments below!