Executive Summary
For most financial advisors, the single hardest part of growing the advisory business is simply getting new clients in the first place. Especially since most financial advisors have very limited capital to invest into the business and its marketing efforts early on.
As a result, most financial advisor marketing strategies involve approaches that have little or no upfront cost, such as partnering in formal RIA solicitor referral agreements that share a percentage of the revenue from the client.
The upside of this approach is that the advisor has an opportunity to incentivize a marketing partner, with no upfront marketing costs. The downside, however, is that given the high client retention rates of most advisory firms, revenue-sharing agreements can actually be an astonishingly expensive form of marketing.
In fact, for advisory firms with 95%+ client retention rates, it would be more profitable in the long run to spend a year’s worth of client revenue just to obtain the next new client – a strategy that can produce an incredible 400% Return On Investment for the marketing dollars… with the caveat that few advisors can afford a marketing approach that might take years to recover the initial investment.
Nonetheless, when looking to the marketing practices of leading independent advisory firms – and even some of the more successful robo-advisors – it appears that the firms most focused on scaling their advisory businesses are beginning to eschew revenue-sharing agreements, and instead are shifting their spending to scale far-more-profitable upfront marketing investments!
Understanding Lifetime Client Value And Client Acquisition Costs
For financial advisory firms that provide an ongoing service for an ongoing payment – for instance, the recurring AUM fees of providing ongoing investment management and financial planning services – the reality is that a single client relationship can be incredibly valuable to the business. Especially given that for many of the top advisory firms, not only do clients pay a significant ongoing fee, but the retention rate of clients can be as high as 95% - 98% each year.
For instance, consider a client for whom the advisor manages $500,000 of assets, and charges a 1% AUM fee. The client pays the advisor an annual fee of $5,000/year. And with a 95% retention rate, the “average” client will stick around for a whopping 20 years. Which means a single $500,000 AUM client represents a potential $100,000 of cumulative revenue for the advisor’s ongoing services!
Of course, the caveat to this statement is that much of the revenue that the advisor generates will go to pay the staff, overhead, and other costs to execute the advisory business itself. Nonetheless, once subtracting out the expenses, an advisory firm with a “healthy” 25% profit margin will still generate a significant amount of lifetime profits from a single client relationship! Anticipating $100,000 of lifetime client revenue means an expectation of $25,000 of lifetime client profits! (Michael’s Note: Technically, lifetime client value should be calculated with a discount rate for future cash flows, which would materially diminish this projected value; nonetheless, lifetime client value is still very significant for advisory firms!)
In fact, with such a significant lifetime client value for a financial advisor’s typical client, advisors could arguably spend far more than they typically do trying to obtain a new client. In the aforementioned example, an advisor who spent $5,000 in marketing costs just to get a single client – even though it’s 100% of the client’s first year revenue to the firm – would actually enjoy a whopping 400% Return On Investment for their marketing dollars (where $5,000 of marketing expenses becomes $25,000 of lifetime client profits, for a $20,000 gain)! In other words, the incredibly high lifetime client value for a financial advisor can justify a significant investment into marketing and “client acquisition costs”!
Balancing Lifetime Client Value Against Short-Term Cash Flow Needs
While the example above showed how an advisory firm could spend $5,000 in marketing dollars to obtain a single $500,000 AUM client and still come out ahead in the long run – to the tune of a 400% Return On Investment! – there is one significant caveat: pursuing such a strategy would create a severe cash flow crunch in the short term!
After all, for a client who pays a $5,000 AUM fee on which the advisory firm earns a 25% profit margin, it may take nearly 4 years (at profits of $1,250/year) just to recover the initial investment! Only then, given the firm’s great retention rate, does the client truly “become profitable” for the firm – albeit still very profitable in the long run, given the average client retention of 20 years implied by that 95% retention rate (not to mention market growth that lifts the value of the portfolio and the associated AUM even further over time)!
From this perspective, the awkward challenge is that most advisory firms are actually businesses with phenomenally valuable clients, and grossly insufficient capital to market to them effectively! After all, if the firm had “unlimited” access to capital, it would arguably want to market and deploy those dollars as rapidly as possible, given that every $5,000 of marketing dollars spent produces a 300% ROI! And arguably, most advisors may well be able to come up with a marketing strategy to get a single client for even less than $5,000 of client acquisition costs… which only makes it even more valuable to invest more into marketing!
Nonetheless, given the lack of available marketing dollars to spend, it’s arguably no surprise that advisory firms tend to rely on alternative marketing approaches that do not require upfront capital, from pursuing informal referral marketing strategies (which rely on the cost of the advisor’s time but not hard dollars), to forming formal referral agreements that agree to pay an RIA solicitor a percentage of ongoing client revenue but only on a variable basis (as earned).
