Kitces.com - Advancing Knowledge in Financial Planning

Hiring Your First Employee: What You Need To Know To Cover Your Compliance Obligations

June 5, 2024 07:02 am 0 Comments CATEGORY: Regulation & Compliance

For the most part, solo advicers launching their first practice often have plenty of time and not a lot of revenue, which means they tend to take care of every aspect of the business themselves. As their practices grow and they start to serve more clients, though, advicers invariably reach a point where they simply don't have the time to do everything on their own and need to decide whether to make their first hire (or not!). If they want to continue to grow and increase their capacity, they'll need to make several important decisions and address a plethora of legal and compliance requirements not only to avoid potential legal issues but also to ensure that their business will continue to operate smoothly.

In this guest post, Jaqueline Hummel, an Independent Compliance Consultant and Director of Thought Leadership at SEC3 Compliance, discusses the initial decisions advicers must make when making their first hire, whether the person they're onboarding will need to register as an Investment Adviser Representative, and the regulatory issues that the newly minted employer may need to address.

Once an advicer chooses to push past their "capacity wall" and make their first hire, the initial step is determining what duties the employee will assume. For instance, if the advicer finds that they have more clients and prospects than they can handle, then they may need an assistant to help with administrative tasks. However, if growth has stalled, hiring (or partnering with) an IAR who can help attract new clients may make more sense.

From there, the next decision will be whether the new hire should be an employee or independent contractor. Notably, onboarding someone as an independent contractor who should actually be hired as an employee (because they work specific hours using company tools and resources, are paid an hourly wage or salary, dedicate their working hours solely to the firm, and receive benefits) can result in significant penalties, including back wages, tax arrears, and other fines.

The advicer must also decide whether their new hire will act as an IAR; in other words, will they provide advice regarding securities, manage client accounts, identify what advice should be given, sell the firm's advisory services, or supervise anyone who performs any of those duties? If so, they will typically need to register with their state regulator. From the firm level, there are several disclosures the advicer needs to make on various SEC forms (e.g., ADV Part 1A, Part 2B, and CRS). Importantly, Form ADV defines anyone who performs advisory functions on behalf of an advisory firm as "employees" – even IARs classified as independent contractors.

Finally, firm owners must determine how they'll supervise their new hire and whether they need to update their compliance manual. While there are multiple issues to consider, some of the higher-risk areas include maintaining client confidentiality, ensuring that marketing materials align with regulatory rules, limiting access to the firm's trading platform and the ability to move funds, securing certain firm documents, investigating the new hire's background, and identifying potential conflicts of interest.

Ultimately, transitioning from a solo-advicer to an employer responsible for hiring and supervising others is a big step that requires serious consideration. For advicers who want to serve more clients, adopting a systematic process can help ensure that the firm complies with all the various regulatory requirements. While doing so may seem daunting, the good news is that making that first hire can be a step towards expanding the advicer's capacity to grow their practice and serve more clients!

#FASuccess Ep 388: Transitioning To Independent RIA With Only $7M Of AUM To Turbocharge Growth With Website Local SEO, With Freeman Linde

June 4, 2024 07:02 am 0 Comments CATEGORY: Financial Advisor Success Podcast

Freeman Linde Podcast Featured Image FAS

Welcome everyone! Welcome to the 388th episode of the Financial Advisor Success Podcast!

My guest on today's podcast is Freeman Linde. Freeman is the Co-Founder of La Crosse Financial Planning, an RIA based in La Crosse, Wisconsin, that oversees nearly $50 million in assets under management (AUM) for 73 client households.

What's unique about Freeman, though, is how despite the conventional industry view that it takes $10s of millions of AUM to go independent, launched his own RIA with just $7M of AUM (and even that was split with a business partner), and found that the subsequent freedom to build their own SEO-optimized website to market themselves the way they wanted in their local community quickly grew the firm from there to $40M in under 4 years.

In this episode, we talk in-depth about how Freeman used a customized spreadsheet to analyze the financials that ended up favoring operating as an independent RIA rather than under a broker-dealer’s grid and platform fees (in particular the ability to boost long-term profitability by paying expenses as a flat cost rather than as a percentage of revenue), how Freeman’s transition to the RIA channel actually allowed him to raise his AUM fees while still providing clients with lower total costs than they had when he was with the broker-dealer, and how Freeman overcame the potential hurdles to going independent, including rebuilding his tech stack and managing his own compliance (in part by communicating directly with his state regulator).

