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Inquiring Minds Want to Know About Transition Money

Inquiring Minds Want to Know About Transition Money

00:00 01 August in Articles Written by Jon Henschen

by Jonathan Henschen, CFS and featured in Broker Dealer Journal
August, 2006:

A common question I get from the heads of broker/dealers is: “What do you see broker/dealers offering for transition help?”  I’m going to avoid interjecting too much personal opinion in this area, although I will say that going to a broker/dealer just looking for a forgivable loan is simply the wrong reason. Here’s a breakdown on what trends we see in the independent broker/dealer channel for helping out with transition expenses.

Reps are on their own for transfer expenses

At one time, if reps wanted to join a firm, they had to cover their own expenses including registration costs, business cards, stationary and transfer fees. Many firms still take that position, but the trend among broker/dealers is evolving to” “We need to offer something to compete.”

[frame]Offer 2% – 3% of trailing 12-months production to cover expenses[/frame]

This seems to be the most common and reasonable option in the independent broker/dealer marketplace. Money is offered at the time of placement with no strings attached. Some firms pay transfer fees separate from the 2% – 3%, especially if numerous ACAT transfer fees are involved, and the advisors are large producers. This option is increasing because it is reasonable for independent broker/dealers profit spreads, and this amount covers most advisors’ expenses.

Accelerated payouts

A less common option is to offer 100% payout from 3 months to as long as a year. Broker/dealer motives here are for reps to re-coup their transition expenses through the additional payouts. Some firms offer combinations of loans up to 5% along with accelerated payouts. When firms are transferring bank or wirehouse advisors, the advisors’ ability to transfer their books can be questionable. For these reasons, opting for accelerated payouts makes more sense than any form of upfront money, which requires first-year production to be maintained at certain levels. The trend here is that even though it makes sense for both sides, reps seem to prefer receiving money at the time of placement or a combination of upfront money and accelerated payouts.

Loans Paid Back via Less Payout

Large capital outlays are often required for Advisors going from warehouses to independent firms. Besides numerous ACAT fees, firms also have capital outlays for computers, software, new office space and furniture. Adding further complications to some transitions are forgivable loans owed by reps to their old firms. Some firms seem open to offering loans up to 20% of trailing 12 months production. In return, advisors payouts will be dropped by 5% -10% or enough that the payback time is within 2-3 years. Trends for this type of loan have increased slightly, but for most firms it is something they deal with on an as-needed basis, and as a last resort.

[frame]Forgivable Loans 5% – 10% of trailing 12 months production[/frame]

Of the forms of forgivable loans being offered, this has been the most popular. The advisor’s commitment time is usually 3 years, with the advisor required to maintain production at 60% – 80% of the loan amount. A surprisingly large number of firms have been offering loans in that range over the past couple of years, and we can see this trend continuing.
[frame]Forgivable loans 10% – 30% of trailing 12 months production[/frame]

At this point, most broker/dealers are scratching their heads in bewilderment. How can you pay this much to a rep and still make money in an independent environment? The few firms offering loans in this range will typically argue:

We can buy a broker/dealer and pay 30% – 40%, or we can approach producers and producer groups and pay 10% – 30%!

The counter argument will be:
When you buy a broker/dealer, you get bricks and mortar and personnel.

The counter argument to that is:
We already have bricks and mortar and staff, what we want are  advisors and assets!

If any area brings emotions to the surface with broker/dealers, this seems to be it. Many firms tell me on a regular basis that they are looking to acquire broker/dealers, but when it comes to offering forgivable money to reps to come aboard, forget it!

With larger loans also comes greater commitment. Loan periods are usually 5-6 years, with advisors required to maintain 60% – 100% of the production upon which those loans are based. If production drops below the predetermined benchmark, the broker/dealer can do any of the following:

  • Extend the loan period
  • Charge interest on the loan
  • Call the note and request repayment of the balance owed

There’s No Free Lunch!

As a famous economist was once remarked, “There’s no free lunch.” The initial greed of such offers can often blind a rep’s perception. So we normally suggest that advisors think through making commitments like that.  To prevent unforeseen nightmares, they should be asking questions like: “What if I become seriously ill in the next 6 years and my ability to produce is hindered?” That often brings them back down to earth fast enough.

As a lover of freedom, I’m a firm believer in being beholden to no one. We’ve seen too many cases over the years where self-confident advisors took large loans from willing broker/dealers, only to realize soon enough that the broker/dealer’s story and cold reality were nowhere close. Those advisors were invariably miserable: wanting out, but still facing another four years on a forgivable loan.

Not surprisingly, their production dropped soon after the transfer, and they ended up spending much of the loan money. The result? They were trapped in a situation that a bit of forethought might well have prevented.