#FASuccess Ep 146: Systematizing Financial Planning Progress For Clients With Your Own Wealth Management Index, With Ross Levin

What You’ll Learn In This Podcast Episode

• How Advisors Can (And Should) Be Tracking Whether Or Not Their Clients Are Progressing Towards Their Goals [06:08]
• Ross' Firm's Organizational Structure Creates Opportunities For Employee's To Develop [21:25]
• The Personality Profiling Tools Ross' Firm Uses [37:03]
• What Ross' Firm Looks Like Today [53:55]
• How Ross Thinks About And Manages His Firm's Profit Margins [1:07:07]
• How Accredited's Ownership Is Structured And How They Value The Firm [1:12:25]
• How Ross Thinks About Selling Shares In A Business He And His Partner Self-Financed (And Started From Scratch) [1:27:48]
• What Surprised Him Most About Building His Business [1:30:31]
• How Ross' Role In The Firm Has Changed Over The Years [1:38:10]
• How Ross Defines Success [1:45:56]

Resources Featured In This Episode:

Ross Levin
Accredited Investors
The Wealth Management Index
Implementing The Wealth Management Index
SKS Consulting Group: Industrial Psychologists
The Capacity Crossroads And The Small Giant Alternative To Building A Lifestyle Or Enterprise Firm
Tradition Bank
Minnesota Bank & TrustLive Oak Bank
EOS (Entrepreneurial Operating System)

Full Transcript:

Michael: Welcome, Ross Levin, to the "Financial Advisor Success" podcast.

Ross: Hi, Michael. I'm really grateful to be here, and I'm honored to be speaking with you.

Michael: I'm looking forward to the discussion today because you are one of the few advisors, I think, who has put a lot of really good, deliberate thought behind this challenge that I think has become more and more apparent to me in living in our advisor world, particularly as it's evolved over the past 20 years or so, which is we do all this advice stuff for clients, and we have all of this focus on creating "the plan" and analyzing all the different areas and giving them all of this different advice. And we've got financial planning software tools that do that. But the reality in a financial planning relationship, in an ongoing wealth management relationship, is that's like the first 6 months of a 30-year relationship. Because a lot of us really only have 2% or 3% turnover rates, so average tenure of a client is measured in decades. And I feel like we have all this stuff about how to do planning and engage clients in the first 6 months, and basically nothing about what you're supposed to do or track how you're doing with clients for the next 29 and a half years after the first 6 months.

And so I remember being struck pretty early on in my career reading this book that you had put out, I think originally back in the mid-'90s, called "The Wealth Management Index," which was, I guess your very systematized version of what exactly are all the different areas that we do planning for clients in: asset protection, disability, investments, estate, which we sort of know because we live that in our CFP curriculum already. But then you had this whole list of like questions you ask, things you evaluate, and you would score clients. You had this like, I forget what it was, 50-point checklist of all the different things that you could score clients in, from they haven't even worked on this to they're working on it to they've completed it.

And so you would get this score, which you called your Wealth Management Index, you would get this score of how clients were doing. And then as you help them through their stuff over time, you could track how the score changed. And I was fascinated by it then, I'm fascinated by it still, this idea of how do we start to more proactively engage clients on an ongoing basis and just, I don't know, either figure out if we're making progress or show them if they're making progress? And so I'm really curious just, I know you wrote the book, does it work this way in practice? Are you doing this in the firm? Can you talk to us about what you've learned in this 20-plus-year journey of how do we actually work with clients on an ongoing basis and figure out how they're doing and if they're making progress?

How Advisors Can (And Should) Be Tracking Whether Or Not Their Clients Are Progressing Towards Their Goals [06:08]

Ross: Yes. Thanks for asking that, Michael. I wrote the book, I've got two versions of the book, but I wrote the first book in I think 1995 or 1996. So if you think about where I was in my life at that point and where financial planning was, that was...I'm 60 now, so that was what, 23 or 24 years ago. And what's interesting about that time, I was in my mid-30s, and what I was trying to understand and try to do was codify what success looks like in financial planning. And what I was really trying to do was bring the relational with the technical. And I really wanted to focus on the why.

What was interesting, and this is true for financial planners, there's kind of the old story that when financial planners die and go to heaven, they can either meet God or they can go to the lecture on God, and they all choose the lecture on God. And I think what happens with the book is that everyone was really excited about the scoring piece and the technical piece. But to me, the most important aspect of the book were the questions around...that led to the scoring. So for example, have you articulated a life insurance philosophy that allows you to have a discussion with your clients about what it means to own life insurance, what they want to think about related to life insurance. And it was the discussion piece that would then lead into the analysis and the results, and those kinds of things. And so what I think...

Michael: Because I know you had a very structured list of like areas and questions and just all the things that you would ask them about or evaluate. Just kind of, again, a checklist-style: has anyone taken a look at the business structure? And then have you done a business valuation? And do you have a buy-sell agreement? And is it funded with life insurance? And do you have a version for disability? Right? And just sit across from a business owner and start talking about those questions, and what starts as kind of a technical conversation, like are you an S Corp or an LLC and have you established a buy-sell agreement then quickly becomes, are you actually developing the talent within your business to create sustainable value beyond you? And how are you handling the issue where your son is in the business but your COO wants to take over and you're trying to figure out how to navigate that? Right? And you quickly go from the technical questions to some very, very personal questions and dynamics around planning issues.

Ross: Right. And in fact, and I would say, for us, and I think different firms who implemented this and the feedback that I got from others is different firms did it differently, so I would say for us, we always started with the questions. Because my fundamental belief and what hasn't changed for a long or over the years is that the technical stuff, you have to be good at. And that is table stakes, because everyone has to be good at the technical stuff, because technical mistakes can cause big problems. But a lot of the technical work, and especially now we're seeing, and this wasn't the case 25 years ago, but a lot of the technical things, artificial intelligence can take over for us. So we're seeing what TurboTax has done to general accounting, and we're seeing what some of the Betterment, some of those different things have done to investment planning. So the thing that doesn't change is really developing a really clear understanding of your client and having a relationship with them so that you understand why you're doing the technical stuff.

So for example, this is just an obvious thing that happened last week, but one of our clients came in, they have a $2 million house. They have a daughter who's a veterinarian. She's 29 years old. They were trying to figure out a way to have her be able to buy the house from them. So to finance, what would make the most sense in financing the house. So maybe 30 years ago, I might have pulled out my spreadsheet and created different ways that they could do, intrafamily loans, and do all of those kinds of things that would create the easiest way for her to buy the house. But instead, we pulled back and we asked the question, "Why do you want your 29-year-old veterinarian to own a $2 million house?" And that to me is the difference between the human interaction that is required, I think, to do financial planning and the things that artificial intelligence will take over.

Michael: It's a good point that, and I think there's been similar criticisms around even some of the robo-advisors and their allocations, the sort of difference between using AI or just kind of algorithmic analysis to say, "Here's my inputs and a question, analyze me and answer." As you said, we can spreadsheet out how to do intrafamily loans and try to make these payments, but the robo-advisor never asks you, "Well, have you considered not saving for your retirement at all and just working on your student loans first?" Or saving for your house first, or saving for your marriage first. Like, if you say you want to put money in the portfolio, we'll number-crunch the best way to allocate it, but sort of these bigger why questions like why are you putting your resources this direction in the first place tend not to come up.

And I think you illustrated in the excellent way here as well. Like, we can do the analysis to say, "What are the economic and financial planning strategies to transfer your $2 million house to your 29-year-old daughter?" But the bigger question is, "Why exactly are we trying to get a $2 million house to your 29-year-old daughter in the first place? Where exactly are we going with this? Does she want it? Do you want to give it to her? You just want it in the family? Are you really just trying to give her some wealth value?" There's a lot of why questions here that could completely take the strategy in a different direction, which you don't get to if you start with the number-crunching and don't get back to the why questions first.

Ross: Right. So I think what's changed over the last several years is that the Wealth Management Index, which we used originally as a scoring mechanism so people could see how they were doing, we still use the Wealth Management Index as a way to make sure that we're covering all the bases in the financial planning piece, but we actually don't do the scoring anymore. And the reason we don't do the scoring, at least for us, we may go back to it, but the primary reason we don't do the scoring is that clients want to understand how they're doing towards their objectives, but they don't necessarily want to be scored on it. Especially clients, for us, and every firm is different, but we have clients that would be affluent, somewhat affluent, are competitive, they want to succeed in the different things that they're doing. And so sometimes we found that scoring can actually make clients feel more anxious rather than less anxious.

And so what we really want to do is make sure that clients understand that financial planning is a process. So we're going to get to all of these different things. And that if they are not doing some of the things that they have told us they want to be doing, we want to explore why that's the case, because there's a fundamental or underlying issue around that. Yesterday we were talking to a client, they're, Rhode Islanders, but they've lived in California for five years. They haven't done their estate planning. They haven't put their Rhode Island property in a trust yet. They pass away and go through California probate, it's very different than Rhode Island. But they haven't gone through the steps yet. They know they should, but there's something that is holding them back. And so until we understand what's holding them back, the fact that they haven't done it is not as meaningful, because they know they should do it, they haven't done it. There's a reason that they haven't done it.