How Revenue-Sharing Agreements Are Extremely Expensive Client Acquisition
For many advisory firms, revenue-sharing agreements (including, notably, popular advisor referral programs from the leading RIA custodians!) are an appealing way to bring in new clients, because they represent a purely variable cost for the business – the advisory firm only pays if/when the client comes on board, and even then payments to the referrer only occur as payments come in from the client. As a result, the advisory firm never has to worry about causing a cash flow crunch for the business, because a revenue-sharing referral agreement has no upfront cost.
The caveat, however, is that because of the aforementioned high retention rate, it turns out that a revenue-sharing agreement is a phenomenally expensive way for the business to acquire a client. After all, a 95% retention rate means not only does the advisor expect to do business with clients for an average tenure of 20 years, but it also means the revenue-sharing agreement will be paid for an average of 20 years as well!
Thus, continuing the earlier example of the $500,000 AUM client who pays a 1% AUM fee, assume for a moment the advisory firm has an agreement to pay the referrer a 25% share of client revenue. As a result, the referrer will receive a payment of 25% x $5,000 annual fee = $1,250/year, and with a 95% retention rate and a 20-year average client tenure, that amounts to a $25,000 cumulative payment of revenue-sharing referral fees (or higher given likely subsequent market growth!)… just to get one client!
Notably, this also means that with a 25% revenue sharing fee, the advisory firm will pay to the referrer an amount equal to 100% of the client’s lifetime value, leaving no actual profits for the advisor!
Now to be fair, because advisory firms often compensate advisors themselves based on client revenue as well (another variable cost strategy that becomes problematically expensive for the business in the long run!), if 25% of the client revenue is taken “off the top” (for the referrer) then the net revenue on which the advisor is paid will be reduced, such that there may still be a small amount of profit remaining for the advisory firm. Still, if the advisory firm manages to retain a 10% profit margin ($500/year of profits) after the revenue-sharing referral agreement, the lifetime client value is $10,000, instead of the original $25,000 (or a bit higher with compounding portfolio growth over time). Which means the advisory firm gave up 60% of its lifetime client value in client acquisition costs (and the advisor takes an indirect compensation hit, too!).
From this perspective, it’s notable that “just” spending $5,000 on upfront marketing costs – spending $5,000 in marketing just to get a client that pays $5,000/year – is actually a whopping 66% cheaper in client acquisition costs. And in fact, the difference will likely be even greater over time, as if/when/as markets grow in the future, with an upfront marketing investment all the portfolio upside accrues to the benefit of the advisory firm and its AUM fee, while with a revenue-sharing agreement some of the growth goes to the referrer, too!
In other words, spending an entire years’ worth of client revenue just to get the next client is actually radically more profitable in the long run than a revenue-sharing referral agreement!
Scaling Fixed Marketing Investments In Lieu Of Revenue-Sharing Referrals
From a practical perspective, while it’s not very expensive to launch an advisory firm, the bad news is that most firms start with so little cash in the bank that there’s simply no money to market. Despite the incredible ROI potential for spending marketing dollars, there just aren’t any to spend. Instead, the reality is that as they’re getting started, financial advisors may have little choice but to engage in strategies like revenue-sharing for referrals, because there’s no other choice.
Nonetheless, given the incredibly high costs of client acquisition embedded in a revenue-sharing referral agreement, arguably advisory firms should endeavor to move away from such arrangements as quickly as they can afford to do so. Ironically, if the advisor had high turnover and poor client retention, a revenue-sharing agreement might be a good way to hedge against the risk of spending too much up front for a client that doesn’t stick around long enough to recover that marketing investment. Yet for advisory firms that are established, and have a consistently good client retention rate, revenue-sharing agreements become even more exorbitantly expensive for the firm in the long run!
In fact, this recognition that just spending upfront dollars on marketing explains both the strategies and success of many of the largest (and up-and-coming) advisory firms. For instance, the largest privately held independent RIA in the country is Fisher Investments, and the company’s growth strategy is somewhat legendary for the fact that Ken Fisher built a whopping $60 billion of AUM using primarily direct mail marketing – a marketing approach that is extremely cost-intensive up front… but once the firm establishes a client acquisition cost that is cheaper than its lifetime client value, it pays to just pour more, and more, and more money into the marketing strategy!
