caution: don’t get hung up on ownership percentage.
by marc rosenberg
how to bring in new partners
accepting a partnership invitation offers two terrific, lifetime benefits to new partners that for most people cannot possibly be matched in any other career pursuit.
more: four philosophies for managing a cpa firm | how partner and staff actions impact profits | nuts and bolts of mentoring staff | nine ways to measure staff performance on the path to partner | sixteen duties of a partner
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if they don’t see this and agree with it, then perhaps it would be unwise for them to accept the partnership offer.
- the monetary benefit. this consists of the substantial return on investment (roi) of the new partner’s initial buy-in (explained in the next section) as well as the outstanding compensation that partners in cpa firms earn compared to virtually all other jobs.
- the nonmonetary benefit. this is just as important as the monetary benefit. most people will spend more of their life working at their job than doing any other activity besides sleeping. so it makes sense that their job should be as enjoyable and satisfying as possible. the benefits of being a partner in a cpa firm include:
- having challenging work.
- helping clients you love and who love you.
- being an entrepreneur in a small business.
- feeling the satisfaction that comes with helping young people grow.
- having staff to delegate work to, making it possible to focus on high-level priorities.
- being your own boss, for the most part. partners have a high degree of control over what they do, how they do it and when they do it.
- working in an organization that has a diverse array of talent to draw upon, making teamwork a rewarding and enviable feature.
the best investment new partners will ever make
new partners make two major investments. the first is the initial buy-in at the outset of becoming a partner. the second is made over many years, sharing in the payment of buyouts of partners who retire or otherwise leave the firm. the burden of the latter is greatly lessened because it is shared with other partners in the firm.
the return on investment for new partner obligations is a whopping 23 percent. here are the assumptions behind this calculation:
- a manager is made partner at age 35.
- the initial buy-in is $150,000, paid all at once.
- the new partner joins five existing partners.
- all partners, including the new one, retire at 65.
- the new partner’s share of buying out the five older partners, over the next 30 years, is $1 million.
- the firm’s annual growth rate over the next 30 years is 3 percent.
- compensation of the new partner starts at $175,000.
- this compensation increases, on average, 7% per year.
- if the new partner decides to quit and work in another job, their compensation would increase 2 percent a year. so, the assumption is that a partner in a growing, profitable cpa firm will outearn all other jobs by 5 percent per year.
in addition, there’s the appreciation of the initial capital investment and its return to partners upon their retirement. a $150,000 buy-in will appreciate to $364,000 in 30 years, assuming an annual increase of 3 percent.
all in all, the financial benefits of being a partner in a cpa firm are quite substantial. the money a new partner invests will probably be the best investment that person ever makes.
create written criteria for making partner
before shooting from the hip and elevating managers to partner because you somehow feel they are “ready” or have “earned it,” think this through. firms should first decide what experience, skills and achievements they want from a prospective partner before making the partnership offer. firms should be consistent in applying this process. then the firm should evaluate partner candidates against these criteria.
here’s another important reason to create written partner admission criteria: it’s a critical part of the mentoring process. when partners talk to staff about their future with the firm and what it means to be a partner, it makes sense to share with them these written criteria.
consider the non-equity partner role first
for many years, local cpa firms have commonly promoted managers directly to equity partner for one or both of these reasons: (1) they intuitively felt that the manager earned the promotion or deserved it because of his or her excellent technical performance, loyalty as staff and years of service (time in grade) and (2) they made the promotion as a staff retention tactic, fearing that if they didn’t, the employee would leave the firm, and that would give the partners heartburn.
there is a trend well under way among cpa firms to raise the bar for becoming an equity partner. one reason for this is the increased use of the non-equity partner position.
two common ways the non-equity partner position is used are:
- as an equity-partner-in-training program. it gives the partner candidate one to three years to demonstrate that he or she is capable of functioning like an equity partner. the main skills to be demonstrated are managing client relationships, bringing in business and displaying leadership skills.
- as a permanent position in the firm. this could be the case if the first type of non-equity partner is unable to acquire the necessary skills to advance to equity partner. or it could be a manager who is unlikely to develop all the equity partner skills but deserves to be called a “partner” and is capable of performing many partner duties. the title is often advantageous for both employee retention and client-service marketing. clients always want to know “who’s the partner?” on their account, and this person can fill that role and save an equity partner from having to keep the client.
avoid overemphasizing ownership percentage
the term “ownership percentage” has wrought havoc in cpa firm ownership structures for decades. throughout my 20 years of cpa firm consulting, i have frequently asked partners to explain how their present ownership percentage was arrived at. invariably, i’m greeted by blank stares. they don’t have a clue.
most cpa firms seem to feel it is intuitive to use ownership percentage to decide important financial and governance issues. why is this? firms reason, “if our clients do it, why shouldn’t we?” here are some reasons why they shouldn’t.
many companies derive a major portion of their growth, profitability, overall success and value from branded products, plant, equipment, proprietary processes, patented technology and the goodwill/market recognition that comes from these assets. it’s understandable that an executive’s ownership percentage in these businesses should impact financial and governance issues.
but cpa firms are different. their primary asset is the partners’ ability to bring in and retain annuity clients, every day in every year, to perform a highly technical service from scratch, every day in every year and thereby earn clients’ trust and respect, every day in every year. the growth, profits and success of a cpa firm occur because of the quality of the owners’ work effort and skills to create these benefits every day in every year. cpa firms need to reinvent themselves every day in every year to remain successful.
relying too heavily on ownership percentage and not performance is a power grab and/or an opportunity to avoid accountability. it’s so much easier to take 30 percent of the firm’s profits because one is a 30 percent owner instead of earning it. it’s so much easier to commit transgressions of firm policies (take excessive time off, be delinquent in billing and collections, give oneself a waiver on business or staff development) safe in the knowledge that one can never be held accountable for those shortcomings because of the protection of a lofty ownership percentage.
one of the strongest arguments to minimize the importance of ownership percentage in cpa firms is simple: fairness. it’s simply not fair to rely on the use of ownership percentage to decide critical financial and governance matters. heavy emphasis on ownership percentage is guaranteed to cause tremendous acrimony among current and future partners. firms get twisted up in the illogic and unfairness of using ownership percentage and find themselves trying to solve problems that are unsolvable with old-school methods. they need to employ outside-the-box thinking.
here is a simple illustration. contrast the performance of the following two partners:
| partner a | partner b | |
| owner percentage | 30% | 20% |
| business originated | $200,000 | $500,000 |
| business managed | $800,000 | $1 million |
| intangible performance | average | great |
can there be any possible justification for partner a’s compensation and buyout being 50 percent higher than partner b’s, simply because partner a’s ownership percentage is 50 percent more than partner b’s?
there are five major partner issues for which firms should resist determining their outcomes on ownership percentage. here are recommended alternative treatments:
- allocation of partner income. it should be based primarily on each partner’s performance, not their ownership percentages.
- calculation of partner buyout. it should be based primarily on what partners have contributed to the firm’s profitability and success, usually measured by relative partner income, not ownership percentage.
- it should be one person, one vote for the vast majority of issues (though most firms tell us they rarely take formal votes). if voting is based on ownership percentage, new and younger partners feel disenfranchised because older partners control the votes.
- new partner buy-in. it should be determined as a fixed amount, independent of ownership percentage. use of ownership percentage to determine new partner buy-in usually results in an enormous buy-in cost that new partners are unwilling or unable to pay.
- allocation of proceeds of a firm sale. it should use the same method as partner buyout. why use ownership percentage for firm sales when you use performance-based measures to decide buyout? this makes no sense. they really are the exact same transaction.