Michael: Interesting. So there's kind of this dynamic then, I guess, that, so you get one subset of clients who are either pretty good at doing the things that you recommend. So they probably like the scoring system because they do the things you recommend and the score goes up. Then I can imagine there's kind of the second set of clients that essentially like to play the game. They may or may not have followed through on their stuff, but the minute I put a scoring thing in front of them and their achiever mentality kicks in, they'll be like, "Well, darn it, I'm going to do everything that they recommended because I just want to get my score to be at 99." Right? And they get focused on that.

But then you get clients in the other end where they have trouble implementing, they have trouble following through on items, or maybe there's just some other blocking points. The real reason I haven't worked on my will is not because I don't know I need a will, it's because I don't want to face the conversation with my estranged child about whether I'm going to disinherit them or not. So the easiest thing to do is to just not work on my will. And if you put a scoring system in front of them and start debiting them for not doing their stuff, at some point, it's just, I guess where they're in, right, either feels like you're badgering them, or it just feels negative, or this just isn't fun anymore. Like, I'm not doing it. I've got my reasons. I'm not doing it. So doggone it, stop penalizing me with your silly scoring system. And I guess that's part of what you were finding? The clients who were good at doing this stuff, the scoring system was motivating, but for the others, it was actually demotivating?

Ross: Right. Yes. And I think another piece, and it's interesting, and I don't know, I'd love your take on this because I've seen your writing evolve, that initially, the technical stuff gave me great comfort because I was young in the field. I was working with people that were older than me, who had more resources than I had, more successful than I was, and the technical piece was a way to level the playing field. And what's changed, I think, over time is that as I've had more life experiences and some of the things that I thought were important became less important, and the technical piece is an and, it's not an or, and what really became clear was that I needed to connect values to everything that we were doing, and making sure that the client was actually connected to their money. Because most clients, frankly, aren't. They don't understand what they have or what they don't have.

And it's interesting because, Michael, I think when you started writing, you were writing a lot about technical stuff, and you've really evolved your own writing into more of the blend between meaning and money.

Michael: Yeah, I think I would certainly...well, so I certainly concur. I think that's where kind of the evolution has been for me. Everything from what I write about and speak about to conversations that I end out with clients and prospects. I spend less time in front of clients than I used to but still end out in those conversations from time to time with clients of the firm or prospective clients who are considering it.

And yeah, there is a piece that I think you said well, like, you do have to have the technical chops, the technical stuff. Like, if you want to get fired really quickly and just actually screw something up for a client that has significant dollars at stake, and like, yeah, I don't really care how good relationshipy you are. If you screw something up badly enough because you just flat-out didn't know what you were doing, you're going to get fired. And it's not just...it's not even just because the actual like financial consequences of whatever your bad advice cause, it's that if you screw something up that badly, your client fundamentally won't trust you anymore because you're viewed as not having competence. And if they don't trust you, then all the rest of the stuff doesn't work anyway. So the relationship is kind of trashed.

So no question, you have to get all the technical stuff right. And I don't regret at all the amount of time I spent focusing on all the technical stuff in the early stages of my career. But I think you said it well with your example earlier, that I think there's this piece to just how you evolve and grow as an advisor. That step one is the client comes in and says, "I want to transfer the house to my 29-year-old daughter." And you've got to know how intrafamily loans work and imputed interest and gift tax complications and all the rest. Because if they really want to do that and you put a strategy out there and it's wrong and causes, in that case, a tax blow up, you have a serious issue. So you have to know that stuff.

But then at some point, the conversation shifts. And when the client says like, "Hey, can you help me implement this strategy?" you say, "Oh, sure, I've got a lot of ideas about how we can do that. There's these things called qualified personal residence trust and intrafamily loan strategies and gifts and a lot of cool things. But I just want to pause for a moment and ask like, I'm just wondering, why exactly do you want to give a 29-year-old veterinarian your $2 million house? Can you just give me a little more context about why we're going down this road and then we can talk about some strategies about how to do it?" And then you find out an hour later you're still talking about the why question and all these other family and personal dynamics that have come forth, and you haven't even gotten back to the technical implementation issue nor may you because the conversation can end out going in entirely different direction by the time you get to the bottom of this discussion.

I kind of view it as a progression about how we develop our skills. Which I think is even getting reflected now in how firms, particularly large firms are making career tracks. And I'd be curious to know if your firm has implemented something similar. We've done a version of this at Pinnacle, that in essence, the first year of your career is sort of the paraplanner or associate planner role, and your job is to learn your technical stuff and prove you know it. So you get your CFP certification. You do a ton of plans and tax analyses and investment analyses and all the different stuff, whatever it is you do in your firm. You've got to learn your technical chops, practice them, and prove that you know them if you want to move up.

But then if you move up, now you're in more of a service advisor client-facing role, and your primary skillset is no longer the technical stuff, you are presumed to know that and not screw it up. Now you actually have to learn all the relationship stuff. Like how do you actually manage a client relationship? How do you actually manage expectations? How do you introduce difficult conversations and not have someone get defensive, angry, or fire you? How do you talk a client off the ledge when they're freaked out about results or some outcome and you want to keep them as a client and help them not do something bad to themselves? And then even from there, I think there's a third tier that emerges of like, okay, great, now you're good at managing the relationships of your existing clients, now, do you know how to establish relationships with new ones? And go do business development.

And that there's kind of this progression like, you don't want to do too much relationshipy stuff before you do the technical stuff, or you just give very well-meaning, completely incompetent advice, which is not good. But the journey doesn't end at the technical stuff. That's just stage one on this like 5, 10, 15-year journey that I think most advisors go through before you really get good at the whole thing.

Ross' Firm's Organizational Structure Creates Opportunities For Employee's To Develop [21:25]

Ross: Right. And you know what's interesting for our firm, so much has changed over the last several years. First of all, we're way bigger than I ever thought we'd be. We have around 50 people. We kind of believe that everyone is an expert in something, but no one is an expert in everything. You're probably excluded from that. But I would say that we have teams for all our clients. So, all our clients have four people working with each of them. We have essentially three wealth managers and an investment analyst. We created education SPAs. So we call in experts in different areas, whether it's Social Security. We have someone who's visited all the continuous care facilities around here and takes clients through that.

Michael: Did you say you call them spas?

Ross: Yeah, we call them SPAs. I've got to remember what they are. I think they're called special purpose, whatever, and everyone is responsible for something.

Michael: Okay. Okay. So this SPA is an acronym, we're not like...we're not actually calling that going to the spa here. Okay. Okay.

Ross: We have specialists, so we have someone, even though we have attorneys on staff and CPAs on staff, we have a philanthropy and director of estate planning that gets called in for complicated things. We have a tax specialist that gets called in for complicated things. But most important, we have career tracks. And those career tracks can be, you could be on a purely technical track or you can be on a track that will get you more into a client-facing role. And you really get to pick which track you want to be on.

And the primary objective for us is to move people into the place they should be when they're ready rather than when we're ready. And the challenges with a lot of firms I think is that you have a pyramid structure. And so you either need someone to leave or you need the business to grow dramatically in order to advance. And we're trying to avoid that. Because we believe the critical challenge for us over the next 10 years is still going to be a people challenge. And we need to make sure that we can create an atmosphere that the right people working with the right clients. And if we get that right, I think that we're going to be in really good shape going forward.

Michael: So can you talk to us a little bit more about that? I think you have a really dead-on point about this dynamic that most firms and I think just most businesses in general kind of have a hierarchical pyramid structure, and you move up the pyramid over time. But the fact that people in leadership have multiple direct reports means kind of the pyramid branches out as the levels get lower. Which means you end out with this dynamic that lots of people are all competing to move up to fewer higher-level jobs. And so at some point, you get outcompeted or you've just got to wait for someone to leave or die or otherwise move up themselves so you can move up the ladder. And depending on the nature of the firm, that can create some friction. That can create some bottlenecks. The easiest solution for a lot of firms is just keep growing. Because if you keep growing, you add more positions to the whole organizational chart from top to bottom, so there's more opportunities for your team to move up.

But you seem to be implying some other non-pyramid structure. So that is, as you put it, people can move up when they're ready instead of when you're ready as a firm. So what does this organizational chart or structure looks like? How are you doing this so that you don't either have these bottlenecks or create these bottlenecks?

Ross: Well, I think there's a few things that you have to accept in order for this to work. And this took us a while to figure out. And again, everything is an experiment in a lot of ways. First of all, I think that what changed for us, it didn't change for us, but what became really clear is the values of the firm were taking precedent over everything else. So when you think about our firm, one of the key areas that we have is "we over me." So it's really important for us to have a team concept. And everyone in the firm has to be a team player. We don't pay for business development. At the end of the year, we give a profit-sharing that everyone participates in. What we like to say is that we try to pay top comp, but we don't bonus people. So we use all those comp studies and we try to pay comp at the rate that people show for comp plus bonuses and make that their actual salary, as opposed to giving performance bonuses, because we have very high expectations for people. But if you're comfortable with those high expectations, you're not competing internally, you're just competing to improve the firm.

So one of the key aspects, in order to make this work, is that ego has to be subjugated enough so that you're willing to share responsibilities with others. And if you're not, then that's one of the things that creates the bottleneck. And I think it's one of the big challenges in succession planning, because I think that a lot of times founders, in particular, have a very hard time letting go of things. And one of the things that I have found is that in order to be a good leader, you have to be a good follower. And if you can draw from everyone in the organization in different ways, people can find their places more quickly.

