Q92 – How Much Cash Should I Have Saved Before Transitioning My Practice To The RIA Model?

Also available as podcast (Episode #92)

Apple  |  Android  |  Spotify  |  Amazon  |  Audible

How Much Cash Should I Have Saved Before Transitioning My Practice To The RIA Model?

There are many due diligence and procedural steps that go into transitioning your practice to the RIA model.  Equally important is how you will fund the necessary start-up costs, as well as provide you with peace of mind through the process.  Both of these variables must be considered when determining what size cash cushion (and/or access to capital) you should have going into the transition.

Found This Video Helpful?

Want to learn even more by better understanding what a transition to the RIA model might look like for your own practice?  I encourage you to schedule a Discovery call, and I’d be happy to begin that conversation with you.

Full Transcript:

How much cash should I have saved before transitioning my practice to the RIA model? That is today’s question on the Transition To RIA question and answer series. It is episode #92.

Hi, I am Brad Wales with Transition To RIA where I hope you understand everything there is to know about why and how to transition to the RIA model.

If you’re not already there, head to TransitionToRIA.com where you’ll find all the resources I make available. This entire series in video format, podcast format. I have articles. I have whitepapers. All kinds of things to help you better understand the RIA model.

Again, TransitionToRIA.com.

As I said at the top, what we are going to talk about on this episode is if you’ve concluded – and again, there’s a whole process leading up to before you would make this conclusion – that moving into the RIA model is a fit for you.

You’ve determined which pathway into the model is best for you, you’ve determined the solution providers you need, etc. That is exactly what I help advisors with, each of those steps.

Let’s say you’ve done all that, and you plan to transition to the RIA model. The transition itself is very important because it doesn’t matter how much planning you’ve done, it doesn’t matter what your future model will be, if you can’t successfully transition your clients, it’s not going to work out well. So, the transition is very important.

Now, part of that is your comfort as an advisor going through the transition. Part of that comfort is going to be, “Do I have enough cash or liquidity saved up to cover all the costs and to get me through the transition to the point where my clients will be moved and revenue coming in?” That’s what we’re going to talk about on today’s episode.

Part of the capital is to cover hard costs that are involved, for the transition period, but part is simply how much capital do you want in reserve to give you peace of mind?

I’m going to go through some of the variables involved, and estimates for each. But as each advisor situation is unique, your individual needs will vary.

To start with, what do you need cash for upfront? Essentially “day one” as you begin the transition.

First, for some of you, you might owe your current firm back some sort of forgivable note from when you originally joined them. It’s money you received upfront with the expectation that you would stay a certain period of time. If you don’t see through that entire runway, you generally owe back a prorated portion or essentially whatever the remaining balance is on the forgivable loan. They will want that money back.

They typically want it back relatively quickly. You will need to understand what that dollar amount is, what that expectation is going to be, and then have that cash available.

This won’t apply to some of you. Maybe you never received an upfront bonus, or you did, and it’s ran its course. But if you have an outstanding balance, you will need that cash ready to go.

They will want it quickly, and by quickly, it’s not like they expect it within 24 hours. They probably will rather quickly send you some sort of demand letter for it, but it generally needs to be paid within the first couple of weeks after you have made the move.

So, that’s bucket number one.

The next “day one” cost is what it takes to get the RIA up and going.

I did an episode on how much it costs to start an RIA. So, if you want to go deeper on this topic, check out that episode. But I will cover it here at a high level because it is relevant to how much cash you’ll need.

There are two main cost buckets of starting and running an RIA.

The good news, most of the costs are forward-looking, ongoing costs that you don’t necessarily have to come up with a lump sum for to start with.

An example of that is most technology you might utilize as your own RIA is typically paid only on a going-forward basis. There’s not a lump sum you necessarily have to come up with on the front end. Tech is typically paid quarterly or monthly or wherever the case is going forward. And oftentimes, you can get the first couple months for free.

So, the idea is with those costs, it’s not something you have to have cash available for on day one. You’ll absorb those costs going forward, and in some cases, even have a little buffer before those costs kick in.

Next, are startup costs that you will indeed need the cash for on day one.

An example of something you must pay for upfront is the RIA registration itself. There is a cost involved. I’ve done episodes on this.

The standard registration path is to hire what’s often referred to as a compliance consulting firm that will do the registration. They do the filing, create the advisory agreement, policies and procedures manual, etc. Everything that must be done to get you to day one from a regulatory perspective of the RIA. It is typically a one-time lump sum payment.

