bonus: seven systems to allocate income … and who uses them.
by marc rosenberg
how to bring in new partners
it would take a book much longer than this post to properly explain the finer points of partner compensation, especially how each of the major compensation systems works. oh, did i forget? we wrote such a book, “cpa firm partner compensation: the art and science.”
more: fifteen steps to new partner buy-in | what buying in actually means | 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 | five people to keep out of partnership
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best practices and key concepts
as is the case with all of my lists, no one firm incorporates all of these practices in its partner compensation policy. but i have observed all of the practices below in one or more of the best firms i’ve worked with over 20 years.
- performance-based. there should be a strong link between pay and performance. when it comes to cpa firm performance and profitability: as the partners go, so goes the firm. the partners have a much greater impact on the firm’s success than professional staff and other personnel. if they perform at a high level, the firm will do the same. if partner performance lags, then the firm will suffer. therefore, the firm needs to motivate the partners to produce at high levels and reward them accordingly. compensation isn’t the best way to motivate anyone’s performance, but it is effective.
- business getting. bringing in business must be a major factor in allocating partner income. business development is the most important aspect of partner performance that is also the most difficult. the majority of cpa firm partners are not highly skilled in business development. it doesn’t come naturally to them. to be successful at bringing in business and contributing to the firm’s revenue growth, most partners need to go outside their comfort zones. these efforts must be handsomely rewarded if firms expect their partners to make the extra effort to bring in business.
- most important partner performance factors. these are easily the biggest factors among many:
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- bringing in business
- managing the firm
- providing world-class service to clients
- managing a large client base
- retaining clients and moving them upscale
- helping staff learn and grow; mentoring them
- intangible areas such as teamwork and loyalty
- multitier compensation systems. most firms adopt two or three tiers of income:
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- return on capital. this tier separates partners’ roles as shareholders and producers. the core philosophy here is that shareholders have money invested in the firm and are entitled to a return on their investment. at most firms, this tier is 2-10 percent of total partner income.
- base salary. this represents what each partner brings to the table every day. the base is primarily based on cumulative, historical performance, reflecting each partner’s street value. at virtually all firms, this is by far the largest tier, usually 60-90 percent of total partner income.
- bonus. this rewards unusually good performance in the current year. whereas the base is a partner’s street value, based a great deal on historical performance, the bonus is “what have you done for the firm lately (this year)?” at most firms, the bonus is 10-30 percent of total partner income. firms treat the bonus in two distinctly different ways:
- the base is independent from the bonus.
- the base is really a draw on a final income number; the bonus trues up the base to the final income number for each partner.
- method for allocating income. firms use several methods to allocate income. the two most common are these:
- compensation committee. this panel of a small number of partners subjectively analyzes each partner’s performance and links the performance to pay. this is the most common system by far at firms with eight or more partners. it’s considered the cadillac of all partner compensation systems because it’s the best system for recognizing the critical importance of both production and intangible factors and it entrusts the income allocation process to a panel of judges that the partners trust to exercise good judgment and fairness in their deliberations.
- the firm develops an algebraic formula for computing each partner’s income. the main factors are production-related: finding (originating clients), minding (managing client engagements and relationships) and grinding (billable hours). every formula must adopt a method of weighting the various production factors. formulas are notoriously flawed for ignoring critically important intangible performance factors. they are most commonly used at firms with five or fewer partners.
- goal setting. there should be a link between pay and the extent to which partners meet their expectations. one of the best ways to measure this is with formal, written goal setting.
- differentiation between management and administration. management is deciding what the firm should be and implementing. it’s leading. it’s holding others accountable for their performance and behavior. administration focuses on the day-to-day running of the firm. it monitors results, operates systems and supports practice personnel. both are important, but management is much more valuable than administration. most firms avoid paying partner-level compensation to do administrative work when the latter can be performed – usually more effectively – by someone earning a fraction of a partner’s income.
- teamwork. firms perform best when their partners work together as a team. they collaborate on clients. from time to time, clients are transferred from one partner to another when it’s in the best interest of the firm.
- originated book vs. inherited book. it goes without saying that bringing in business is a critical performance factor. managing client engagements and relationships is also very important, including situations where partners inherit clients that they did not originate (a partner retires or otherwise leaves the firm, new partners are assigned clients he or she worked on, etc.) in compensating partners, when a weight is assigned to managing clients, originated book should always be compensated more than inherited book.
- partner evaluations. there is a common myth among both partner candidates and partners themselves that once people become partners, they no longer need performance evaluations. better firms say hogwash to this. the purpose of partner evaluations is to improve performance; partners need to improve their performance, just like staff. partner evaluations should be used as a factor in allocating partner income.
- partner accountability. there are several ways to hold partners accountable for their performance and behavior. compensation is probably the most commonly used accountability measure in cpa firms, though it is not always the best.
seven systems used to allocate partner income
the following chart shows the kinds of systems that firms across the country are using. the information is from a recent edition of the rosenberg map survey.
| system | 2 partners | 3-4 partners | 5-7 partners | 8-12 partners | 13 + partners | all firms |
| comp committee | 6% | 12% | 33% | 57% | 78% | 33% |
| formula | 30% | 33% | 31% | 18% | 16% | 27% |
| paper & pencil | 3% | 2% | 5% | 2% | 0% | 3% |
| ownership percentage | 6% | 4% | 7% | 5% | 3% | 5% |
| mp decides | 15% | 17% | 9% | 13% | 3% | 12% |
| pay equal | 27% | 6% | 0% | 2% | 0% | 5% |
| all partners decide | 12% | 26% | 14% | 3% | 0% | 14% |
observations that can be drawn from the chart:
- the compensation committee method is clearly the choice at the larger firm levels.
- the formula is the most commonly used system at the smaller firm sizes. one reason for this is that the firm doesn’t have enough partners to justify using a compensation committee.
- using ownership percentage to allocate partner income is not very common because it is inherently unfair: only through a quirk of fate will partners’ ownership percentages be in line with their relative levels of performance.
if your firm uses a formula, new partners will likely not fit into your system because most new partners have not built up their client base and other production metrics sufficiently to result in a reasonable compensation under the firm’s formula. in many cases, trying to fit new partners into an existing partner compensation formula will result in reducing their salaries, which of course is unfair and inappropriate.
to address this dilemma, most firms continue to determine the new partners’ compensation the same way as when they were managers. this means the compensation amount of new partners needs to be carved out of the formula system.
what promotion raise should new partners receive?
the key concept is this: new partners should not receive a compensation windfall. they should receive an increase in pay that is
- a reasonable or even slightly generous promotion raise because it is a big promotion
- sufficient to put their take-home pay higher than during their last year as a manager
- recognition of what they are contributing to the firm’s growth, profitability and success
most new partners receive an increase in the range of 10-15 percent. firms find this is adequate to address the three issues above.
one final suggestion: many firms i have worked with have a policy of erring on the side of being overly generous to new partners in their first few years as a partner. the objective is to get them up to a “healthy” compensation level relatively quickly. this practice is much more common at firms with well above average profitability levels because they make more money and can afford to be generous. it goes a long way toward making new partners feel better about their minority roles in the firm and more comfortable taking on the retirement obligations to come.