Now, you still require growth. The organization still has to grow, especially when you're doing succession planning because you're selling stock on a EBITDA multiple, and the banks, if you're using outside financing like we are, the banks require a certain kind of succession. But you need to grow anyway, I think, in order to create sufficient opportunities for the next generation to be as financially successful as the first generation was.

Michael: This kind of "we over me" framework that you set forth, "We don't pay for business development, everybody effectively participates in business development because they get their profit-sharing bonus at the end of the year," how do you end out in a world where people just don't do business development? Say like, "I'm not incentivized for it." Or I guess alternatively, that when you get people who are really good at business development, they say, "Well, I'm actually so good at business development, I just think I'm going to go to another firm that actually will pay me for the business development. Because I'll make a lot more money or get more equity or have more partnership or whatever it is at the other firm." To me, there's a competitive dynamic to that as well, not within the firm, but in keeping your team members who are good business developers. So how have you found this plays out for you in I guess how you just get people on board with business development or keep people who are good at business development?

Ross: I think there's a couple things about that. And you're absolutely right with what you're describing. The first thing is who we're hiring. And one of the things that we do is every single person in the firm goes through psychological testing. We use an outside industrial psychologist. And whether it's a receptionist or whether it's a wealth manager, they're going through testing. And that testing helps us identify who the lone rangers are versus who the team players are. And in the past, we have had...before we did the psychological testing, we have had people that wouldn't fit in the organization because they didn't fit that culture of "we over me."

I think the second thing is that we've created an environment where the right kind of people, the people that fit our firm really, it works well for them. So we don't believe in balance, we believe in harmony. And what I mean by that is that there are times where work is going to be extremely busy and you're going to have to put in the hours. And there's going to be a lot of times when you want to go to your kid's soccer game or you want to do that, and we want to create an environment for that. So we have five days a week of paid volunteer time off that they can use to work with whatever charity they want, or they could work with their kids at their school. We have very generous paid time off. We give extra days around holidays so if people will need to travel or whatever, they can get away. And then we comp people fairly.

Our belief is, and I don't think I'm being Pollyannish about this, I really believe that it's worked for us, is that if you service the heck out of your clients, you're going to grow the business. So 75% of our business still comes from existing clients. One of the shareholders in the firm is responsible for our firm growth initiatives. We don't call it business development, we call it firm growth. And she's so much better at it than I was. And I used to be the one that was in charge of it. And what she has done, I think, that has really been helpful, she would be great on a podcast with you, Michael, she's really helped create systems around firm growth. Systems include, like tonight, we're having an event. One of the reporters from Minnesota Public Radio is coming to speak to a group of clients and invited guests on "We Know How This Ends," which is around living while dying, which is something that she's written about.

And so we're going to have probably around 150 people coming to an event like this. Many of them aren't clients, but many of them are invited by clients. And they get a chance to see our firm, understand our values, understand whether we're a good fit. Because from a client standpoint, we don't want to close on 100% of the people that come into the office, we want to work with the clients that need and value in-depth advice and relationship and are willing to pay for it. So those are the right kinds of clients for us. And so we have to make sure that we're finding those. Our firm growth person finds opportunities for staff to be engaged. And she follows up with the staff. And she happens to be extremely extroverted. I'm an outgoing introvert, but she's an extrovert to the max. And so, she goes to a lot of events and things like that, where she meets a lot of different people.

One of the things that we're trying to do, and we've said this all along is for the firm to succeed for the next generation, they don't want me to get smaller, they want everyone else to get bigger. And we have to make sure that that's happening. So I write a column for the newspaper that gets...twice a month column on money and values for the newspaper. So there's people in the community who know of me, but the firm has a team approach, and the firm is much bigger than I am. And in fact, you know this, when one of our partners left a few years ago, we didn't know how that would work because she was responsible for a third of the business. But we lost I think roughly 5% of the business. And the reason clients stayed was that they have a team, and the team represented more than any individual on the team. And that includes me, and it includes my other founding partner, Wil.

Michael: I think there's a powerful point in that that a lot of firms miss about the team dynamic beyond just more people serve the clients and do more things for them, as long as your clients pay you enough for the economics to work. And I think it's something, ironically, that the wirehouses seem to have figured out long before most of the independent firms did, which is from a competition for talent perspective or the dynamic of what happens if you lose an advisor, if you service clients with the team across the firm, then if an advisor leaves, even if they were the primary client-facing person, they're often not the only client-facing person. And if clients have a relationship with two, three, four, or five different people on the team with your firm, then if one person leaves, even if it was the advisor at the head of the team, it's much more likely you can retain the clients by just getting another good advisor in there to continue working with the team that the client already knows, and holding onto them.

Or conversely, if your competitors want to lure away your top talent and actually get the clients to go along, they don't just have to lure the advisor, they have to get the entire team. They have to get all the people. And that's much harder, because not every team member necessarily wants to change firms and disrupt their lives. And they may be happy there if the advisor was not. And just there's kind of a robustness, safety dynamic to the firm of having teams with multiple people at the firm who all interact with the client directly, at least to some extent, that when turnover happens, your risk as a business is reduced because clients weren't solely dependent on one point of contact. Where if that point of contact leaves the firm, just the client has no more connection to the firm, so they may as well leave, too.

Ross: And it's more rewarding for the staff because the staff is in the business. They're not working at a manufacturing plant. They want to interact with clients. So, the more the clients see the group, the better. And we also don't silo teams. So we have a little bit more of a matrix because we're trying to put the right people together. So even what you're describing, if someone wanted to take a silo away, they wouldn't be able to because there's so many different people that are working with the client that no single person would be responsible for a significant percent of the business.

The other thing that's a little bit different about our business, I don't know how other people run, we don't have a single client who represents more than 1% of our revenues. That is incredibly liberating. Because even though our retention rate for clients is high, like everyone's, we're not at risk of if something goes wrong with a particular relationship, we're going to have to be in trouble. We're not an ad agency.

Michael: Yeah. No, out of curiosity, is that because you've steered away from having any whale clients or just as it's turned out in the business, you haven't ever ended out with one client that became a huge dominating portion of the business revenue?

Ross: I actually think it's partly because of the way our fee structure work. So the way our fee structure levels out, not completely, but it's essentially, we're still an AUM-based fee structure, but above $15 million, it's 25 basis points. So the $50 million client and the $20 million client don't create significant more revenue for the firm. So I think that that helps balance things a little bit there.

Michael: Oh. So just the fact that your breakpoints get pretty low by the top end means even if someone comes in and has tens of millions of dollars and is significantly above your average client, their revenue contribution to the firm isn't overwhelmingly dominating. It's not like a client who's 10X the size pays 10X the fees because they've dropped several tiers on the breakpoint schedule down to a pretty low threshold.

Ross: Right.

The Personality Profiling Tools Ross' Firm Uses [37:03]

Michael: I do want to go back for a moment, though, and just ask you, you had talked about putting everyone through personality profiles to try to figure out whether they're, I guess basically like a team-oriented person versus a lone ranger. Not that you can't be successful with both, but your culture clearly leans one way versus the other. And you're using an industrial psychologist to do this. So can I ask, what are the actual like profiling tools that the firm uses that you found works? And who are you actually working with to help you implement this stuff?

Ross: Well, the firm we're working with is in Minnesota. It's called SKS Consultants. It's a different process for wealth managers than it is for secretaries, for example. But the wealth manager process takes a day to a day and a half, includes individual interviews, includes testing, various kinds of testing for different things. And they use a variety of tests. It includes even an inbox kind of thing. Before we get to the SKS, we do meetings. Two of our people in the firm are primarily responsible for hiring, Jeremy, who's one of our shareholders, and Megan, who's been with us for several years and is terrific. And they set up an interviewing process to see whether people are comfortable with the person. Once several people in the firm have met the person, that's when they go through the testing. And then from the testing, we get an individual report back. And the report either says basically that it's a perfect fit, a more good than bad fit, not quite a fit, or doesn't fit.

What's interesting Michael is that we are much more respectful of the hiring process than we used to be. So several years ago, we had someone else who was in charge of our hiring, and that person would disregard the industrial psychologist testing, which is kind of ironic because why are you paying a couple thousand dollars for tests that you're not going to look at. And the ones that were not good fits did not turn out to be good hires.

Michael: Like, doggone it, the tool worked.

Ross: The tool worked. Yeah. And that's universal. So what's interesting is, when you use an industrial psychologist, it doesn't mean you're going to be 100% right. The research that we've seen shows that it increases your success rate from probably 30% to closer to 65% or 70%. So you're still going to have misses, you're just going to have them less frequently.

And the other thing is that when someone misses, you're going to be pretty sure why that person's going to miss. So when someone is hired after meeting with the industrial psychologist, we also encourage them to go back and meet with industrial psychologist so that they can talk about what their anticipated weaknesses are and how to overcome those within the firm structure. And then we have a really intensive onboarding process for people. So they meet everyone in the firm. Every single person in the firm sits down with them, talks about what's working, what's not. I would say that we have an open organization. It's not transparent in the sense that not everyone knows everything that's going on, but we have a very open organization. We're pretty comfortable with sharing what's working and what's not.