As I have discussed on several episodes, you typically also continue to engage the compliance consultant on a going-forward basis to help you manage your compliance responsibilities. But those are going-forward costs that you’ll pay over time. You don’t pay for that upfront, but you do have to be able to cover the cost of the registration itself.

Again, I’ve done other episodes on that, and I’m happy to have a one-on-one conversation with you about what your registration cost might look like because it depends on your size and complexity and those sorts of things. But that is an upfront cost that you would need to have the cash available for.

Another example of a startup costs is what you intend to do from an office perspective. This can vary wildly.

Some of you might go and say, “We’re embracing the work from home or the virtual environment, and we do things by Zoom, or we go and meet clients where they are. And so, we need a very small, to no office print at all.”

If that is your strategy, your startup costs from an office perspective are going to be rather low. On the far other end of the spectrum, you might say, “Not only do we want an office, we want to buy the building,” which has significant long-term benefits for those that are able to do that, either initially or at some point.

If you’re going to buy a building, maybe do some remodel or build-out of it, furnish it, there’s a lot of startup costs involved in that. You must factor those costs in.

And then, of course, there are flavors in the middle. You might lease an office that requires no build-out, or the landlord gives you a build-out credit. That can lower the startup cost.

It really depends where you fall on this spectrum. For those of you that might already be independent with, for example, an independent broker-dealer, and you already have your own office, there’s no upfront office expense cash you need to come up with.

Those of you at a traditional W2 broker-dealer that supplies you with an office, you will need something, whether you go virtual or whether you go full purchase of a building and build it out yourself.

This expense is very advisor-specific. But whatever the cost is, you typically are going to need the cash or the capital upfront to be able to make the move.

Another example of “day one” costs are for your website or marketing strategy.

I talk a lot about these basics. You must have a website, you must have a logo, etc. You need basic marketing collateral about your practice to be able to share with your clients while you’re talking to them about this new path you’re taking with your practice.

What you don’t necessarily need upfront are going forward marketing strategies. Even if you intend on holding webinars or making YouTube videos or having a podcast, those typically are things you can start implementing after you’ve crossed the bridge, after the revenue’s coming back in, after moving the clients over.

Those strategies can all be important to your business development, but they don’t necessarily have to be covered upfront. But there are some things that arguably are table stakes you must have. A website, basic marketing collateral, etc. Those are another example of what you need cash for on the front end.

Related, and I’ve done episodes on this, but if you decide to join an RIA, vs starting your own, then some of these upfront costs might be mitigated.

An example of this is you won’t have to register your own RIA. You won’t have that startup cost. So, there is a way to mitigate some of these costs, it depends on whether you are starting your own RIA or perhaps joining an RIA.

Now, let’s move to the third main bucket of “costs.”

To recap, the first is if you will owe money back to your current firm.  The second is startup costs of the RIA itself.

The third is there will be a temporary dip in revenue during the transition.

Consider your fee-based accounts at your current firm, so there is the reoccurring revenue. The moment you resign and then move to launch your own RIA, you have to move the accounts to your new model before you can start billing again.

For some of you, depending on your circumstances, might not require a change in the custodian. But for many of you, it will require a change. Until those accounts are moved and you’ve had the client sign the necessary paperwork – typically something for the custodian, and your advisory agreement – at that point, you can turn the fee billing back on for that client.

There typically is a gap, though. Even if 100% of your clients come with you, and even it’s a relatively quick process, there is still going to be a gap because literally, the accounts must move. You have conversations with clients, they must sign paperwork. You’ll want to anticipate the temporary dip in revenue. It is a normal part of the transition.

An analogy I typically give regarding this is refinancing a mortgage, which is not nearly as timely an example as it once was. But back when interest rates were lower it made sense for a lot of folks to refinance their existing mortgage to get a lower interest rate.

But when you refinance a mortgage, there are closing costs involved. You usually must pony up that money on the front end. But the idea is, it makes sense to do, because going forward, you’re going to have that lower interest rate, you’re going to save on your interest each month.

And yes, it will take a little bit of time in saved interest to recoup the initial closing costs. But once you’ve broken even on that, you’re better off going forward.

Same thing here with the revenue dip. Yes, you’ll incur a temporary revenue dip. But if you’re making this move, more than likely, the economics are not only going to be better, in some cases, significantly better. So, it’s worth it to essentially take one step backwards to go two steps forward.

