How Business Owners Should Pay for Advice
The dominant fee model in the financial advisor industry does not work for business owners.
Here's why. When times are good, business owners are likely to have excess cash in their companies and can therefore ask the question: should I distribute some of that cash to myself and do something else with the money?
But before we even talk about distributions it's important that business owners re-assess their business plans and ensure their companies are adequately capitalized. Excess business cash could be used to:
1. Fund organic growth via new projects, R&D, more marketing resources, etc.
2. Buy another company
3. Create a new partnership by investing in another business (via joint venture or minority ownership stake)
4. Pay off business debt
5. Leave cash in the business in anticipation of doing 1,2, or 3 in the near future (setting aside asset protection considerations for a moment)
At this point all we've done is assess the business. Yet we've already come up with five things the owner might do before thinking about distributing cash to themselves.
Let's say the owner is satisfied the company is adequately capitalized for current and future needs, and there is still excess cash available. Now we can start to think about how the owner might size the distribution and what they might do with the money. For example (in no particular order):
6. Create a personal reserve account (usually bank account or brokerage account) to ensure adequate liquidity for future business or personal needs
7. Pay off personal debt
8. Buy investment real estate
9. Buy personal-use real estate (residence, vacation home, etc.)
10. Fund private investments
11. Fund cash value life insurance policies (or other tax-deferred assets - yes, in certain circumstances, when structured appropriately, some life and annuity products can make sense)
12. Make gifts to family members or charities
13. Fund investments in a brokerage account
Here we've identified at least a dozen options that the business owner could consider before they take a distribution from their business and drop it into a brokerage account. Yet the "financial advisor" industry (which continues to proclaim "FEE ONLY" as if that solves any conflict-of-interest issues and there's nothing else to think about) is highly incentivized to encourage the business owner to select #13. Under the Asset-Under-Management (AUM) fee model (e.g. 1% of $1M of investment assets), the advisor is paid more if the business owner selects #13, but nothing for #1-12.
AUM fees are fine when the only (or perhaps even primary) service is managing traditional investments in brokerage accounts and IRAs. But let's acknowledge that the AUM fee model is a terrific business model for the advisor (revenues naturally increase faster than GDP over time, all else equal; no working capital; most clients don't pay attention because they don't make the fee payment themselves) that is NOT well suited to giving business owners advice on a broad range of financial issues and challenges.
The alternative is a fixed fee based on complexity. We think it's the best way for business owners to pay for advice. It may not be the perfect model, but we think fixed fee is the best method available for aligning objective advice with financial compensation.
Yes, registered advisors are held to a fiduciary standard - which guarantees nothing. Incentives always matter. Follow the money.