Michael: So in terms of the tools themselves, is this some standardized like Kolbe, DISC, one of those tools? Is this a more custom thing that SKS has made for themselves to vet and evaluate people?

Ross: It's a combination of things. They don't use the Kolbe, they don't use the DISC, they don't use the Myers-Briggs, but they do have some tests that they have. And what I can do is after this, Michael, if it's helpful, I'll talk to the industrial psychologist and get him to get you the tests that we're using.

Michael: Sure. That'd be great. Just if they can share out a sample of what that looks like, we're happy to list that, put it in the show notes with the people, with our listeners.

So SKS kind of has this proprietary tools that they use. And so I guess they're kind of overlaying this against their understanding and assessment of your culture to say, "This person is a perfect fit or more good than bad or not a fit." Because what might be a horrible fit for your firm is a perfect fit for someone else. It's not a this is a good human being or a bad human being kind of thing. It's just a, is this person a good fit for your firm and what you do and the way that you do it?

Ross: That's exactly right. And that's a key point that you're making. Because one of the things that can happen is that, for example, a staff might recommend a friend who they think would be a good fit for the firm for whatever reason and they don't make it through SKS. But as you said, it doesn't mean that they're not competent or it doesn't mean that they shouldn't be in the field, it means that they're not a good fit for the way our organization is run. And our organization is different than other. For example, we've never had a successful hire from a brokerage firm. It doesn't mean we can't. But like you had mentioned before, some of those people are often more directed towards business, getting business and those kinds of things might be more individually competitive rather than team-oriented. And those are just things that just don't work for us.

And we just want to make sure that just like we want to have the right clients, we want to have the right staff. The risk is when you have a very...an organization with a very clear culture like ours is can you be guilty of groupthink and not exploring alternative ways of thinking. And I think that one of the aspects that works in our culture, generally, is that we are comfortable with people who play devil's advocate role, a devil's advocate role. And we're comfortable with it because that's probably the role I've played in my entire career. So it's not something that we shy away from. We like people questioning what we're doing. And in fact, some of the best ideas we've had have come from people lower in the organization than the leadership.

Michael: Who said, "Wait, what the heck are you guys doing?"

Ross: Exactly. Yeah. Or, "Have you thought about this?" or, "Why not?" I keep thinking, Michael, one of the things that has made us successful in some ways, and success is how you want to define it, but there's a lot of things that we didn't do. And those are counterfactuals, but sometimes the things that you avoid doing are what make you more successful than the things that you actually do do.

Michael: And so do you have examples? What do you look back at and say, "Thank God we didn't do that?" Aside from not have a giant whale of a client that overly dominates your business. And I do know a lot of firms that have struggled with that. When you get a really big client, it's a lot of money, it's a lot of revenue, sometimes it's really hard to say no. But then they really struggle because they become beholden to that client, and they literally can't afford to lose the client. And if you can't afford to lose your client, it's really hard to make proper business decisions for the whole firm.

Ross: That's exactly right. And I think that that happens in a lot of different areas. So for example, we currently own our building. We've owned our building for I think 15 or 16 years. But before we bought this building, six years earlier, we had the chance to either rent office space or buy a building. We were much smaller firm at that point. And had we bought the building six years earlier, a lot of our revenues would have gone into the building. And as a result, I think it, and again, I don't know for sure, but I think it would have impacted our growth, it would have impacted who we hired, and we would have made a potentially sound short-term financial decision that would have cost us a lot of money in the long run. Instead, we ended up buying our building when we could get a 17,000 square feet for the same price that we were renting 4,000 square feet. And that's enabled us to grow our staff into the building. We're now in a situation where we're actually having to explore putting on a second floor on this building, but we can stay in this building.

But I do think your business is...I don't know what kind of...what plant grows to the size of the container it's in, but that can happen in the business world, too. So you have to be really careful about that.

Michael: So just being willing to take a leap on saying, "We're committed enough to the growth of business that I'm not just signing a multi-year lease, I'm going to sign a multi-decade mortgage loan to buy or create a building so that I can control my destiny a little more and control fixed costs for longer." Because obviously, your mortgage doesn't inflation-adjust up the way that your rent does if you continue to be a lessee all the way through.

Ross: But not doing it earlier...not doing it too early, because if you do it too early, then you've got too many resources going in a direction that's going to inhibit your growth. So it's kind of getting that time in there.

Michael: But you guys did it 10 years into the business?

Ross: We did it, let's see, we probably owned this 16 years ago, yeah, probably 15 or 16 years into the business.

Michael: So do you recall, how big was the firm by assets or revenue then? At least in your experience, what was big enough but not...not too early but not too late, kind of the Goldilocks timing for you?

Ross: At that point, I'm guessing we probably had 20 employees and maybe $600 million under management maybe. And now we have close to 50 employees and over $2 billion under management. But we had to...we bought a building, and this was another interesting thing, we bought a building, half of it was single-person offices when we bought it, and we only needed half the building. And so after a year, we kicked out all the people that were in the single-person offices, even though we didn't need the space. But we realized that their office was the most important thing to them, and it was the least important thing to us. And so it was taking our time, and it wasn't fair to them, and it wasn't fair to us. So we just took over the rest of the building.

But that's one of the things, like, I was an agent, a sports agent, because my business partner's nephew was a quarterback for a national championship team and was going pro. I did that for a year, and I hated it. And it was terrible, and it was bad for our clients. It took my eye off the ball with our existing clients because that business needed so much attention. And so we just stopped it.

And so I think one of the other things that we did well is we didn't allow bad decisions to run. We never worried about sunk costs. We would always make a decision that what's the right thing to do irrespective of what we have into it. We haven't done multiple offices, even though our clients are all over the country. And the reason why we haven't is it's really hard to run a single office. It's really hard to find people. It's hard to maintain a culture. We don't know what it would be like to have an office in Florida, an office in Arizona. It could work, but we just don't feel like we've had to do that. So I would say that we're very incremental. We're not early adopters. We tend to step into things rather than just be the first one in.

Michael: So can I ask, though, how do you avoid getting caught up with sunk costs? Because that's kind of human nature for most of us and a really hard thing to get over sometimes. Is that just part of how you're wired? You're just very, let's look forward and not backwards in what are already sunk costs or do you have some system or mental framework about how you work through that challenge?

Ross: Well, I think one thing is that, I don't know, some of it could be wiring, frankly, one of it. And again, I think some of it could be ego in the sense that we are not uncomfortable making mistakes, and we are very comfortable exploring how the mistake occurred. And we like to share our mistakes with the group. We want to fix our client mistakes. That's one of the things...one of the things early on, and again, I don't know if this story is real, but it's become so real to me that it feels real, which is when Wil and I were starting out, one of our clients, we made a trading error for a client who was 80 years old at the time. And the trade error would have cost us 10% of the revenues of the firm at the time. And the client didn't know that we had made this error. And Wil and I went back to the client and explained the error and fixed it.

And I think what that did for us, and again, this is the story that I believe, is that what it taught both Wil and me is that when we sit down with someone who's interested in joining the firm, we can tell them unequivocally that, "We're going to do what's right for you." And we have evidence of that. Now, we don't recount that story to people. We don't tell the...

Michael: You don't exactly want to brag to clients like, "We so do the right thing that we can blow up like hundreds of thousands of dollars for you, but we'll totally own it when we do. So it's all good."

Ross: Well, and trust me, back then, this was a long time ago, it wasn't hundreds of thousands of dollars, but anyway. So I think that that opened our eyes to when you make mistakes and you're open about them and everyone in the firm sees your openness around mistakes, they're not inclined to cover up mistakes. And again, those are the things that can bring down a firm. Compliance is the one thing I would say that all firms need to be really aware of, because that's the...no matter what you do, that's the...if you do something wrong from a compliance standpoint, that's the thing that's going to blow your firm up.

We have our compliance person on our executive team. So she's involved in all the decisions that are going on. And sometimes it means that she suggests things that I wish she didn't. So for example, the Barron's Best Advisors, it's really clear in the Barron's Best Advisors that you're supposed to only talk about the clients for whom you're responsible for. Well, we have a team approach, so I'm not individually responsible for any one, and I'm responsible for everyone. We didn't feel comfortable submitting our name in the Barron's Best Advisors. Where I know that other advisors, again, they might do it differently and be in there, even though they do operate their firms the same way we do. But from our standpoint, our compliance person was uncomfortable with it, and we adhere to what she says.

Michael: Well, and I'm struck as well just when you talk about kind of, I guess other mistakes avoided or mistakes that you learned from just this hiring process, that I still know a lot of firms that are wary about spending whatever it is, 100 bucks to get Kolbe assessments, or whatever exactly it costs, for prospective employees. They're like, "That's kind of a lot of money to do that with a lot of prospective employees trying to figure out if they're right fit or not. We'll just try to figure out in interviews with them." And you guys, I think you had said like you're spending thousands of dollars with your industrial psychologist evaluating employees. And I'm going to presume like that means you actually spend more than that. Because not everybody you put through the process is necessarily going to get the job at the end. So some of those you're spending thousands of dollars to figure out, you're not going to hire them. How do you think about or rationalize that? Because that adds up. That's going to add up quickly.