Similarly, many robo-advisors have raised significant capital in recent years, after they built their initial platforms, because the purpose of the additional dollars is not about building the solution anymore but is specifically to help scale the marketing to get clients to invest. Again, once the business is confident that clients will buy into the service, and retain as clients, and there’s a marketing strategy that can bring in more clients at a reasonable cost… it pays for the business to raise as much “cheap” capital as possible, and just plow those dollars straight into the marketing and growth of the advisory firm (with the caveat that eventually, the original marketing channel may be tapped out altogether, and the firm will have to find new strategies to market, at a hopefully-still-reasonable cost).
And the strategy isn’t unique to robo-advisors. Recent industry benchmarking studies have begun to reveal that the largest RIAs are also beginning to systematically scale their own marketing efforts as well, as $3B+ RIAs each discover that marketing may be expensive up front but for larger firms with available cash flow is ultimately the best return on marketing investment. As a result, the largest advisory firms are enjoying the fastest growth rates despite spending the least (as a percentage of revenue) on their marketing – the ultimate in marketing economies of scale!
In other words, once the firm is large enough to make significant investments into marketing staff and resources (and outright client acquisition) – and acquire clients at a lower long-term cost than with revenue-sharing agreements – the financial success of the firm, and its growth rates, begin to accelerate (in part because the more profitable marketing strategy frees up more profits to reinvest into the more profitable marketing strategy in a virtuous circle!).
Of course, the presumption in all of this discussion is that the advisor can come up with a way to spend marketing dollars that really can attract a single client at a cost of “just” one years’ worth of revenue. However, in practice it seems that most advisory firms are so cash constrained, they don’t even consider spending that much in marketing efforts, and/or fail to realize the incredible long-term profitability of committing so much up front just to get a single client. If your budget was $5,000 to get one client, or $20,000 just to get four clients, could you come up with any marketing strategy that might get those clients in the door? Because it’s a 400% ROI potential in the long run!
Ultimately, though, the fundamental point is simply this: while a variable-cost marketing approach like revenue-sharing for referrals may be a ‘necessary evil’ for a new advisory firm that lacks the cash flow to reinvest, it ultimately may be the most expensive form of marketing for advisors with high retention rates. Even at a cost of paying an entire years’ worth of client revenue (or more), for advisory firms with strong client retention, it really does pay an astonishingly good “Return On Investment” to reinvest more into upfront marketing costs! So be certain that if you’re using revenue-sharing solicitor agreements with referrers to build your business, it’s really because you can’t find any other path to invest your marketing dollars instead!
So what do you think? Do you use revenue-sharing solicitor agreements to build your advisory firm? Do you feel it’s been a good investment for you in the long run, or was it done out of necessity? As the firm grows, are you more inclined to shift to fixed-cost marketing strategies instead?
While I’ve come to the same conclusion (at least in regards to giving anyone a perpetual revenue share) there are a lot of “if’s” in those assumptions producing your numbers which might as well be completely arbitrary.
Michael, in your opinion, how many revenue sharing agreements are ongoing, or for a set number of years? I haven’t heard of someone say the revenue split is infinitum, but for 2-5 years.
Dave,
Anecdotally, I find most advisor revenue-sharing agreements that go ad infinitum – and as far as I know, that’s still the standard for most/all the advisor custodian referral programs.
But I’ll admit I’ve never seen any good industry-wide data on this. My sample set is ‘decent’ – I talk to a LOT of advisors – but not exactly scientific. 🙂 But I’m finding the overwhelming majority are paid indefinitely in the conversations I’m having. :/
– Michael
I’m sure you talk to more advisors than I do so maybe I’m talking to the wrong crowd 🙂
Yeah well, apparently your crowd is doing a LOT better than my crowd. 🙂 Limited-term revenue-sharing isn’t too problematic. It’s the indefinite ones that REALLY hurt!
– Michael
Michael, Has there been any further research on this topic. Maybe there is a piece on reasonable revenue sharing model you can reference?
Great analysis and perspective. I would guess that you are right on that many, many firms/advisors don’t even consider the lifetime value (CLV) of a customer at all, much less compare it to the customer acquisition cost (CAC). I am steadily surprised at how many advisors don’t really understand the difference the between their JOB and their BUSINESS (go read The E-Myth!)—even those that have added other advisors, staff, etc.
I can see value to these kinds of referral relationships for someone that is still trying to achieve a “minimum viable practice.” One potentially beneficial dynamic is that you might pay a revenue share to infinity and beyond for those clients, you do NOT pay anything for the referrals that come FROM those clients….so a high CAC for your first, say 25 or 50 clients might be acceptable if it helps you establish a foundation with much lower CAC going forward. Many of us have leveraged our former employer’s resources in loosely this way (in the “old days”): we needed/wanted street cred and a salary–at a high “cost”–when getting our first clients, then depart for better economics (both operationally and in marketing) once we were viable.