When you form your own RIA, you must establish what type of entity you want to be.  As part of our series on Starting Your Registered Investment Advisor, our experts discuss the different options and things to consider like tax and cash flow ramifications, and the immediate, interim and long-term impacts of your choice.


Transcript provided by Temi transcript services

Libby Hall:  Hi, and welcome to today’s podcast. I’m Libby Hall, and with me are Oyster CEO Buddy Doyle and consultants Fred Wagstaff and Jay Donlin.  When you form your own RIA, you must decide what entity you want to be. As part of our series on starting your own investment advisor, we’ll be talking about the different options and the things to consider like tax and cashflow ramifications and the immediate interim and long-term impacts of your choice.

Buddy Doyle:  Okay. Thanks Libby. And I’m pleased to be joined today by Fred Wagstaff and Jay Donlin. Welcome back, Jay, Fred. Thanks for joining us.

Jay Donlin:  Thanks, Buddy.

Fred Wagstaff:  Thank you, Buddy.  Good to be here.

Buddy Doyle:  All right. So today we’re talking about establishing your entity and when you form your RIA like any other business, this is one of the decisions that you have to make, and these decisions we’ll have some consequences for you. I always encourage people to get advice from experts, and more than one on occasion, because I think when you’re establishing your entity, it’s going to have some ramifications on how you’re taxed.  But it can also have ramifications on how you handle your capital. And so with that, Fred, maybe we can talk a little bit about some of the kinds of entities you’ve worked with and maybe run down some of the thoughts that you can think through from a what kind of firm you want to create.

Fred Wagstaff:  Sure thing, Buddy, one of the first things that comes to my mind to be decided when establishing a new entity is what’s the legal construct going to be like.   So, will it be a sole proprietorship? Will it be a C-Corp? Will it be an S-Corp or an LLC?   So, I think each of those types of legal constructs has positives and negatives.   At least from where I sit, from a financial perspective, you know, I think your words are wise.  Consult with someone to assist you in this process. And that’s always during this process, a good attorney and a good tax advisor are really prudent to have as you go through this process and establishing an entity. So, it all depends upon your circumstances in terms of how you want to construct this, or how you need to construct it.  I think that’s certainly something that you should do, and there’s obviously the way you construct the legal entity has tax consequences and some of them are substantial dependent upon, again, the circumstances of the individual and what their goals are.

Buddy Doyle:  Yeah. And I think one of the things is how many people are with you on this. Are you going to be a sole owner of the company? Are you pulling in partners or other shareholders or members, depending on the way this is structured.  Jay, any thoughts on the partnership angle and bringing more than one person to the table?

Jay Donlin:  Yeah, Buddy, all good points.  How many people are going to come along with you? You might not know that right away. I mean you might just want to sit down and think about what is your two year, your five year, your 10-year goal? You might not have partners now, but you could have partners in five years that you want to have a structure that you can apply to that partnership pretty easily while you’re building this thing out of the gate.  The other thing is transition.   At the end of the day, if you’re going to retire in 10 years, you want to make sure that you have a succession plan, and the type of entity might make it easier in that succession.

Also as you continue to wind down yourself, if you want to have an entity still going, you don’t want the entity tied strictly to you if that’s what you’re choosing to do, and have the partnership continue to go after you retire. So there’s all those different questions that need to be just thought about and considered when you’re going out of the gate. It’s not hard to adjust the kind of entity you have.  It’s just some legal work and maybe some tax things that need to get done.  But if you can establish the most flexible type of entity for you out of the gate, it just may lend to more efficiencies later on.

Buddy Doyle:  Yeah. And I think when you’re thinking about partnerships and bringing folks in, it’s important to think through the immediate impact of that, but also the interim and long-term impacts of these decisions that you’re making.  Think about what happens if your firm is wildly successful and  becomes very valuable, but you have a partner that isn’t as valuable, right? How are you going to work yourself through that challenge, where you could have someone with a large amount of equity in your organization that is no longer contributing.  How do you want to deal with that? Do you want to have the hands-on equity partners that are part of the business?  Are you looking for capital, but don’t want them as involved in the business? So if you’re going to go outside your firm and raise some capital, there’s some considerations to take on that front as well.

