Brooke’s Note: I remember what it felt like to give up my Massachusetts real estate license. I remembered all those winter evenings I went to some paint-peeling place to take the course for the exam. I heard all the people who said I should just keep paying the annual renewal fee — just in case. It was hard to give up, but liberating. I think that’s one message of this piece.

Every year thousands of financial professionals debate the wisdom of converting current business models that are based on securities licenses to new models that are based on RIA or IAR registrations.

These advisors have three choices: Keep their current business models as is. Dump their securities licenses and go with an RIA or IAR business model. Or, keep securities licenses and add RIA or IAR registrations.

Licensing and registration determines what is sold to investors (products, advice, ongoing services) and how advisors are compensated (commissions, fees).

Before making a final decision, advisors should weigh some of the pros and cons that are described in this article. Please be advised this is a partial list of issues.

Who are the real financial advisors?

In a recent Paladin Registry survey, we asked investors two questions about advisors:

1. Would they continue to follow the recommendations of advisors if they knew the advisors were really securities licensed sales representatives?

84.2% said they would not.

2. Given a choice — and most of the time investors are not given this choice — how would they compensate advisors they are dependent on for specialized knowledge, advice, and services.

76.7% said fees (asset-based, fixed, or hourly) that are paid by them and not by third parties.

Based on this survey, real advisors are RIAs or IARs who charge fees. These financial professionals do not require securities licenses to provide advice and services. See: What exactly is an RIA?.

What is best for investors?

When advisors are paid recurring fees for their knowledge and services, they can focus on helping clients achieve financial goals. They do not have to be in continuous sell mode to make money for themselves and their firms.

Fees that require RIA or IAR registration are a win-win situation for investors and advisors. See: 11 steps to becoming an RIA without upsetting Merrill Lynch, the SEC or your clients.

Companies create pressure

Companies, in particular public companies, are under a lot of pressure to generate revenue and profit that drive share prices and executive bonus pools.

If advisors dump securities licenses, they eliminate potential conflicts of interest that companies create when they put their financial interests first.

Compliance departments

Advisors who hold active securities licenses are subject to the regulatory requirements of FINRA and the interpretation of those requirements by B/D compliance departments. See: One-Man Think Tank: Six reasons that FINRA should be dismantled.

These departments serve an important purpose when they make sure companies and advisors follow industry regulations. However, they also represent the financial interests of companies when they determine what advisors can and cannot do to obtain new clients and what they can and cannot sell to current clients.

When advisors dump securities licenses they remove many of the obstacles that are imposed on them by compliance departments that represent the special interests of their companies.

Renewable revenue

RIAs and IARs have hundreds of thousands of dollars of asset-based revenue on the books on Jan. 1. If they don’t add one new client during the year, they still benefit from market appreciation, re-invested income, and contributions. Their revenues may grow 10% to 25% without adding a client.

The same cannot be said for commission advisors who have zero revenue on the books, except trailers, on Jan. 1. In addition, there is constant pressure to produce new revenue every month. Advisor jobs may depend on the production of this revenue.

The value of fee businesses

According to some valuation experts, a commission business is worth about .25% of revenue when the seller is exiting the business. That is because the revenue is non-recurring. It takes sales activities to produce new revenue and there is no guarantee investors will buy from the new owner.

On the other hand, fee-for-service businesses are worth two times revenue or more because revenues are recurring. Buyers do not have to sell products to produce revenue and they should retain most of the seller’s clients as long as they continue to deliver the same services.

All advisors should convert to a fee service model before they retire.

Protecting commission income

The single biggest reason why some advisors retain securities licenses is to protect current and future commission revenue streams. Dumping securities licenses means this source of income goes away.

Ideally advisors can transition commission relationships to fee relationships. These advisors should make more money after they have converted their clients to a fee-for-service business model. The challenge is to convince clients to pay for services that help them achieve their financial goals.

As an example, an advisor currently averages $350,000 of net commission income per year. Let’s assume the advisor receives a 70% payout on fee business. The advisor needs to generate $500,000 of fee revenue to produce $350,000 of net income. If the advisor’s average fee is 1%, the advisor needs $50 million of assets under management to produce this amount of revenue.

In this case, the advisor has to convince investors with $50 million of assets to pay $500,000 of fees for the advisor’s knowledge, advice, and services.

Knowledge-based business models

Most advisors who dump securities licenses adopt one or more of the three primary types of fee-for-service business models. Sales skills are still important, however.

In all three cases advisors must have specialized knowledge to be competitive in the RIA/IAR marketplace. This is one important way they add value.

Some advisors market themselves as financial planners. Consequently they must have adequate planning knowledge and access to sophisticated software that produces financial, retirement, college, and estate plans.

Other professionals market themselves as financial advisors who provide non-discretionary investment strategy, asset allocation, manager selection and performance reporting services.

A third type of professional provides discretionary investment services that include securities research, asset allocation, and portfolio management.

A high percentage of professionals provide various service combinations to maximize revenue per client relationship. See: What is the value proposition of a financial advisor — and how is a budding RIA culture upping the ante?.

Jack Waymire is the author of Who’s Watching Your Money? and the founder of Paladin Registry an online service that matches investors to pre-screened financial planners, investment advisors and money managers.