Many insurance agents and financial planners get to a point in their careers where they need a new challenge. Because of their numerous years of experience in the financial services industry, they believe they want to and can actively manage their clients' money. When they call me to assist with creating their registered investment advisor, I make sure they can answer these seven critical questions, because the answers will make or break their new business.
1. Do I want to be a business owner and am I driven to build a business?
Perhaps this is the most fundamental question that needs to be answered, because it takes a lot of work to run a successful business, let alone an RIA. However, most individuals that are faced with this decision have already run a successful business, such as an insurance agency or branch office of a broker/dealer. This experience will be valuable as they set up their new firm.
2. How much money under management do I anticipate having within the first year?
This question should be asked early in the decision process, because if there isn't a large enough book of business to manage, there's no point in setting up an RIA. More importantly, it will help answer the next question.
3. Will my book of business generate enough fees to pay for the added expenses?
The prospective owner must sit down with pen and paper and make a list of expected expenses. At a minimum, the list should include RIA-specific expenses such as errors and omissions insurance coverage, billing software, compliance system creation, performance reporting software (if desired), disaster recovery system and record keeping systems. The list should also include traditional business expenses such as rent, telephone and computers, to name a few. At the end of the first year, the generated fees and expenses should break even or come close to that point. If they do not reach the break-even point after 12 months, there are not enough assets to make the move profitable, and the prospective owner should concentrate on securing more clients before starting an RIA.
4. Do I want to and do I know how to manage money?
Most people in the financial services industry have some money management skills, otherwise they would not be in this business. However, actively managing money can be a very time-consuming and stressful task. Money managers need to constantly monitor and adjust their portfolios to the regular fluctuations of the markets. While some individuals may thrive on these duties, others may not want the burden. With the constant monitoring, it can be difficult to continue gathering the new assets required to keep the new business growing. Still, those who do not want to actively manage money but still want their own RIA have the option of outsourcing the money management. The prospective RIA owner should take time to reflect on what level of involvement they wish to have in this aspect of the business before opening the firm.
5. What services do I want to provide my clients, and how are those best delivered?
Typically, one reason a new RIA owner starts his firm is to fill a perceived gap in his service, such as the ability to charge a planning fee or charge a fee for assets under management. It is important to identify what new client services will be provided, how to best deliver those services, and whether they can be delivered at a reasonable price to the client. This is usually done through a custodian and a good custodian, can make or break a start up RIA.
With the recent growth of RIAs, many custodians have designed new platforms with powerful trading software and back office support systems. But, a poor custodial can strain startups through poor pricing structures, weak back office support, or labor intensive trading platforms. Proper due diligence should be conducted on various custodians and the services they provide to make sure they benefit the new firm and its clients.
6. Do I want to be in charge of my own compliance responsibilities?
This is a critical question that must be affirmatively answered by anyone wanting to open a RIA. An RIA owner must be willing to put time, money and resources into their compliance department as the business grows. Opening an RIA guarantees that a regulator will walk through the front door to examine the firm within the first one to three years. Thus, proper set up and administration of a compliance department is critical to the long-term success of the business.
7. How comfortable am I disclosing all of my conflicts of interest?
A registered investment advisor has a fiduciary duty to its clients. All boiled down, this means the RIA must put the clients' interests ahead of its own, and disclose all conflicts of interest. For some, this is not easy. For all, it is not only necessary, it is required. When conflicts are properly disclosed, they can eliminate potential client and regulatory headaches.
The formation of a registered investment advisor is the most important time of its existence. Mistakes are often made because of poor planning and decision making. To avoid these mistakes, the owners must ask and answer several important questions that hold the keys to the long-term success of the new firm. If a prospective owner can answer these seven critical questions and feel good about the answers, it might be time to look into opening a registered investment advisor.
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