But nonetheless, you must be able to weather that temporary dip until you move the accounts and get them started on the fee billing process again.

So, those are some of the upfront things you need to be prepared for. Again, are you going to owe money back, startup costs, and the inevitable temporary revenue dip that comes with it.

The question is, “I can pencil all that out and that’s helpful, but what’s the best way to think about how much in total I want available?” (I’m going to talk about sources of cash or liquidity that you can use for this in a moment.)

One of the best answers I’ve heard for this was from the lead advisor of a ~$500M team that left a traditional broker-dealer environment, started their own RIA, went through all the steps, and had a transition.

After the dust settled from their transition, I asked him….in hindsight, what rule of thumb you would suggest of how much liquidity you would’ve had and what would you suggest to other advisors? I think his answer was good.

This is very advisor-specific, so your comfort level might be more or less. But what would’ve given him the ultimate comfort is to have enough cash to do two things.  (Again, I’m going to talk about how you can come up with this liquidity in a moment.)

First, enough cash to cover the necessary startup costs. Estimate what that hard cash amount is, and have it ready.

Second, have enough cash to cover four months’ worth of overhead costs on a going-forward basis. This is for things like rent, staff, utilities, tech, etc. Hypothetically assume no revenue comes in for four months, so you need cash on hand to cover these expenses.

Now, this is not how a transition typically plays out.  You generally have revenue coming in a lot sooner than four months; almost all your anticipated revenue back on before four months.

But in hindsight, for him, that sort of way of viewing it is what he concluded would have given him the maximum amount of financial comfort going into the transition.

Each advisor will have their own comfort level, but I thought this was worth sharing to give you an idea of how much cash, how much liquidity you might feel comfortable with.

The final thing I’m going to talk about is sources of capital, sources of cash for this.

First, is personal savings. If you have saved up and you have cash available, or maybe you have securities you can borrow against – though I’ll give a reason why that can be tricky in a moment. But if you have personal savings, that is going to be a bucket of money that you could use for a transition.

A word of caution though if the bulk of your cash holdings are, as opposed to at a bank, held in for example a brokerage account at your current firm. If that is the case, my suggestion is you remove that cash out of your current firm before you resign and give notification.

Particularly for those of you that have an outstanding note that you would owe back some amount of money to your prior firm, I have heard of firms that once someone resigns, they quickly scramble and ask, “Whoa, whoa, is this advisor going to owe us money? How much money is in their account?”

And if money is owed, they put a freeze on the account. A freeze, meaning you can’t access that capital. You can withdraw it to use it.

We could argue they maybe don’t have any legal right to do that, but I have heard it before where the firm’s stance was, “We would rather put a freeze on their account and deal with them maybe sending us threatening legal notices or even trying to sue us. We’d rather deal with that then possibly have that capital leave and this person not pay us back what they owe us.”

I have heard of that before. So, what I would suggest is if you have cash and it’s in a brokerage account at your firm, take it out of there.

Now, the tricky part I alluded to prior, is you might also have securities, equities, whatever you’re invested in, also at your firm. Typically, because you’re required to have it in an account at the firm (for supervisory reasons.)

That can be tricky because unless you liquidate that and move it to cash and take it out of the account, typically, most of you are not allowed to open a brokerage account and move those securities elsewhere.  This also makes using a margin loan or non-purpose loan as a potential source of cash more challenging as well.

But to the degree some/all of your holdings are in cash or you feel comfortable converting it to cash, I would say get the cash out, again, before you resign from your firm. That way there is no chance they can freeze your cash against your will.

Next, whether you’re starting an RIA or joining an RIA, there is sometimes opportunity for some upfront capital from wherever you’re landing.

If you are starting an RIA and you’re going to a custodian, it’s fairly limited, but depending on your profile, depending on how much assets you have, there could possibly be some, often referred to as “client benefits” that a custodian might be able to provide for you to cover certain costs.

I don’t want to overplay this though. If you’re at one wirehouse, and you go to another wirehouse and get some big check, that’s a whole different arrangement and whole different set of handcuffs and ramifications of doing that.

The economics that a custodian could provide are not even remotely close to that if it’s even available at all. But there’s a chance there is possibly some opportunity for some capital there.