Ross: I think, boy, the cost of a mistake is way more expensive. And one of the weaknesses that we have had in the past is that we maybe...we're too slow to act on misses. I think that that can create havoc in the firm. So when I look at it, the savings is significant over the cost. The upfront cost, it's the challenge that all of us have. Why do we save for retirement? Right? We're sacrificing today for what the future may hold. But it's the same thing. The savings that we make by increasing our good hires is so significant that it's really worth it.

What Ross' Firm Looks Like Today [53:55]

Michael: So can you paint a picture for us of just what the firm looks like today, as of now?

Ross: Sure. Today, right now, like I mentioned, we have around 50 people. Of the 50 people, slightly less than half are women. We have a variety of professionals. We have CFAs and lots of CFPs and CPAs, couple attorneys. So a wide variety of experience. We have 10 shareholders in the firm. We're active in our succession plan. I'm 60, Wil is, I think he's turning 63.

Michael: And Wil was your co-founder from the start?

Ross: Yep, Wil is my co-founder. And that's an interesting aside. We place a lot of value on loyalty. I've been in a 36-year marriage, as has Wil. We've been partners since 1987. So that's 32 or 33 years we've been partners together. And what that means is that our inclination is that when things are going wrong, to turn toward each other, rather than to turn on each other. And I think that from a partnership standpoint, that makes such a big difference. And a lot of times people are kind of grasping for what they should look for in a partner. I would say Wil and I have extremely different skills. For the first three or four years, I might have been a little bit resentful of Wil, because I was bringing in all the business and Wil was making sure that we did what we said we were going to do. And so until I got over that ego piece and recognized that he was as important to me as I was to him, I think that would have been a challenge.

And now from a shareholder standpoint, I think the reason our succession planning so far is working, and obviously, things could change, but we have a deep appreciation for what G2 has done for the firm. And I think G2 appreciates what we've done. And that makes a giant difference. And so again, I would say that it may be a lack of ego on both sides that we are really trying to distribute leadership across the firm. We have identified people. We have an accountability chart. We understand who reports to who. We have a lot of people in the firm responsible for a lot of different areas. And we're willing to share that. We have accepted the fact that different people don't do things the way Wil and I did them. And frankly, some of the people and some of the decisions that they're making are better than the ones that we were making.

Michael: Oh, that's the hardest part to accept. Oh, God, they didn't do what I'm going to do. And it actually turned out better.

Ross: Well, you know what? This event that we have tonight is exactly that. I had said for so long that we can't...our clients are private and we can't open up clients to events. And Becky, who's in charge of our business growth, fought me on that, and I conceded. And it's been a fantastic thing for the firm. And if she fought me on it, I would say this about Wil and me and other people in the firm, if she fought me on it and it didn't work, no one would say, "I told you so." Which is really, like I said, we really want to work with each other. And we're not trying to one-up the other person.

Our overriding mission is to improve the collective lives of all we serve, which are clients, cohorts, and community. And we really try to...we do try to live that. And I know that that's kind of a platitude, but we actually try to believe that. And we also don't view the business as a zero-sum game. So for example, one of the challenge always is that the founders are selling the past to the buyers of the future. But it's not a zero-sum game. We think that it's actually, things will...everyone can benefit from that.

Michael: So how big is the firm overall in terms of I guess assets, clients, revenue, however you do your primary metric?

Ross: Well, so our assets, we have over $2 billion of assets. We have roughly 475 clients. The assets under management is not the best metric because different firm...I always think EBITDA is a better metric, but assets under management is a good kind of a measure. And again, for the way we charge, the way things work for us, our sweet spot generally is clients that are in the $3 million to $15 million range, but we have clients that are bigger than that and we have some older clients that are smaller than that.

Michael: Well, I'm just struck, over $2 billion of assets under management and under 500 clients means your average client is more than $4 million. Which for a firm having done it for 30-plus years, where we tend to have some legacy clients around is a pretty hefty average. So have you actually cycled older, smaller clients out of the firm as you've lifted up? How do you handle the dynamics where you say your sweet spot today is $3 million to $15 million? And I'm going to assume if you've been doing this for 30-plus years, if we go all the way back, your original sweet spot was like clients who had $3,000 to $15,000 when you were getting started in the mid-1980s. So you've added many zeros to the ideal client profile.

Ross: Well, what really changed is we didn't start off as fee-only. So we didn't become fee-only until probably, I'm guessing right around maybe '98 or '99.

Michael: So how did you start out originally? Were you under a broker-dealer?

Ross: We were fee plus commission, yep. In fact, I was a...we were affiliated with a broker-dealer. I actually ran a broker-dealer when I was...before I started Accredited. I didn't own it, but I was president of a broker-dealer. And then I was so bad at that and I hated it so much that I decided to join...Wil and I decided to join each other and start Accredited in '87, in 87. So once we became fee-only, our minimum account size to start was $500,000. So that was that. So it's not as big of a leap as it would have been if 32 years in the business we were working with $10,000 client.

Michael: But still going from a minimum of $500,000 to an average of $4 million, I'm going to assume most of those $500,000 didn't grow all the way to $4 million. That would be a pretty big growth rate. So as the average or the target clientele has lifted up, how do you handle 30 odd years of legacy clients?

Ross: We still work with them. Again, I would say that our median client is probably not $4 million. Our median client might be, and I don't know what the answer is, might be lower than that. So an average versus a median is different.

Michael: Sure, sure, because you get some big clients that add a lot to the asset base.

Ross: Right, right. But again, we don't have the $100 million client either that's adding to the asset base. So I just think if you do a scatter chart, most of the people probably fall on the $2 million to $10 million range.

Michael: Okay. And so do you have like tiered services? Do you handle them differently at these tiers or no? So just philosophy is you're a client, you get the same deal regardless of where you are on the asset scale.

Ross: Yeah. And that is a challenge, Michael. I would say that when you think about what our challenges are, I would say probably the key things to pay attention to, that we're paying attention to is how do we stay a small, big firm. Scaling is not something that we believe is possible with the way we do things. So we have never been motivated by AUM. For example, we'd never said, "Okay, we're a $2 billion firm, we want to be a $10 billion firm." We've always said we want to make sure that we're delivering to clients. We've increased the services that we deliver to clients. We just believe that that will take care of ourselves. We're a big firm now with 50 people, but we want to have a small profile in the sense of people feel like they're working with a small firm.

But logistics are really challenging. And that's something that's going to continue to be challenging. I would say that the key thing for us there is again, the fast work, the stuff that we have to do quickly, we have to be really good at, and the slow work, which is the interpersonal interactive work, we have to be good at. And they're both very, very different.

And I think the other thing is because we don't pay bonuses based on production and we don't pay bonuses in general, instead what we do is, like I said, we comp people in the high end of the salary plus bonus range, a downturn can impact us because 80% of our operating costs are salaries. We're going to be impacted at the next market turn.

And what happened to us in 2008/2009 was that we did not lay off people. Our premise was that people needed more service rather than less. This was going to be an opportunity to get clients who were unhappy. And it actually increased our workload, because that's what was happening. What we had said, I remember, I'll never forget this, we called a meeting in March of 2009 when things were basically at the bottom, and we said, "Okay, folks, this is what we're doing. We're not laying anyone off. We're freezing salaries. We can't give any salary increases. We're not going to be able to contribute to a profit-sharing. And if things continue to stay like this, we'll have to set aside the 401(k) match." But fortunately, things turned around and we didn't have to do that. But I don't know what's going to happen during the next downturn. I know that our belief is that the staff is what makes us unique. And so sacrificing staff in a downturn doesn't make sense to us.

Michael: It's got to be daunting, though, just as you look on a $2 billion base staring down the next bear market. It's a phenomenon to me that I've been struck by just as we've gone through the bear market cycles, even for my career of 20 years now, 20 years ago, when the tech crash hit, even for firms that were independent RIAs, the average firm had $20 million or $30 million, a big firm had $100 million or $200 million. And so even with like a 20% market pullback on $100 million base, if you can get a half-million-dollar client here and there through the bear market, you can pretty much still grow your way, or business-develop your way through this challenge. You really only need like two or three new clients a month, which is a heavy load, but hey, if people are getting dislocated with their advisors because they're upset in the downturn, you've got a shot at it.

By the time you get to the 2008 financial crisis, the typical firm was hundreds of millions of dollars. And so now all of a sudden, even if your diversified client base is there, you get a 20% pullback, you might lose $100 million or $200 million, or at least like $100 million-plus of assets under management, and now all of a sudden, it's like, "Oh, so you want to make that back on like half-million-dollar clients? Good luck because you need 200 of them." Which means if you want to make this back, like, "Oh, you need a new client every business day of the year, minus a few holidays."

And then you get to $2 billion, and now like, I hope I'm not scaring you or anything, but, right, I'm sure you and Wil have done this math at some point, now, a 20%-plus pullback is $400 million of pullback. And the good news is advisory firms tend to run really healthy profit margins. But I think sometimes firm owners in the business forget, particularly when we're 10 years into a bull market and get a little complacent, like you actually have to run really good profit margins because you have to deal with the fact that next bear market could clock hundreds of millions of dollars off of your top line, which goes straight to the bottom line if you don't want to fire or let go of any staff. And you have to be able to absorb that. Because if you don't have enough margins, your cash flow goes negative, if it goes negative, you have to fire people, if you have to fire people, you reduce services in the middle of a bear market, and now you can literally blow up your firm. Because you want to service your clients when they're panicking, and now the downward spiral goes.