Oyster is an S corporation or a holding company with LLCs underneath.  One of the challenges of having an S corporation is all our shareholders have to be individuals, and we all have to be here in the US.  That is part of the tax construct, where we are a pass-through entity. So, I have the privilege of paying taxes on Oyster’s profits, whether I put them in my pocket or whether I leave them in the company. And that can be challenging for different organizations. LLCs give you some similar flexibility in terms of how you handle pass through for taxes. However, you can raise money from institutional investors with an LLC structure. So you really want to talk to some folks about those various ways of constructing your firm. But again, I think, a lot of times when you’re getting started, you’re all excited.

You’re all ready to go. You’re trying to run fast, you trying to run hard, but if you’re running together as an organization, you need to take that moment and ask yourself is my time horizon, and my partner’s time horizon the same. And if not, that can factor into how you structure that kind of entity.  Another thing to think about in terms of funding your entity, and what structure to use, is how you’re going to try to fund that entity.  If you’re going to own this in your RIA, there may be some challenges to having a LLC or an S Corp or partnership in your RIA.  Firms may not allow you to put that there. So maybe that’s a C Corp.

Jay, one of the things that often comes with different types of organizational structures is how you can manage the liabilities. When you think LLC, it’s a limited liabilities corporation. How do you look at liability when you’re putting these entities together, Jay, and what are your thoughts?

Jay Donlin:  Buddy, you know, risk management is always a key with any organization that you have or participate in, and you want to make sure that whatever structure you do choose, that you do have a layer of liability protection for yourself, your personal assets, as well as yourself, and your personal income.  There are different things you can do, different structures.  You mentioned limited liability corporations. LLCs, C Corps are similar in that way, where you can make sure that there’s a layer of liability protection in there. Of course you can buy insurance, to offset some liabilities. You just don’t know what’s going to pop up over the time of your entity that could create a lot of issues.  Whether it be from some sort of property casualty loss, or a client complaint, a regulatory action, those sort of things. It can lead to a pretty significant liability on your part if you don’t structure it correctly  at the start.

Buddy Doyle:  And of course, even with your entity, you’re going to have to face the banks, or if you’ve taken out a loan or have a line of credit, they may ask for your personal guarantees, regardless. Certainly if you use SBA, the Small Business Administration to fund this, they’re going to be looking for guarantees from you to help back some of that. So I think you can try to limit your liability as best you can, but realize your creditors are going to be looking through these entities to your holding company. Or if you have a holding company and two sister companies, they’re going to wonder how these things are being managed independently and thinking through it when times get tough. So you may not be in the same framework of how you manage your liability when the time comes to face some consequences for decisions.

But I think having this plan is really important. Having this framework can be really important. And it seems to me that being a sole proprietor where everything’s just in your personal name, isn’t quite as segregated as the rest of it. And for me, being able to segregate different types of businesses, measure them independently, whether they’re inside of an entity or outside, is part of why we’re structured the way we are. As I mentioned before, we are an S corporation in our holding company.  We didn’t start out that way. We actually did convert to an S corporation. It was a fairly painless thing that we did. It was just a little bit of paperwork, but when we decided after running the firm for several years, that we wanted employee ownership beyond just our founders.  We did that for the purpose of having not just employees as members, but there were some consequences into how you count things for benefits than others. When your, when your owners or your employees, you want to make sure there’s some way to distinguish certain activities so that you can sort of look like a company to the IRS, look like a company to your benefits providers and not like all the owners are just out for themselves. So something also to consider.

Jay Donlin:  Yeah, Buddy, you also mentioned personal guarantees and people may think – well, if I’ve got such a great business, they would just see my business plan and they would just go ahead and let the organization take on that responsibility. It’s not the case. I’ve been involved in businesses that were 30, 50 years old and underwriting is still requiring personal guarantees. So, it’s very unlikely as a startup or even a company that is older than several years, that you’re going to get away if you’re going for financing, whether it be SBA or not, without a personal guarantee for that lending.

