Analysis

Using Business Models to Evaluate Employers

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Michael Kitces is one of the leading voices in the American financial advisory industry. He's worth paying attention to if you've ever wondered “how do brokerages make money in a zero fee environment?” or “how are robo-advisors changing the fates of the financial advisor?”

(Financial advisors are also called financial planners, depending on where you live; I'm talking specifically about paying someone for their financial expertise — whether that's allocating resources for retirement, negotiating a better contract at your job, or setting aside a sum of money for your kids's education.)

At around 1:04:00 in this episode of Invest Like The Best, host Patrick OShaughnessy asks Kitces what advice he would give to young people starting out in his industry. Kitces responds with something that is a wonderful demonstration of ‘using business models to drive career decisions’. (Something we've talked a lot about on this blog!)

I've taken the liberty to transcribe what Kitces said. Let's analyse it together:

... The other big (piece of) advice and caution I give to anybody who’s coming into the industry today is … we still have the problem in this industry where huge swaths of people call themselves ‘financial advisors’ but some are actually in the business of financial advice, and some are in the business of product sales and distribution. And it’s often hard to tell the difference, particularly if you’re younger and newer and coming in, and you don’t know the lay of the land yet. So trying to clarify like are you taking a financial sales job or a financial advisor job is really important. The easiest way to tell is, sales jobs require you to get your own clients out of the gate, and advisor jobs do not. So if you’re talking to a firm that says “we’ll help you get your clients from day one”, you’re there to sell, you’re not there to learn to be an advisor.

Some context. What Kitces is implying here is that people in financial product sales don't have quite the same careers as financial advisors. Earlier in the episode, he establishes that having 50 good clients is all a financial planner needs to have a great career. He also describes several planners he knows who have done exactly that — including one that specialises in bass fisherman (million dollar prize purses make for really interesting investment advice!) and another who specialises in U.K. expatriates working in the US.

Kitces then describes a more nuanced predictive test for the two types of jobs:

So, go find financial advisor jobs. The primary way I tell people to do that — first of all, ask them to show you a sample version of their financial plan. If they don’t have one, that pretty much answers the question about how focused they are on financial advice.

Number two, ask them how they make their money and where it comes from. And what you’re actually looking for isn’t the industry ‘fees vs commissions’ debate — the fundamental question is ‘is there revenue recurring?’ That could be 12B1 fees, that could be AUM fees … is there revenue recurring? Because if the firm doesn’t have recurring revenue, the truth is every January 1st they wake up and they have no revenue in the bank … and so all firms tend to hire — when they have no revenue coming in until they sell something — is more sales people. Firms that have recurring revenue — (they go) ‘January 1st, I got a million dollars of revenue coming in, all I have to do is to be an awesome financial planner for my clients, so that my clients stay’. Firms that have recurring revenue tend to hire financial planning jobs. Firms with non recurring revenue, tend to hire sales jobs.

So, ask to see a sample financial plan. Ask what kind of revenue they earn and whether it’s recurring. If at least 70% of it is recurring, your odds are good that you’re getting into a good place.

Notice what Kitces is using as his test here: if the company has recurring revenue, it doesn't need to be so sales driven. The 12B1 fees and AUM (assets under management) fees are merely expressions of that. The firm's business model determines your lived experience.

Kitces then closes with some universal ‘growth is good’ advice:

And (finally) find out if they’re growing. Firms that are growing tend to create more opportunities as they grow. So you may not know what it’s going to look like (in a few years). There’s a saying in SV, if you have a chance to get on a rocket-ship, you don’t quibble about which seat you’re gonna get on, you just get on the rocket-ship and you figure it out later. Because growing firms tend to create lots of opportunities for everyone.

So: what’s that sample plan look like, do they have recurring revenue, and is the firm growing … and if they can check all three of those boxes, you’ve probably crossed off 80-90% of the firms you’ve going to be talking to, and there’s a pretty good chance that you’ve found a good firm that’s a solid first step into the industry.

Breaking It Down

Now, I’m not particularly interested in becoming a financial advisor. But that’s not why I’m quoting from Kitces. I think he’s given us a wonderful example of what it looks like when someone parlays an understanding of an industry into actionable career decisions.  What I’m interested in is in generalising from his example.

Kitces asks three questions, which may be broken down like so:

  1. Show me a sample financial plan.
  2. Does your firm have recurring revenue?
  3. Find out if the firm is growing. (In practice, one way to find out is to ask: “tell me about the changes you’ve experienced at the company over the last year?” and listen for thoughtful answers about the ways the company has grown, e.g. “wow I can’t believe how much we’ve done/grown/changed when I think about it”.)

