Op-Ed: Is that all there is?

by John Nicola, Chairman, CEO and CIO, Nicola Wealth

Is that all there is, Is that all there is?
If that's all there is my friends
Then let's keep dancing
Let's break out the booze and have a ball
If that's all there is 

• Jerry Liebman and Mike Stoller, Sung by Peggy Lee

As financial advisors approach the end of their careers, they could easily be forgiven for expressing the sentiments made famous by Peggy Lee. After spending 30-40 years building their business, only to find that it is, at best, a practice and not a business, designed typically around one advisor and with little in the way of exit or transition planning.

This is a hypothetical story about two advisors in their late fifties and early sixties who have the same issue regarding the next chapter in their professional careers. They have been good friends for more than twenty years, and even though they work at different firms, they now find themselves with more questions than answers.

Meet Tony Wallace and Michelle Lee. Usually, they find time to meet for lunch or coffee once every couple of weeks to catch up on family, friends, successes and failures at work, and life in general.

By way of background, Michelle is licensed as a portfolio manager with an independent CIRO registered firm and currently has a book of $350M AUM and 250 families. After expenses and her share of the grid, she nets just over $1M per year in revenue.

Tony works with an independent financial advisory firm. While his client AUM is less than Michelle’s at $250M, he is quite skilled with respect to estate planning and thus earns considerable additional revenue from life insurance policies. In most years, Tony and Michelle’s incomes are similar.

Today they met for coffee at their favourite cappuccino bar, – Barista’s. After their usual pleasantries and family updates, they get to the heart of their biggest career and business challenge.

Michelle: Tony, I have been approached by one of Canada’s biggest banks to join their private client group. I am seriously considering it. They are offering a forgivable loan over five years for two million dollars and I would still own my book of clients. I’m 58 now, and that takes me to 63. If I retired, then I should still be able to find a buyer for my client base. What do you think?”

Tony: At the risk of being the nattering nabob of negativity, let me suggest that there could be a number of reasons for why this might not be the great deal it appears to be. First, let’s look at the loan offer. The two million dollars is forgivable over five years. That works out to $400,000 per year. However, I have looked at the details of these loans, and there are a few important factors:

• You must declare a taxable benefit equal to the prescribed rate from CRA it averages 6% over the next five years; that is $373,000 of taxable income to you.
• The principal forgiven each year is also taxable, so that will be two million dollars over five years.
• The tax in Ontario on both of these is over $1,280,000 over five years or 64% of the loan you received up front.

Here are some other questions to ask the bank:

• What other asset classes are they offering besides those available in public markets?
• What analysis tools do they offer to allow you to provide financial planning or insurance analysis for your clients?
• Can you retain your staff?
• When you decide to retire, are they offering a buyout of your book? If so, what would the terms look like?

It seems to me that if either of us take offers like this from banks or other CIRO firms, we will still be operating as silos.

Michelle: I see what you’re getting at. I was reading recently about firms that are mainly private investment counsellors (PICs) that offer a much different model. Their focus is team-based versus individual advisors operating as silos. I saw an article about one of them recently. Let me see if I can find it. (After a few minutes) Yes, here it is, Tony. Here is how their model works:

• Clients are owned by the firm, and if you join them with a book of business, such as ours, you exchange your book for shares in the PIC. When the transaction is done, there is no upfront tax to pay at all. When you sell the shares, they will be taxed as a capital gain, not as income.
• Compensation is based on advisor income paid as either salary bonus or as a percentage of revenue generated.
• In addition, you would receive dividends on your shares. If your book for share exchange was done at five million dollars, and the expected dividend was 4%, then you would earn $200,000 in dividends, which would then be taxed at preferential rates.
• Typically, these firms are owned by a combination of advisors, management, and staff.
• They offer pools or segregated accounts managed both internally and with external sub-managers.
• Some of them offer alternative investment options such as private credit, mortgage pools, private equity, venture capital and real estate. When this is the case, they typically recommend an asset allocation model that closely resembles what one would find with successful pension plans or endowments such as Teachers, OMERS, BCI, CPP, and Yale.
• A few of these firms offer in-depth, sophisticated levels of estate and financial planning along with insurance solutions.
• Over time, you can increase your equity in the company through a combination of share price increases or acquiring additional shares using both options and cash.

Tony: What happens when you decide to retire?

Michellle: You can sell your shares back to the company or other shareholders. Usually, these groups are private. They will often get an annual valuation done by an outside firm, and then shares are bought and sold at that level until the next valuation. Before that happens, you would have transitioned your client base to other younger advisors. You might even decide that you want to have the option of looking after a smaller client base on a part-time basis.

Tony: Okay, let me see if I understand this model:

• You exchange your book of business for equity in a larger enterprise that now owns all the clients. At the time of the exchange, there is no tax to pay.
• You are entitled to your share of the profits on those shares through dividends.
• At retirement you can “sell” your shares back to the company or other shareholders for cash. That sale will be taxed as a capital gain as opposed to ordinary income.
• The advisor has access to both traditional asset classes and private capital in many cases.
• Many, but not all, have built a robust platform for financial, estate planning and insurance.

I have to say this sounds much more attractive for my clients and me than taking a forgivable loan and continuing to operate as a silo.

Michelle: I agree, Tony. How about we speak to some of these groups about their model and see if it is a better fit for both of us.