Buddy Doyle:  Yeah. And I think you can get debt financing for a lot of things as well, especially in this RIA world, where there are banks that are very focused on funding recruiting and funding lift outs. So there is financing available in the form of debt. And that’s another kind of thing that you think through, right? What is the long-term cost of debt? What is the long-term cost of equity? And the answer is, I’ve found, it depends.  If you’re wildly successful, then equity is expensive. But it probably feels pretty good, even if you’re the one that was using equity, to get the organization funded when you’re wildly successful.  If you’re not, then debt probably feels worse.  So I think that is something to keep in the back of your mind, is that either side of this, no matter how you go, think about it over the 1, 3, 5, 7, 10 year, whatever your career looks like for this entity.

And think about the different paths that you can go down. And again, I would talk to people who’ve done this before and, it actually helps if you talk to people that have gone all the way through the process before.  Not just starting an RIA, but starting an RIA, and then exiting that RIA for various reasons. And that can really help you line up your goals to your reality.  Fred, any other thoughts on, things that advisors should consider when they’re starting RIA, as it comes to the legal entity that they’re putting together, or the capital structure that they’re putting together?

Fred Wagstaff:  Buddy, I think it’s the thing that you just hit on – equity versus debt decision – that needs to be made in a lot of cases. I think that is extremely important. And again, I echo what you said. I think it really has to be weighed very carefully by whoever the owner is and whoever the owner or owners are going to be, and they need to weigh the options and, I think, it really depends upon the circumstances around that entity and what their objectives are as to whether it should be debt or equity.

Buddy Doyle:  My advice is if you reach out to somebody for advice and you ask them this question and they give you a snap answer, have somebody else that’s going to ask a lot of questions to find out who you are, what you’re about and what you’re trying to put together. And as you’re dealing with them, if you do have partners that you’re bringing to the table, have good, honest conversations with them about their time horizons, what they’re looking for out of the company.  You want to know what’s coming as best as you can. You want to know if you plan on sticking around for 10 years longer than one of your partners or 10 years shorter than one of your partners. So that is in the plan as you transition. If you’re doing this to make money and fund your retirement, you’re going to want to have funding at the end of this instead of equity.  Existing business, potentially, you may be comfortable taking profits for the long run, but will you be comfortable taking profits from a company you’re not involved in managing?  So lots of different things to think through.  As you go through it, take your time, address it carefully with good tax and legal advice, as well as the advice of your peers and you should be okay.

Fred Wagstaff:  And Buddy, to tag onto something that you said just a little bit earlier about asking a lot of questions, right?  I think that’s extremely important. I kind of look at it from the perspective of surround yourself with an advisory group, right? And look to friends and professional friends, attorneys, and tax advisors and things of that nature that can really assist you in just throwing out things that need to be discussed and get them to help you in any way that they can through their experiences.

Libby Hall:  Thanks everybody for listening. If you’d like to learn more about how Oyster can help you start your own investment advisor, contact us @oysterllc.com and we’ll be happy to chat. If you like what you heard today, follow us on whatever podcast platform you listen to and give us a review. Reviews make it easier for people to find us.  Have a great day.

About The Podcast Speakers
Photo of Jay Donlin

Jay Donlin

Jay Donlin has led and worked on numerous projects throughout his career ranging from system conversions, data center relocations, acquisition due diligence and integrations, correspondent conversions, recruiting and expansion, and process re-engineering. Through his many years in executive leadership roles for both introducing and clearing firm operations, as well as his financial advisor roles, Jay brings a unique and extensive industry experience to the team.

Photo of Buddy Doyle

Buddy Doyle

As the CEO of Oyster Consulting, Buddy Doyle has led the charge to create a successful organization built on the belief that transforming experienced industry practitioners into consultants adds more value to our clients.

Photo of Fred Wagstaff

Fred Wagstaff

Fred is an accomplished financial CFO and FINOP with extensive experience in the full-service broker-dealer, clearing, and registered investment advisory industry. Fred’s experience includes merger and acquisition financial responsibilities, financial and operational responsibilities including financial statement preparation, net capital computations, regulatory filings, incentive compensation development, commission payout systems and financial/accounting optimization and strategy.

View Our Team