We also talk about how Freeman has been able to turbocharge growth in his RIA, going from $7 million to now approaching $50 million in AUM in under 4 years, by using a local SEO strategy that emphasizes their status as one of the only fee-only fiduciary firms in their geographic area, why Freeman created 3 different websites targeted at the separate niche markets he and his 2 fellow advisors serve to maximize the SEO value of each one, and how Freeman converts prospects into clients using a structured discovery meeting process that includes giving prospects planning recommendations that they could implement themselves regardless of whether or not they become a client.

And be certain to listen to the end, where Freeman shares how he has attracted clients and won their loyalty by expanding his comprehensive suite of services including in-house tax return preparation (by becoming an Enrolled Agent) and outsourced estate document services using EncorEstate, how Freeman feels that operating as an RIA has allowed him to build a more sustainable business by focusing on existing client relationships with recurring revenue rather than product sales that always kept him on the hunt for the next new client, and why Freeman hopes that more newer advisors will be able to get their start learning firm operations and how to serve clients within a fee-only firm rather than starting out in a product sales role and moving to an RIA later.

So whether you are interested in learning why Freeman chose to operate as an independent RIA over remaining under a broker-dealer, how Freeman used local SEO strategy to turbocharge firm growth, or how expanding services to include in-house tax preparation and outsourced estate planning helped him attract and retain clients, then we hope you enjoy this episode of the Financial Advisor Success podcast with Freeman Linde.

The Latest In Financial #AdvisorTech (June 2024)

June 3, 2024 07:02 am 0 Comments CATEGORY: Technology & Advisor FinTech

Welcome to the June 2024 issue of the Latest News in Financial #AdvisorTech – where we look at the big news, announcements, and underlying trends and developments that are emerging in the world of technology solutions for financial advisors!

This month's edition kicks off with the news that 'startup' custodian Altruist has completed a $169 million fundraising round as it continues to rebuild the RIA custodial tech stack layer-by-layer while positioning itself as the biggest RIA custodian built from scratch and solely for advisors – which, while making it the clear #3 custodian behind Charles Schwab and Fidelity, leaves open the question of whether it can grow large enough to challenge the dominant position of the 'Big 2', which are able to leverage their massive retail operations not only for economies of scale but also to create a large pool of potential clients for RIAs to convert or be referred to (making it a less attractive proposition to switch to a custodian that by definition has no retail client base)

From there, the latest highlights also feature a number of other interesting advisor technology announcements, including:

Communications archiving solution Archive Intel has recently raised $1M in startup capital, as it builds a tool that reflects clients' changing communication preferences by including messaging apps like iMessage and (in the near future) WhatsApp – which raises the question of how long compliance archiving solutions can keep up with an ever-growing number of communications channels before they become more expensive than is worth it for advisors to keep communicating via their clients' preferred medium
Financial planning software platform RightCapital has introduced its own built-in risk tolerance assessment tool, RightRisk, allowing users to embed risk tolerance conversations directly within the financial planning process (and for many, possibly eliminating the need for a standalone risk assessment tool)
Couplr, a white-labeled software tool for creating data-based matches between prospects and advisors, has announced a partnership with the American College of Financial Services – which, while addressing a potential opportunity for better matches than existing lead generation platforms based on clients' unique needs, raises questions about how big of a market there is for Couplr's services given that most firms' main challenge is simply bringing in prospects at all, not just 'good' prospects

Read the analysis about these announcements in this month’s column, and a discussion of more trends in advisor technology, including:

XY Planning Network has announced that applications are open for its annual AdviceTech Competition, which showcases emerging advisor-facing technology for XYPN's network of planning-centric advisors without the high costs of a traditional exhibitor booth (while also giving potential investors a look at early-stage companies that could fuel the future growth and innovation of the AdvisorTech space)
While the initial wave of hype surrounding AI tools has cooled off amid recognition of their inherent limitations, the potential for AI-based meeting notes tools to eliminate hundreds of hours of advisor work around meeting preparation and follow-up has spawned numerous solutions competing for advisors' business – raising the question of how to actually choose between them when new solutions are popping up continuously and the pace of development is such that today's inferior option might be next year's category leader?

And be certain to read to the end, where we have provided an update to our popular “Financial AdvisorTech Solutions Map” (and also added the changes to our AdvisorTech Directory) as well!

*And for #AdvisorTech companies who want to submit their tech announcements for consideration in future issues, please submit to [email protected]!