How Ross Thinks About And Manages His Firm's Profit Margins [1:07:07]

Ross: I totally agree. And I think that that's a really important point. And I think a lot of firms, I would say, for us, one of the things, again, that's changed probably over the years is that we're not a practice, we're a business, and we have to maintain or we have to pay attention to our EBITDA much more closely for a couple of different reasons. One is that we have shareholders, and the shareholders have to pay down their debt, so the banks require a certain amount of EBITDA. Secondly, we have to make sure that the business is sustainable for all the families that we're serving and all the employees that are here. And so what we pay really close attention to is that if our EBITDA is too high, we haven't invested enough in the business. And if our EBITDA is too low, we don't have a sustainable practice. And so we have to make sure that we're managing within this range of EBITDA that allows us to have a sustainable practice. And we really believe in sustainability.

Michael: So out of curiosity, where do you put those guardrails? I'm assuming you probably do it in percentages, like profit margins as opposed to hard dollars, but what do you view is a healthy profit margin range for an advisory firm? What's too low to be risky? What's too high to say you're probably not reinvesting enough?

Ross: I really actually think it depends on the advisory firm and the kind of practice that they're running and the flexibility that they have. I would say that some of the things that we have been able to do to manage our expenses are the fact that we own our building. Our rental costs are probably lower than most advisory firms for building this.

Michael: Fifteen years of not having rent increases probably compounds quite nicely for you after a while. Hurts in the early years, but it kind of gets nice now.

Ross: Yep. And I think the other thing that large firms like ours have is we do have some economies of scale related to things like technology and things like that. But again, 80% of our costs are salaries, so that's going to affect...that is the one thing that is really hard to adjust in bad markets. Again, we'll have to see what happens, but we were...in 2008, I can promise you, in 2008 and 2009, we weren't getting fat on distributions.

Michael: No. No. For most firms, I know even if they ran pretty healthy margins, distributions basically went to zero or near zero for a year or two there. I think that's part of the driver around the profit margin discussion I'm not sure is talked about enough in firms, particularly once you get to the point where it's a business. Meaning it's beyond just you. There's other advisors and employees and people who count on your ability to pay their paychecks, to have their jobs, which then is how clients get serviced so that they stay clients of the firm, that unless you have a pretty uniquely flexible cost structure, you pay your people on a variable compensation.

I get really nervous anytime I hear about advisory firms that have profit margins lower than 20%. Because even if your clients are reasonably balanced, show me a really nasty bear market that goes down 40%-something from top to bottom and your revenue is going to get clocked by solid 20%. It happens. And if you're running profit margins under 20%, when that bear market comes, you're going to have to fire people, because you don't have any flexibility. And even if you have some flexibility, that usually only goes so far. You can take away people's bonuses and profit-sharing plans and perks and the rest, but you really only get so long to do that. And if you're running it too tight and you take away too much of them, you might spread the pain so you don't have to fire anyone, but the firm up the street that ran healthier margins, that rebounds faster than you will recruit all your employees away the year after the bear market if you don't have enough room there to recover that quickly.

Ross: And that's absolutely true. And I will tell you, for us, we absolutely view the bear markets as turf grabs for us. Because we will pick up clients, there's more client churn in general, and we will pick up good staff. So in an environment like this where everyone's hiring and things like that, it's much more of a challenge to find people and grow. So I agree with you. And I think I don't think that people pay enough attention to the business aspect. And I will tell you, from my standpoint, again, when you think about a partnership that I have, I have really been fortunate because my...Wil is an internal guy, I'm more an external guy. I'm the big picture, Wil is the detail. And now we have a group of other shareholders who are looking at all of these things. And so we've been really fortunate to have I would say kind of a comprehensive view of the business as well coming at things from different angles rather than just everyone being similar and thinking the same things.

How Accredited's Ownership Is Structured And How They Value The Firm [1:12:25]

Michael: So speaking of this dynamic around succession planning, sharing equity, allowing other people to participate, having more shareholders, can you talk about how that works at Accredited? How do you decide who gets to participate in equity? Is equity given? Is it earned? Is it bought? How does it work for someone that wants to be a successor or shareholder in the firm?

Ross: Sure. Well, the way it works now, Wil and I are down to 30% ownership each, and our intent is over the next 10 years to be basically out of ownership. It doesn't necessarily mean we would be out of the business unless the shareholders at that point in time don't feel like we're creating enough value for the business. We have banking relationships, and so people are buying our shares, and they are using bank financing. And the way the bank financing is set up is that from the profit distributions, 35% of the distributions goes to the employee or the shareholder for taxes and 65% goes to the bank to pay down debt. The challenge around that is that anyone who says owning stock is in lieu of comp isn't...that's not the case. Because it will take...

Michael: Because they're not getting any of their comps. They're like, 35% goes to Uncle Sam and 65% goes to the bank. Now obviously, at some point, the loan gets paid off and then the 65% that went to the bank goes to you. But I'm presuming that's like seven odd years down the line.

Ross: Right. And then it also...they want to continue to buy stock. So that continues to prolong.

Michael: So when you're finally about to pay off your loan, you just take on another one.

Ross: Yeah, that's sort of the way.

Michael: Because you're kind of snowballing your equity bigger. Obviously, that gets good in the long run, but it doesn't pay the bills or put food on the table in the interim.

Ross: Right. And what's kind of interesting about that, I would say, and it's not necessarily a great thing, but when you think about, for example, Wil and I, when we were growing our firm, God, we went for a lot of years without taking much salary. We went seven years before we could say that if our wives weren't working, we wouldn't have had a business. Now, what's different about shareholders today is that they're getting market comp for the work that they're doing. But really the stock ownership, at least currently, is just a way for them to build their net worth. It's not necessarily building their cash flow.

We have a group that meets to...any shareholder can nominate another employee to become a shareholder. And that's considered on an annual basis. And then since Wil and I are selling roughly 6% of the stock of the company, meet with another...one of the shareholders who's not on the executive committee to determine how that's getting distributed to the rest of the existing shareholders, who gets to buy what. We have tranches, basically, for different levels of ownership, so where people can expect to reach a certain level of ownership over the course or their ownership unless they move into a different tranche. And those tranches are a little bit dependent upon functions in the firm. And it's decided by the other shareholders who's in what tranche. So I would say it's a relatively open process. Wil and I, it'll be interesting, Wil and I are reaching the point where we won't be majority shareholders anymore.

Michael: I guess two more years or so at the current pace?

Ross: Yep. And so we'll see what happens from that point. But again, I think that what we have done really well as an organization is we communicate really well with each other. And again, that hasn't always been the case, but we've learned. Whenever something goes wrong, it is such a great gift because you get to get so much better. And things that are painful in the short run always tend to be a benefit in the long run. And that's what's happened with us for many, many years and many times. It's not like things have been perfect for us.

Michael: So how do you value shares in this environment? Because I know just valuations for, well, for advisory firms, in general, is still widely debated, but in internal succession plans tends to be even more actively debated. So how do you handle the, I guess at least sometimes sticky issue of just how you're valuing shares as you do these transitions?

Ross: It's a multiple of the EBITDA. I've never understood the multiple of sales because EBITDA is so different for a firm. So we've done a multiple of EBITDA.

Michael: Okay. So that's what ensures the thing actually produces the cash to help cover the cost. When firms are reasonably profitable, multiples of revenue work okay because they just recreate multiples of EBITDA anyways. If your firm runs at a 25% or 30% profit margin and you sell it for 6 or 7 times, 7 or 8 times free cash flow, you will end out at 2 times revenue. Because 7 times 30% margins is 2.1 times gross revenue. So you can get back there, but that quickly falls apart. Then when you get back to firms we were saying earlier that don't necessarily run healthy profit margins, if other firms are selling for 6 to 8 times free cash flow but you're only running 15% margins, you're not going to get 2 times revenue, you're going to get 1 times revenue. And larger firms sometimes get bigger multiples, but it still only works if you've got healthy EBITDA in the first place.

Ross: Yep. And I think the other thing, and I would say, and this is really important, and again, this is where I've seen some firms kind of get messed up on their succession plan, the founders who are selling still have to have a vision for a future that they may not be part of, because otherwise, they won't be investing in the future of the firm. And so Wil and I place a huge value on the next generation being successful. And if they're not successful, and we don't...what's interesting Michael is that we're not personally guaranteed on the bank debt or anything like that. So that's an unusual. A lot of banks...

Michael: Because the buyers are putting their own guarantees in the line, I guess?

Ross: They are, but the buyers, in general, don't have the resources, don't have the collateral other than the stock to support it.

Michael: And so who's the bank you're working with that's willing to do this and structure these arrangements?

Ross: We have two local banks that we work with.

Michael: Okay. So you're not necessarily working with some of the big national firms that are trying to do all this M&A financing for advisory firms. Can I ask who the local banks are if I guess other advisors are curious?