The third question is generalisable and applies to industries outside of financial planning. But what about questions 1 and 2? How may we generalise those?

If you think about it, Kitces is asking for two things:

  1. Show me proof of work on some measure that matters to my career. This measure should be something that I want to gain while working at your company.
  2. Explain to me your firm’s structure and business model, so that I may work out the implications on my career if I were to come work for you.

In the financial advisory space, proof of work is simple: either you have a good financial plan template because you are a real planner or you don’t — and if you don't you are likely to be a salesperson.

I’m sure you can think of equivalent questions to ask in your field. For instance, in marketing, one question I use to evaluate where startups lie in their evolution is “who is your ideal customer and why do they buy you?” A good answer to this question is detailed and nuanced — the more detailed, the better. My personal bar is to ask ‘who doesn’t buy you, and why?’ If they can answer that question, then it is likely they have cleared the bar for clarity.

The way a company responds to this question also reveals just how mature they are in terms of marketing thinking; an acceptable answer is “I don’t know yet, but we’re going to find out, and here’s how …”; a messy answer that assumes they already know means they’re likely thrashing about, applying whatever marketing fad it is that’s the flavour of the week. The implication: if you’re applying to said company to learn marketing, then it is not likely that they’ll have much to teach you.

A similar question on the software engineering side (but for a B2B software company) is: “how do you manage the tension between sales customisation for specific customers and the overall product roadmap?” I’ve talked about this tension before in my post about ‘head-fake questions’, but the key idea here is to test for thoughtfulness around the issue.

Ideally, you want to work for an engineering team that has given some thought to the tension between accepting sales customisation requests, while building towards a longer-term product roadmap. (It doesn’t matter that they are doing badly today, so long as they recognise that the tension exists, and have the organisational power to act on it in the future!) A bad answer here is one that is abstract (which means the answerer is trying to dodge the question), or which displays ignorance of this source of tension.

Kitces’s second question is about the business model of the firm. In the past, I’ve argued that business models are like the physics of careers: they determine your arc within the business. I then wrote an entire piece about the consulting business model as an example, arguing that you should be familiar with the structure of the firm before you join one, because that structure determines your likelihood of advancement.

In comparison, Kitces’s business model question is easier to understand: financial advisory firms that have recurring revenue have incentives that align with the typical financial advisor career path. Firms that do not have recurring sources of revenue must sell to survive. They can give all the lip service they want to ‘helping our clients achieve their financial goals’ … but if their business model forces them to sell, then the business model will win … because the business model always wins.

In tech startups, one technique that I use to evaluate my career prospects is to ask carefully about the business fundamentals. If the company is bootstrapped, then I want to know the levers around their retained earnings. What are their customer acquisition costs? What are their unit costs? And how much of their profits must be reinvested to be a going concern? Each of these levers will have real consequences on my career — because together, they act as constraints on the rate of growth of the overall company.

With venture-backed companies, this calculation changes. Venture-funded companies are rarely profitable. But in most circumstances, it’s possible to do a back-of-the-envelope calculation for the startup’s runway. If the company has three years worth of money left in the bank, then I should be prepared to leave at the two year mark (assuming a worst case scenario, where the startup looks unlikely to raise a follow-on round of funding ... and even if they can get a bridging loan).

In my experience, companies with a year’s worth of runway left tend to act in various ways that constrain their people's career growth.

Putting It All Together

I think it’s important to point out that such questions work only when you have a good understanding of your industry. Kitces can come up with his questions because he understands the types of business models that exist in the financial advisory space, and because he has an intuitive grasp of the factors that influence the fates of those firms. Similarly, I can only give examples from startups — since that is what I know best.

I’ll give you a real example of failing to come up with questions for an industry … because it is an industry that I do not understand. I recently talked to a friend who works in the VC space in Singapore. His firm is one of the many subsidiaries of Temasek Holdings, the Singapore Government’s investment management company.

I asked him “how do you guys think about portfolio construction?” and “what are your IRR targets?” He could not give me good answers for either of these questions.

Now this could mean that he is a bad VC. But it’s more likely that I do not understand his industry — and have asked the wrong questions. After all, despite all the recreational reading that I’ve done on the history of the venture capital industry in Silicon Valley, I have little to no understanding of sovereign (or sovereign-adjacent!) wealth funds — particularly those that operate in Asia.

The takeaway here is to study the business models of an industry first, before using that to inform your evaluation of the firms you would like to work for. Kitces’s example gives us a template for what that evaluation looks like:

  1. Demonstrate proof of work around some measure that matters to my career.
  2. Explain your firm’s business model.
  3. Convince me that you’re growing.

It's probably a good idea to adapt this to the fields we work in.