Insights & Market Outlook

Two Important Benefits of a Fiduciary Model

Redefining Wealth Management

I am passionate that a stronger independent investment counselling market is needed in Canada.  There are numerous benefits to this fiduciary model for clients as well as advisors – today I discuss a couple of the most important benefits.

(1) Transparent reporting of growth across the market

When I started researching the United States’ RIA market  – the fastest growing segment of American wealth management – I was struck by the transparency of reporting.   Because of the publications readily available in the United States on RIA firms, you can analyze the actual assets of each RIA firm monthly with the SEC reports or with the excellent materials published by both Fidelity & Schwab.

Fidelity publishes an annual M&A Valuation study which highlights the sale events over the year and Schwab provides an excellent annual benchmarking study as well which is worth reviewing.

Here is a link to two of these studies:

Fidelity:

https://clearingcustody.fidelity.com/app/literature/item/9910073.html

Schwab:

https://content.schwab.com/web/retail/public/about-schwab/schwab_ria_benchmarking_study_2023_deck.pdf

(2) Equity Sale vs Employment Income

Ownership has many benefits including the beneficial tax treatment of capital gains on sale. With the reports on RIA firms I’ve mentioned above, the financial impact of ownership vs employment is calculable and clear.

I’ll set out a conservative example to highlight the retirement tax benefits of being an owner of an investment management firm contrasted with the employee model so dominant in Canada.   Business succession will be an increasingly important consideration as many Advisors near retirement in the coming years.

To illustrate the difference, I’ve used an example of a client advisory business generating $2MM annually.

(1) Traditional employee model

At retirement, the Advisor’s business is transferred to another Advisor, and the transferring Advisor generally receives a multiple of revenue, typically over 3 years.  We will use 1.5X revenue in this example.

$2,000,000 revenue x 1.5x = $3,000,000

Employment income tax at 53.5% marginal tax rate: $1,695,000

Net:  $1,395,000

(2) Sale of equity in RIA firm

Using the published values in the referenced studies, we will assume the firm generated an EBITDA margin of 25% and P/E valuation of 9X EBITDA

$2,000,000 revenue X 25% = $500,000 x 9 = $4,500,000

Capital gain tax:  $4,500,000 x 50% x 53.5% = $1,203,750

Net: $3,296,250

The math is clear, however, owning a firm as a partner is definitely not for everyone and the financial aspect should not be the prime motivator.  Nevertheless, for advisors choosing to expand their investment management business as an owner, there is great potential to participate in that growth in a way simply not possible in the employee models. This is one of the reasons that the RIA model has grown so tremendously in the U.S. representing a third of the overall market today.

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