Or if you were to join an RIA, some RIAs extend some upfront – I don’t want to say a bonus, we’ll call it transition assistance – to be able to help you with the move. These are modest amounts though, not meant to be a life-changing wealth-building event, but to help you with these capital requirements of making a transition.

Extending some sort of capital is specific to each RIA. Some do it, some don’t. There’s no free lunch. If you receive money, typically they’re going to require that you stay there a certain amount of time so that they can make a return on that investment. But just know that there is potential for that to be partial part of how you’re going to come up with the needed capital.

The third example of capital is you might consider taking out a home equity loan or at least have a home equity line available to you.

This comes back to the four-month cushion the one advisor had. You don’t necessarily have to have the cash in your pocket, but you want to at least have access to the cash in case you feel, “The accounts didn’t move as quickly as I thought they would.” And there’s more of a revenue dip until it returns to expectations.

If having a home equity line in place is something you’d be interested in, I would recommend, particularly if you’re W2 now, you need to have that in place before you resign from your firm.

If you’re W2, and you’ve resigned and then two months into the transition, you decide it might be nice to have a home equity line for financial comfort, it’s going to be significantly more difficult to go through that process with a bank than it would’ve had you done it while you were still employed as a W2 employee.

The bank will say, “You’ve just started a business. You only have two months’ income run rate.” Fair or not, they will see you as a higher risk. Or at a minimum, it will slow the approval process down.

If you think some sort of home equity loan or home equity line would be part of your capital pool, start working on that now ahead of the transition. Have that in place ready to go.

And then the final thing I would note, there are specialty lenders in our industry that gladly loan to advisors that are already on the other side that have demonstrated cash flows, a demonstrated client base. There are a lot of lenders that would love to have a conversation with you about loans they can extend to you.

The challenge with using those lenders for what we’re talking about here today, they typically need the assets to have been moved over before they will loan against them. So, even if you have $500 million at your current firm and you say, “98% of it’s going to move over with me,” even if you’re confident that will happen, the lender wants to see that it happens before they extend the loan.

That’s the challenge. I’ve talked to a lot of these lenders about trying to extend some of the loan as the start of a transition. I know they’re working on it, but it’s a challenge for them because the collateral they use for these loans is the cash flows of the business. It’s better for them to have seen the assets move over first, before extending a loan.

Where this might still be an option for you is perhaps you have cash in the bank, and you’re willing to commit it (to the transition), but you also prefer on a personal level to have a buffer there in general for life and for your family.

What I’ve seen some advisors do is draw down on those savings to get through the transition, and then once on the other side, after the dust settles, after the assets are there, then look at one of these lending sources, take out a loan and essentially recapitalize your personal balance sheet at that point.

So, that’s a strategy you might want to consider as well. But again, that’s usually only after you’re on the other side to be able to even consider having that kind of conversation.

We haven’t covered any and every possible cost that might be involved in a transition. But on this episode, I wanted to drive home the point, it is important to have cash, have liquidity to pay for a transition.

The costs you must pay for ahead of time. Cash to cover the temporary revenue lull going through the transition. Whether you are on the same viewpoint as the advisor I mentioned on financial comfort, whether you’re more or less conservative, that’s up to you.

I’m happy to have that conversation with you to help you map all these things through. But I hope this episode at least gives you a general idea of what you would be looking at to make the transition.

With that, like I said at the top, my name is Brad Wales with Transition To RIA. This is the kind of thing I help advisors with every single day.  What pathway into the RIA model is best for you, the steps involved, and the cash you might need to make the transition.

Whether you want to dive into today’s topic, and how it would apply to your practice, or anything else RIA-related, I’m happy to have that conversation with you.

If you head to TransitionToRIA.com, you’ll find all the resources I make available to help you better understand the RIA model. This entire series in video format, podcast format. I have articles. I have whitepapers.

At the top of every page is a contact link. Click on that and you can instantly and easily schedule time to have a one-on-one conversation with me. I’m happy to have that conversation with you.

With that, I hope you found value on today’s episode, and I’ll see you on the next one.

Want To Learn More?

Schedule a Discovery call and lets begin a conversation.

Share this post

Read my free whitepaper!

Get instant access to my free whitepaper on "11 Ways The Economics Of The RIA Model Are Superior To Other Advisor Affiliation Options".
FREE WHITEPAPER:  “Steps To Take Now If You Anticipate Transitioning Your Practice To The RIA Model Anytime Within The Next 10 Years.”