Top 3 things young advisors get wrong about RIA equity

When I became a partner at my employee-owned RIA in 2015, I was 30 years old, had been married for all of six weeks and was looking to buy a home. Which means that, like many younger financial advisors on the partnership track, I was contemplating a significant monetary investment at the same time as I was pursuing other major financial goals. 

I'm embarrassed to admit that back then I didn't fully understand what the heck I was doing. Why did I need to "buy in" to the RIA — and what exactly was I buying? How did the economics of the purchase truly work? After all, didn't I steer my clients away from concentrated investments? 

The truth is that even though we're CFP professionals, most of us haven't been taught how to accurately assess the risks and rewards of investing in a well-run, growth-minded RIA. Yet after analyzing the financials backward and forward I took a deep breath, a bit of a leap of faith and became a partner. 

Nine years later, I like to think that I'm a little bit wiser about how partnership programs work and why.

Here are the top three misunderstandings I encounter when I advise the next generation of future RIA owners.

Partnership is just an expense

Partnership is a wealth-building opportunity. Let me say that again for those in the back: Becoming a partner means you are buying an appreciating asset because you are literally buying a piece of that firm. This typically involves putting some money down — commonly 25% to 30% of equity being purchased — and financing the rest through a bank, the company or by using seller financing. 

READ MORE: How to compensate partners to keep your firm on track

Because you have invested in an asset using leverage, you must now make loan payments on the debt you have incurred. But because you are now an owner of an asset, you get profit distributions to help offset that debt. And while you need to make sure you can service that debt in a variety of profit environments, that debt does not last forever. If your firm is growing, the value of your ownership will go up, and the distributions associated with that ownership will also go up. When your loan is paid off — or given sufficient growth, even before payoff — you'll have a second income stream. 

So, likening a partnership loan payment to an auto loan payment misses the mark — you are comparing apples (appreciating asset) and oranges (depreciating asset).

Partners need you more than you need them

Most founders and majority shareholders I've met with are quite happy to hold onto their ownership of the firm. They are getting handsome profit distributions from a high cash flow business that gets a growth kicker of market appreciation on top of any organic growth. 

In the process, they are able to hold on to more control of the business. For partners who risk foregoing the guaranteed salary that starting your own firm naturally entails at the start — and have a bit of luck along the way — it's a good gig.

READ MORE: More RIA buyers are offering equity. Here's what sellers should know

Also keep in mind that the private equity and banking sectors have taken note of the lucrative RIA industry and are hungry for their piece given its high client retention, strong cash flows and ability to scale. They are willing to pay a premium, and since they entered the game have pushed valuation multiples up higher and higher. There is also demand from other RIAs and aggregators, making the marketplace very competitive.

So why do RIA owners sell internally, when they could theoretically get nearly double the price for their shares if they went to market? 

Simply put, by selling internally an owner bets that expanding the equity table will help make the company more successful. To paraphrase one of my co-founders, they are willing to sell some amount of ownership internally over time so that the company can thrive. 

This means clients can be well taken care of by employees with a long-term interest in their RIA, that those owners can grow their own personal net worths and, of course, that the firm can remain independent as its advisors mint future millionaires. Other reasons include maintaining the culture, attracting and retaining top talent and broadening the company's impact.

READ MORE: Looking for capital? 5 key sources for RIAs

Partnership is just about the money

After a few years at my current firm I thought about striking out on my own. After conversations with our co-founders, others in the industry and after some soul searching, I decided to stay put. Here's why:

•  I knew that I would get to own a piece of the company in the next few years. 
• If I struck out on my own, I would try to build a company just like my current one, a feat that would entail doing work that I didn't want to do as opposed to serving clients.
• I loved my colleagues and clients.
• Starting a company from scratch means you also have no salary. At that point in my career a guaranteed salary with growth potential, added to future equity ownership, fit my risk profile.

Ultimately, I believed in the company, the people, the culture and the mission. Being able to call myself a partner in a firm like that was something that I wore — and continue to wear — with pride. 

READ MORE: How to improve your RIA valuation in this — or any — market

As an owner, I can say that selling equity internally can be a beautiful thing. 

It allows more team members to own more of their destiny, deepen their relationship with other partners and forge long-lasting ties with clients. Client relationships can strengthen, work relationships can deepen and employees become operating partners in what's likely to become their largest and best-performing asset.

If you believe in yourself and your colleagues, the return on investment can be huge.