Most registered investment advisors spend decades building a practice based on a solid reputation with a core clientele.

But principals of RIA and wealth management firms who hope to eventually sell their businesses and retire comfortably are in for a rude awakening.

Despite those client relationships, the firms still lack the enterprise value to make a deal worthwhile to the owner, according to Mark Hurley, president and chief executive officer of Dallas-based Fiduciary Network.

In a report, Creating, Measuring and Unlocking Enterprise Value in a Wealth Manager, released Monday, Hurley gives advisors a wake-up call about their real prospects for a payoff after years of working on their businesses.

One illustration indicates, hypothetically, what would happen if a roll-up firm did an initial public offering to monetize its investment in a wealth management practice. Out of a potential $450 million in enterprise value, the principal ends up with just $98 million from the deal. 

A lot of wealth management firms are unprofitable so-called lifestyle practices, Hurley said. After covering the firm’s expenses, the owner’s earnings fall short of the prevailing market salary he or she would earn as an employee at a larger firm. They end up subsidizing the practice with their labor.

“In terms of finding someone to replace you and make less, they won’t step into your shoes for the pleasure of doing that,” he said.

Hurley, who has a reputation for generating controversy, points out what he says are specific shortcomings to the fee-based and fee-only business models that dominate the industry. Many firms that collect fees nevertheless have to sell products to remain profitable. Also, there is no empirical evidence that suggests that a fee-based firm’s client list is transferable to successors. Therefore, the fee-based firms have no transferable goodwill, which is the intangible asset that carries enterprise value.

But the report did highlight an area where the fee-only model could redeem itself. It generates exceptionally stable revenue streams, with relatively low annual client turnover rates, between 1% and 3%. That suggests the average tenure of client relationships will start at 33 years, so they stand to generate a “staggeringly large” fee stream over a single client relationship.   

Hurley said, to be sustainable and transferable, firms must create a consistently high level of service that does not rely on the founder or senior partners. There are seven critical steps. First, recruit and retain successors, and give them clearly defined career paths. Next, institutionalize the firm’s relationships so that clients associate the brand with the entire company and not just the founder. Third, build a client base that is profitable—and demographically diverse. Next, market the firm as a brand that has evolved from the founder’s reputation; this way new clients will still be attracted to the firm. Change the governance structure so that critical decisions get broader input from key stakeholders. Create a robust culture of compliance, because a damaged reputation can sink a firm. And finally, reinvest in the business.

Even a clearly defined plan does not guarantee success. The report also asserts that only a small portion of the 200 to 400 firms that could build enterprise value will succeed. The process is an emotionally wrenching one that basically asks the person who built the firm to step away from it for its own good.

Hurley said that many advisors might scoff at the report’s findings, because Fiduciary Network invests in wealth management firms and has an interest in seeing them thrive. Also, he acknowledged that some advisors just want to run their practices and eventually close the business. But those who have made big investments in their firms and want a return should consider how the recent financial market correction would impact that and their retirement.

“We found that almost as a rule, the first transaction any of these guys will participate in is the sale of their business,” Hurley said. “The time to learn about this is not when you sell the firm.”