Ross: In our market, we're using Tradition Bank and Minnesota Bank & Trust. And this was not a financeable transaction for US Bank. It wasn't financeable for Wells Fargo. It's interesting, they don't finance on cash flow. I'm in a group called Young Presidents' Organization. One of the people in my group has an $800 million company with $18 million of profits, and they can get any bank financing they want. And we have, not in gross dollar amount of profits, but from a margin standpoint, we have a much more profitable business, and those banks won't even look at us.

Michael: We've seen it as well. I think a lot of advisors have. It's part of why some of these niche players like Live Oak Bank have gotten traction in the advisor space. Because if you can't find that local bank that actually understands or is willing to understand advisory firms, you quickly get stuck in this realm where like, I have high-profit margin, wonderfully profitable advisory firm with clients who stick around for an average of 30 years, and you go to a bank and they're like, "Well, where's your collateral?" I'm like, "Well, I have Goodwill with clients who stick around for like 30 years." They're like, "Yeah, we don't really see that as hard collateral because we can't foreclose on it. So we're not lending you anything against your wildly profitable, incredibly sustainable, successful growth business." It's kind of fascinating to me in the current environment, but it's what's opened the door, again, I think for some banks to specifically come into this space and say, "We understand lending against sustainable cash flows."

So do...shareholders are buying and still have to come up with down payments? What do typical terms look like?

Ross: They don't have to come up with down payments. The terms are simply they get the 35% for taxes and the 65% goes to the bank.

Michael: Interesting. And how many years does that typically run?

Ross: It depends how long...what kind of profits...growth we have. So most likely, as you described it, we're looking at, depending on the kind of markets, anywhere between five to nine years.

Michael: Okay. Right. So it just depends how quickly the growth goes. So does the bank give them a fixed payment they have to cover and it just so happens a 65% distribution usually does it or do they literally just take like a variable percentage of EBITDA, whatever it happens to be, so if it grows faster, you have to pay the bank more, but you'll pay it off faster, and if you don't, the loan structures out?

Ross: Yep. No, it's the 65%-35% regardless of what those distributions are.

Michael: Oh, interesting. So you can't even...you can't grow faster to get free cash flow...to make your minimum bank payment and get free cash flow. If you grow faster, the bank just says, "Awesome, you'll pay off the debt faster," and then you'll get your full distributions.

Ross: Exactly. And one of the things that happens is there's always kind of this tension between how much stock they'll finance and how quickly the stock gets paid down. So remember that since every year 65% of the previous loans are essentially getting paid, 65% of the distributions are going to paying down loans, the amount of outstanding debt decreases each year, except new debt gets created through those purchases. And so the banks continue to get a little bit more on the hook every year.

Michael: And talk to us again of just how you decide who gets access to this. So it's a committee of the shareholders that decides who else is going to be introduced as a shareholder? Because I know you have had the history of bringing in a shareholder as a partner and then having them leave, which is challenging for any firm. So I guess I'm curious, what did you learn from the experience of having a partner come in and then leave that sort of drives now the way you decide who you're going to introduce as a new shareholder?

Ross: I think there's a few different things about that. And I think that one is, again, making sure that the shareholders share the values of the firm in the direction...and agree that the direction of the firm is a direction that they want to be going in. I think a second thing that we've done is we actually have changed our buy-sell. So liquidity is really created at a certain age so that we wouldn't have this situation where people could...if they wanted to leave, they could leave anytime and create liquidity. Because it was a challenge when founders are trying to sell their shares. If other people would leave for whatever reason, then the founders would end up not being able to sell their shares. So, we were trying to work through how that would work out. And so that's been a big change. I think the other thing that's...

Michael: Wait, wait. I want to make sure I understand what's going on there. So you kind of have the classic challenge like, you're founders, you're trying to sell, then a new shareholder leaves, so you have to buy them out, which then creates a problem for the founders because you now have to buy back the shares of the departing shareholder, when your whole goal was to sell shares, and they're like boomeranging back to you. So what have you structured now that avoids that?

Ross: Effectively, in our buy-sell, unless someone leaves for like disability or death, and I believe it's 50 or 55, before that, they essentially just get book value rather than share price.

Michael: Oh, interesting. So in essence, you have to stay to a certain age to get the full value of your shares.

Ross: And I think if you think about it, it was Wil's and my goal to create a vehicle for owners of the firm to create long-term wealth. It wasn't the objective to create kind of a short-term wealth.

Michael: Interesting. Yeah. So it's kind of a version of like an, I don't know, I was going to say like an option vesting schedule kind of thing. Obviously it's not literally that, but there is this dynamic, you have to stay to a certain age to get the full fair market value if you want to sell, otherwise, we'll give you some value when you exit, we'll let you recover what you put in with book value, but if you want the pop, you've got to stay to see it through.

Ross: Right. And if for some reason you're upside down on your loan, you don't have to...we take that over so that no one would have to come...yeah.

Michael: Okay. So you kind of give them a...the good and bad news of the put option at original purchase price is, if it's underwater, we'll eat it, but if it's up, you don't get the upside unless you stay to a certain age and stick it through. And that's just spelled out in the terms of the buy-sell agreement and the shareholder agreement in the first place.

Ross: Yes. Yep. Yeah.

Michael: Interesting. So from your end, I do have to ask, just how do you and Wil think about this dynamic of selling away equity of cash flows that you could have just kept and held onto? I know a lot of firm owners that have struggled with this, particularly with financing options like yours, where essentially the bank is 100% financing, that the buyers are getting access to the shares with no cash out of pocket of cash that you could have just kept and enjoyed those profits. And obviously, at some point down the road, you want to...you have to sell it, but you also would have harvested a lot of value in the meantime.

How Ross Thinks About Selling Shares In A Business He And His Partner Self-Financed (And Started From Scratch) [1:27:48]

How do you think through in your heads, particularly when you created as much wealth as you have by growing from 0 to $2 billion in the first place? How do you think about that dynamic and trade-off of transitioning shares to people, or I'll call selling shares to them, but selling shares to them that fully self-finance, when you could have just kept those economics yourself?

Ross: Yeah. It's an interesting question because I think that that's where a lot of founders get tripped up. And I think that the way Wil and I have thought about it, and I want to stress that this doesn't make Wil or me angels, because this is still a business transaction. We're getting paid fairly for our stock. We're getting paid less than if we'd sold it to private equity, but we're getting paid fairly for our stock. But what we really believe in our hearts is that we want a sustainable business. And a sustainable business is better for our clients. Long term it's better for ourselves because we might want to stay connected to the business, if we're allowed to, into our...I can't imagine retiring to play golf. And we want to create opportunities for that next generation to be able to reap some of the successes that we've had. It's unlikely that since Wil and I own so much of the company for so long, the company would have to grow at really high rates for a 3% shareholder to kind of benefit the way Wil and I did, but they could still have huge benefits from the company. And we just believe it in our hearts that that's the best thing for everyone involved.

And I don't know, again, against these counterfactuals, would people stay if they weren't owners? Probably. I think many would. I don't know that all would. But it just feels like it's the right thing to do. And you know what? I will tell you, I think that the next generation of owners, they're really thinking about what's it going to be like for the people behind them. I just think that that is just the...it's the personality of the firm. And people who don't have that personality don't last in this firm. They just don't. It won't work for them for a lot of different reasons.

Michael: It's part of that just the "we over me" team culture environment in the first place.

Ross: Yep, it really is. And again, I have to say it's recognizing how many different people contributed to the success, that no one person did this. This was a group effort from day one.

What Surprised Him Most About Building His Business [1:30:31]

Michael: So as you look back over the years, what's surprised you the most about trying to build your own advisory business?

Ross: That's an interesting question. I think there were a few different surprises. I think one surprise, how easy it was and how hard it was. And what I mean by that was that we didn't set out to grow a business like this. It happened through having great clients tell other clients about us. So that was easy. I think the hard part was all the little things that could bring us down that didn't, and some of the good fortune that we had. Gosh, we started the business in '87, that was a pretty good time to start an advisory business.

Michael: Yeah, just have a ginormous market crash in your first year.

Ross: Yeah. But once you survive that, it was fine. And I think that, as you have seen for your own career, Michael, there were...when I started, it was harder for you, I would say, you became prominent in a field that was way more crowded than when I was active in the field. Because it was a nascent, wealth management was sort of a nascent industry when I started in 1982. And in 1987, it still wasn't very big. So I got to be...create some notoriety when it was, I think, much easier to do so.

So I think the people stuff, I would say that all our mistakes and all our challenges have always been people challenges. It's never market challenges. It's hiring...either not hiring the right people, it's moving past the skillset of some people who were really good when the firm was smaller, but where we needed different skills when the firm grew, I think that that was hard, recognizing that some of our own skillsets have been moved past. I was really great for the firm 10 years ago. I think some of the things that I do are still beneficial, but gosh, it's a lot of other people do a lot more than what I'm capable of.

Michael: I think there's an interesting piece there that a lot of firms overlook as they grow, that just this dynamic, as the business grows and gets more complex, it really is possible that that person you hired for a role who's been fantastic at it and has just crushed at it for 3 or 5 or 10 years, can't do the job that needs to be done now, because the firm...the complexity of the firm grew beyond the original job that they took. And they...either just they haven't grown and developed with it, or the really hard part sometimes, they're just not up to the task of being able to learn to do the more complex role and the more complex business that exists today.