Weekend Reading For Financial Planners (June 1-2)

May 31, 2024 01:15 pm 0 Comments CATEGORY: Weekend Reading

Enjoy the current installment of “Weekend Reading For Financial Planners” - this week’s edition kicks off with the news that the Financial Planning Association and Money.com are planning to publish a “Best Financial Advisors” list based on advisors’ education, credentials, and experience, as well as harder-to-quantify areas such as trust factors and client communication. Going beyond FPA’s existing PlannerSearch tool, the narrowed-down list is meant to help consumers identify a focused subset of the most reputable planners. Though given that the list will be limited to FPA members who complete a detailed questionnaire, it might not be a truly comprehensive list of the ‘best’ planners… and even more impactfully, could upset current FPA members who pay their dues like every other member but are told they’re “not good enough” to be recognized by their own membership association as one of the “best” to Money.com’s millions of consumers?

Also in industry news this week:

Legislation that has passed through the U.S. House of Representatives and is now being considered in the Senate would increase the number of firms classified as “small entities” and would require the SEC to assess the impact of proposed regulation on this newly enlarged class of investment advisers (which tend to have fewer compliance staff and resources available compared to larger firms)
A recent study indicates that many retirees, particularly those that engage in a “partial retirement”, experience spending volatility at a time when sequence of return risk is the most threatening

From there, we have several articles on tax planning:

The IRS released its annual “Dirty Dozen” list of tax scams, many of which target wealthy individuals, including abuses of certain trusts, monetized installment sales, and improperly valued art donations
How advisors can help clients avoid falling prey to tax scams, from encouraging good cyber hygiene to serving as a second opinion on questionable tax strategies that have been pitched to the client
How advisors can support clients in evaluating the qualitative and quantitative consequences of engaging in geographic arbitrage to reduce their state income tax bills

We also have a number of articles on clients going through a divorce:

How advisors can add value for clients going through the divorce process, from offering an empathetic ear to analyzing the impact of a proposed division of assets
The unique challenges (and rising incidence) of “gray divorce” and the key planning topics for advisors and their clients in this situation to address
The ethical considerations for financial advisors when client couples are going through a divorce

We wrap up with three final articles, all about career satisfaction:

How the concept of the “hedonic treadmill” can help explain why reaching professional goals often leads to fleeting satisfaction, and the alternative practices that can lead to enduring happiness
Why letting go of the “pursuit of happiness” might be more likely to lead to greater contentment than trying to cross off as many items as possible from a ‘to-do’ list
3 mindset shifts that can help advisors find satisfaction from their (incremental) professional accomplishments

Enjoy the ‘light’ reading!

Kitces & Carl Ep 139: When Have You Done ‘Enough’ For Clients (And How Do You Know)

May 30, 2024 07:02 am 0 Comments CATEGORY: Kitces & Carl Podcast

Kitces & Carl Ep When Have You Done 'Enough' For Clients (And How Do You Know)

Over the past couple of decades, the financial advice industry has seen a tremendous shift as the focus has evolved away from being primarily transaction-based and towards forming long-term service-based relationships with clients. Yet, one of the hurdles advicers have faced along the way is figuring out how to demonstrate the seemingly intangible value of financial planning as a service. The good news is that the profession has been blessed with an ever-expanding supply of credentials and software solutions to give advicers the tools and opportunities to expand their expertise and create deliverables to demonstrate their value. However, since advicers tend to be service-oriented and enjoy helping their clients in as many ways as possible, the challenge is that there can be a tendency to always do more for clients. Which begs the question: Is there a point at which advicers might be doing too much where they should stop pressing so hard to expand their service menu and even cut back on some items on their client service calendar?

In our 139th episode of Kitces & Carl, Michael Kitces and client communication expert Carl Richards explore ways for advicers who may feel like they are doing too much for their clients to identify the service offerings they can eliminate, implement strategies for phasing out superfluous services, and think about how their own personal learning journeys fit with their visions for their business.

One challenge that advicers may face when figuring out what they can remove from their service calendars is that it's nearly impossible to get all clients to agree that a certain offering is unnecessary. As while most clients would be perfectly happy without certain services, all it takes is for 1 or 2 to say they want to keep them for advicers to feel obliged to continue delivering them, even if eliminating them might create better efficiencies within the practice or help the advicer achieve a better work-life balance.

One workaround advicers can try is to simply stop doing a 'thing' (e.g., quarterly performance reports) and see if anyone notices... and if they do, it's perfectly okay for the intrepid advicer to say it was simply an oversight. Meanwhile, an even more effective (and data-driven 💙) approach would be sending clients a survey asking them to rate the perceived value of all the services they're receiving. From there, the advicer can jettison the lowest-ranking offering, knowing that the odds of a client moving on in response would be relatively low… and even if they were to leave, then maybe the advicer would get the added benefit of realizing that the client wasn't a good fit after all!

