How Much to Pay for a Client?

By: Philip Palaveev

As originally published in Financial Advisor magazine.

Growth has been difficult to generate in the last four years. The average advisory firm targeted 10% growth in 2018 (a sign of lowered expectations in itself) but achieved a growth of only 9% according to research surveys by our firm, the Ensemble Practice. Gone are the days when firms targeted 20% growth and achieved 25%.

Many firms, hoping to energize their professionals and get them to contribute to growth, have considered incentive compensation (bonuses) for business development, and many have looked to enhance the value of existing programs.

Unfortunately, most of the time, the carrots are there but the bunnies don’t seem to be running. That warrants a discussion about whether the carrots work in the first place (they do, but only for bunnies) and how the bonuses ought to be structured.

Should You Pay for Clients in the First Place?

Paying bonuses to advisors for developing new business sends a clear signal that growth is very important and valuable to your organization. But bonuses can be expensive. Also, contrary to popular perception, they do not change people’s behavior. Bonuses don’t magically turn non-rainmakers into skilled networkers. Also, bonuses, like certain medicines, have some side effects. With medications, it could be headache and nausea. With bonuses, there could be some complications, some calculations, some commotions and some curmudgeons.

Why Bonuses Don’t Produce Rainmakers

Contrary to what many believe, by far most of the growth from business development incentives comes from those already good at developing business. Let me explain why in pseudoscientific terms using fake mathematics.

You could express the result in terms like these:

Business Development = Skill x Motivation

First of all, bonuses do not change skill—they may only change motivation. If the skill is not there, you won’t get any results. It doesn’t matter how much you pay me to sing karaoke, I will still be the worst singer you ever heard.

Bonuses can indeed change motivation, but only marginally so. People are motivated by many factors and compensation is only one of them. The exact motivational formula is specific to each individual, but as psychologist Harry Harlow noted in his monkey experiments in the 1940s, compensation may demotivate people as well.

If a bonus is an ingredient, a 10% increase in that motivation will increase the result by 10%, which is great! But we need to go back to skill, which is a more binary part of our formula. Business development is a lot like swimming—before you reach a certain level of proficiency, your results could be disastrous no matter how motivated you are. If you can’t swim, you drown even if you really try not to.

This is why bonuses tend to only change the results for those already developing business. The others simply don’t have enough skill to produce any result, and trying to push them into the water doesn’t really help.

So let’s look at the formula this way:

Business Development = Opportunity x Skill x Motivation

Now we have introduced a new factor. Even with the advantages of skill and motivation, we still often lack opportunity. Your professionals are often already capturing all the opportunity available to them, and to create more they need a change in strategy and perhaps more resources. (To complicate the formula further, realize that opportunity is also a function of motivation and skill.)

Common Business Development Bonuses

I don’t want readers to walk away thinking business development bonuses are a bad idea. They do send a clear signal to an organization that growth is a priority.

Here are some examples of bonuses I’ve seen in action that are quite effective (each strategy assumes the professional’s primary compensation is salary):

  • Many advisory firms pay 25% to 30% of the first-year revenue generated by a new client as a bonus to the professional that developed the business. The bonus is paid quarterly as the client fees are billed and collected. I like this system because it is simple, there are no complex calculations and there are no cash-flow issues. The cost is reasonable (see the last section) and the total amount earned can be quite significant. If a professional generates $50,000 in new client revenue in a year, he or she will earn a bonus of $12,500 for that. This is a good incentive for a lead advisor, assuming that person also has a good salary and wins other bonuses for achieving other performance goals.
  • Some firms complement that first-year revenue component with some “residual” compensation. For example, a popular formula is 25% of year one, 15% of year two and 5% of year three. As former advisor and consultant Jeff Filimon explained to me, sometimes clients cannot transfer all their assets in the first year for various tax and liquidity reasons. In such cases, the second-year component captures that residual revenue when the assets move.
  • If you are trying to send a signal that new business development is valuable, there is no reason you can’t amplify the signal and increase the incentive to as much as 50% of the first-year revenue. While I am not sure that double the bonus will get double the result, the higher number will certainly add an exclamation point to that statement, and perhaps that’s necessary. For a firm expecting a long-term relationship with the client, this can still be a reasonable approach.
  • I am not a fan at all of incentives that continue for a long time. For example, a typical solicitor arrangement pays 20% of the revenue in perpetuity to the source of the referral (the solicitor). This may very well be the economic limit of such arrangements. You have to remember that the long-term cost of sale and service should be no higher than 40% (according to our benchmarking studies). Anything higher than 40% reduces the profitability of the relationship substantially. I have seen arrangements where the source of clients is paid 50% of the revenue, and the result is a relationship that can never be profitable.

In addition to the high cost, ongoing payments can create the wrong incentives. Paying in perpetuity allows someone after 10 years of successful business development to enjoy a great annuity from the income of past sales, and thus feel less motivation to seek new clients. Why develop new relationships if you can simply harvest the results from past success?

Ongoing payments can also create confusion about who owns the client, especially if the solicitor is another firm. If I am getting paid in perpetuity for the client I referred to you, can you actually ever sell that client?

Some Pesky Questions

While the bonuses described here are fairly straightforward, there are still some pesky devils in the details to be dealt with:

  • Should we only pay for “new clients” or should we also pay for new assets from existing clients? What if an existing client adds $5 million in new assets to his or her account? Isn’t this more valuable than a new $1 million relationship? The answer is complicated. To me, business development bonuses are meant to reward business development—the addition of new clients. Growing existing relationships—client retention—is something firms already do well anyway, and in my mind, there is perhaps less reason to give additional rewards for it. But this demonstrates one of the “side effects” of bonuses: They prompt the question, “If you pay for this, why not pay for that?”
  • What if more than one person contributed? Most firms allow the bonus to be split between two professionals. This in fact is highly desirable, and “team selling” is something firms try to encourage. But problems arise if one person disagrees about the split, and the arguments can get very ugly, damaging the team relationships. I know of one managing partner who got so tired of compensation disputes that he created a new rule—if anyone quarrels over who gets credit for a client, no one gets credit for that client.

Of the firms we work with, all those with a strong track record of growth have a business development bonus. In fact, the firms that pay the most for new business tend to have the strongest growth. Conversely, all the firms that struggle with growth tend not to pay for it. Somewhere in the middle there are plenty of mixed results—firms that don’t pay but do OK and firms that pay and do OK.

It’s a strong case for paying for growth. Still, the same can be said about paying boxers. The fighter who’s paid more (someone on the “A side,” as it’s called) tends to win a lot more, but that’s also because he or she is simply the one who has a better track record, has more titles and is favored to win. The money reflects the result, doesn’t cause it. I strongly suspect that firms growing faster tend to emphasize growth more, and as a result are likely to also offer more training, do more marketing, focus their management attention more on growth and also reinforce the effort with bonuses.

New business bonuses are not a magic pill that will energize growth in a firm, but they are like a good cup of coffee—it will perk you up, especially if you are a committed coffee drinker already.