If there's one thing I probably see most often in firms that go through these kinds of growth cycles that you have of from zero, from just we're scrapping it out with our own two hands to being a multibillion-dollar firm, it's that either the firm outgrows the skillset of some very valued employees and they can't figure out how to work around that, and then eventually, the limitations of that employee become a limitation for the growth of the success of the entire business, or for some firms, it's the founder skillset that gets outgrown. Like, the things you need to get a firm from 0 to $100 million or even 0 to $1 billion is not necessarily the skills it takes to get you from $1 billion to $2 billion or $2 billion to $5 billion, or whatever you want to grow to from there, because you've got a different business with different kinds of complexity challenges. And firms outgrowing key employees or even founder abilities who can't then go hire the right people often becomes the thing that flattens a firm eventually.

Ross: Yeah. I think the other thing, and I don't know that this is a mistake, but I think a lot of firms might look to the outside as a way to solve their problems, as opposed to figuring out who's capable in the inside. So we went out and hired an outside COO a few years ago, and that was a disaster, a complete disaster for a whole bunch of different reasons. But one of the reasons was that we probably hired them, I don't know if we would necessarily say this, but we probably hired him to do the things that we didn't want to do. When you bring in an outside person, they don't understand the planning business, unless they come from another planning firm, which is unusual. And the planning business is really a client-centric business. And so sometimes the outside person is just looking at things quantitatively instead of qualitatively. And that was not going to work for us.

Michael: So that became your problem. They, I guess, no offense to the MBAs, but they MBA'ded [SP] a little too hard? "This quantitatively looks great in the business projection, so we're going to go ahead and do this." And from the client-centric perspective, you're screaming like, "No, no, we can't do that."

Ross: Yep, exactly right. And again, one of our challenges was, in order to create viability for the position, we had to cede a certain amount of control that turned out not to work. And now the way we're working... We've been using EOS Traction, you know that. And we love that. But anyway, what we have is we have internal people filling those roles. We've identified kind of who our successors are going to be. They know it. We're building out the skillsets. And it is just so much more comfortable, and it's so much better. So when we hire an outside person coming into the firm, it can be someone for like HR or a function that is more a supportive function rather than one that's calling shots that are going to affect clients in ways that may not be good.

Michael: Interesting. And so is that kind of your hiring philosophy now? Like, "Support functions, we'll hire externally, but future leadership positions, we're trying to groom them internally?"

Ross: Yes. Yeah. And that's, again, it could change. The next generation might say they want to do an acquisition. What we have to be comfortable with is that the next group of leaders will see and do things differently than us for good reasons. And you know what? They're going to make some mistakes that we made, and there'll be different mistakes. And it's all going to work out because they have a framework and a foundation that I think will encourage them to challenge the decisions that they've made and reverse course when they need to, which is how Wil and I have operated.

How Ross' Role In The Firm Has Changed Over The Years [1:38:10]

Michael: So can you talk about how your own role in the firm has changed over the years?

Ross: Sure. I think one of the things that hasn't changed and it's still, I would say, exist today is that I'm probably, I would say head of strategy and more of the big-picture person who's kind of thinking about what's going to happen 10 years from now rather than 10 minutes from now. I still have a significant client role. I still bring in a fair amount of new clients, mostly on... Just one of the things that happens is that you often...one of the challenges for a lot of financial planning firms in growing, and I don't know if this is still true, but it seems like it is, is that you tend to work with people who are in similar situations to your own.

Michael: Yep. Most advisors basically work with themselves plus or minus 10 years. Almost up and down the line, I find it's pretty consistent.

Ross: Okay. So if you look at me now, who's 60 years old, has been part of building a business, I'm in a financial position that I wasn't in 20 years ago. And so I'm in a group of people that are also in financial positions that make them good clients for the firm. So it's easier for me to bring in those kind of people sometimes than other people. And Wil's the same way. Wil, who for years wasn't really doing much on the business development side, is actually doing a lot in that area now. And it's, like I said, it's just kind of where we are in the lives that we live. So I'm still doing that.

I'm involved in a lot of outside things that benefit the company. For example, I was on the Presidential Search Committee for the new president at the University of Minnesota, which is kind of a high profile thing. I was chair of the foundation at the university. So I'm doing a lot of outside activities that raise the notoriety of the firm. And I still write regularly. I write for the "Star Tribune" twice a month, and I write for "Financial Advisor Magazine." I'm spending a lot of time, I think that I'm spending more time with the leaders of the firm, just talking to them about leadership. I'm trying to spend more time with the rest of the company talking about relationships, because that's what...everything for me is a relationship. And I really try not...I don't think I used the word "prospect" in our talk, because I kind of view people as people, and I don't want to make them an object, and a prospect becomes an object. So I'm trying to help in those ways.

And I think that most people would say that I create kind of a lightness to the firm. I don't get too stressed out. I've got a daily practice, which has really helped me with that, but I don't get too high or too low. And so we went through this thing where we were looking...we had at one of our study groups, there was an expert on knowledge transfer, and that expert was trying to ask us critical knowledge transfer, what the next generation needs from me. And I thought it was going to be about client stuff. And the two people who were there said, "We need basically your equanimity. How you can step back from the emotional stuff and just kind of say, 'Okay, this is really what the right thing to do is, or this is what the best thing to do is.'" And we should just do it irrespective of kind of what that might cost. And so we've got people now, I think, who think more like that, but that's I think something that I continue to add.

Michael: So what was the low point for you in this journey?

Ross: What was the low point? I think we had a few low points. I would say Wil and I took way longer to get a start than either of us thought.

Michael: You mean just getting clients going, getting revenue going?

Ross: Yeah, yeah. For us to make more money than our secretary did. I think that was a low point.

Michael: Out of curiosity, how long did that take?

Ross: I'm guessing, and again, it's hard to remember, but I'm guessing at least five to seven years. And again, if our wives weren't working, and neither of them had big jobs, but if our wives weren't doing well, we wouldn't have been able...I don't think we would have been able to do this. That's one low point.

Michael: And I think it's an important point for folks that are starting out and launching firms today that just you can look at a firm like yours that exists and say like, $2 billion under management and 50 employees. And we can all do more or less the revenue and valuation economics on the wealth that's been created and now it's going to successor generations who participate. And there's a lot of economic opportunity on that plate now. Then there's this kind of parenthetical like, "Oh, and by the way, for the first five years, we made less than our entry-level administrative staff." Five years of making less than your entry-level administrative staff. I think there's a powerful thing of just how hard it is for basically everyone in the early years to get going,

Ross: It was really hard losing partner. That was hard for a lot of different reasons. Again, there's a whole bunch of different stories about that, but one of the things that I realized, and it's a challenge for me, is that people are everything for me. And so, when something doesn't work out, if it's with a client or with a staff person or a partner, that has an impact on me, and it's one that is painful. It strengthens the business, but personally, it's a painful, painful thing. And then I think right now, Michael, I think the hardest part for me is being in the business as long as I have, we have a lot of deaths of our clients. And I can't tell you how sad that is. It's just these are people who basically we've helped them kind of live the life they want to live, and then...

Michael: And they lived the entire thing.

Ross: And they lived the entire thing. And I don't think that will ever be easy for me. And that we're just going to have more of it as I continue to age and they do.

Michael: So what advice would you give to young advisors that are getting started today? And I guess like, what do you know now you wish you knew 20 or 30 years ago as you and Wil were getting started.

Ross: I think we were fortunate in this one aspect, and this is what I really think is the most important thing, and that is Wil and I are very different people, but we've shared values of what matters. And I think advisors sometimes try to figure out what they want their business to be before they figure out who they want to be. I think that that's why so many advisors have successful businesses and kind of bankrupt lives. And so I would...that's the piece that I think that matters the most. Because then it's going to...you're going to have the greatest chance of building a practice that's going to be aligned with your values rather than having a practice that creates those values.

How Ross Defines Success [1:45:56]

Michael: So as we wrap up, this is a podcast about success. And one of the themes that always comes up is just even the word "success" means different things to different people. And so you built what certainly anyone would objectively call a very successful business with billions of dollars and dozens of employees. But how do you define success for yourself at this point?

Ross: Well, I think there's a lot of different ways. So in the business, I would say I really like the people I work with, and I really like my clients. And we've been able to contribute to them and in ways that are meaningful, and we've been able to contribute as a firm and individually to the community. So I think that that's really...I think we've had some impact.

I'm married to the same woman. I've got a good relationship with my two daughters, who are, like I said, 26. I have friends that are important to me. I kind of face every day with awe. I am appreciative of what's going on in my life, and I'm appreciative of so many people who have helped me in a lot of ways. Be it my study groups. I've had great study groups. People like you who contributes to the greater good. I feel really, really lucky to have been placed in a role where I've got to be with so many great people.

Michael: And I love just the way that gets then espoused in the culture and the values in the firm as well. That I think you kind of live your life with a "we is greater than me" mentality, and then that gets reflected in the firm, the culture, the way that you give other people equity opportunities. And it kind of has multiplied forward in some really cool ways to zeros.

Ross: Wow. Thank you very much. I really appreciate that. Thank you.

Michael: Oh, absolutely. Thank you for joining us on the "Financial Advisor Success" podcast.

Ross: Well, it was a lot of fun. Like I said, I'm honored that you asked me to do this.

Michael: Absolutely. Thank you.