Meanwhile, for advicers on their own learning journey, it's important to note that just because they learn something new doesn't mean they have to bring it into their business. Instead, advicers can (and probably should) stop adding to their business as soon as what they're charging aligns with the value they're delivering. And if, along the way, they find something they do want to add, they can always find a lower-value offering for the new thing to replace.

Ultimately, the key point is that, just as clients can experience 'lifestyle creep' as their earnings increase, so too can advicers experience 'service creep' as their businesses grow… especially since many advicers are hard-wired learners and helpers. The key is understanding that it's okay for advicers to stop stacking on additional services even as they continue to expand their knowledge and expertise. And if there's a question around whether or not they're doing enough, advicers can take stock and observe whether they're getting referrals and if their attrition rates are higher than normal. In the end, the odds are that they'll find they are, indeed, enough!

Why “Deferred Sales Trusts” Can Be A Risky Way To Defer Taxes On A Business Sale

May 29, 2024 07:02 am 0 Comments CATEGORY: Taxes

Small business owners often treat their businesses not only as their source of income during their working years, but also as an asset that can be sold to fund their retirement. And while many businesses can build up substantial value over the years, the downside is that, when that value is realized upon the sale of the business, a large amount of it is treated as taxable income. And for many business sales that create capital gains of more than $500,000, the one-time spike in taxable income created by selling a business can bump the seller into a higher income tax bracket, requiring them to forfeit a significant chunk of their funds needed for retirement to pay their own tax bill on the sale.

One way to reduce the tax impact of selling a small business is by using an installment sale. Under IRC Sec. 453, capital gains on the sale of assets, such as privately held businesses where the payments are spread out over a period of 2 or more years, are deferred until the years when the payments are actually received. Which not only defers the taxes owed on the sale to future years, but can also reduce the absolute amount of tax on the sale by spreading out the tax impact over multiple years and keeping the seller within the lower capital gains tax brackets.

The downside to installment sales, however, is that, being essentially a loan from the seller to the buyer of the business, the seller takes on the risk that the buyer may ultimately be unable to make their payments as required by the installment note. Additionally, it can sometimes be difficult for a business seller to even find a buyer who is willing to agree with them on the terms of an installment note. And furthermore, because an installment sale involves one or more payments being deferred until future years, the seller can't use or invest any of the sales proceeds until they're actually received.

One purported solution to the issues with installment sales that has been promoted by a group of accountants, attorneys, and financial advisors is known as a Deferred Sales Trust (DST), which works by using a third-party (the trust itself) to buy a business or other asset from the seller under an installment agreement, rather than selling directly to the ultimate buyer. The trust then sells the asset to the buyer in a lump-sum transaction and invests the proceeds to pay back the seller under the terms of the installment agreement. As the sales pitch goes, this allows the seller to benefit from installment sale treatment, while eliminating the credit risk of selling to a buyer and giving them at least some ability to choose how the proceeds are invested even before they actually receive them.

However, closer scrutiny of the DST strategy raises significant red flags that aren't included in the sales pitch. For one thing, details of the strategy are kept closely under wraps by the group that promotes and sells DSTs, limiting advisors' ability to vet the DST's legitimacy. Additionally, although DST promoters tout the strategy's ability to eliminate the credit risk of entering an installment agreement directly with a buyer, in reality, the risk is simply shifted to the trust itself: Because the seller cannot be the owner, trustee, or beneficiary of the DST (because doing so would cause the transaction to lose its installment treatment), they are wholly reliant on the trust to be able to make its required installment payments. Meaning that, for example, if the DST trustee mismanaged the sales proceeds and caused them to default on the installment loan, the seller would have no recourse to recover those funds. (While at the same time, any extra funds that are left over after the note is fully paid off go to the DST trustee, not the business seller – a true 'heads I win, tails you lose' proposition.)

In other words, the characteristic that is needed to make DSTs work from a tax perspective – the ceding of all control over the sales proceeds to a third-party trustee – can make them even more risky than a traditional 2-party installment sale. Which is why instead, sellers of small businesses may want to consider other strategies such as structured installment sales (in which the installment note is funded by a large insurance company that has significantly more assets with which to pay off the loan), entering into the installment agreement directly with the buyer, or even simply selling as a lump-sum and taking the entire tax hit in 1 year – which, while being possibly less favorable from a tax perspective, at least ensures that the seller receives all of the sales proceeds to begin with!