Keys for Crafting a New Partner Buy-in
Marc Rosenberg, CPA
Here are 6 concepts for CPA firms to take into account for deciding how to structure a new partner coming into the firm:
Should this person BE a partner? Too many firms shoot from the hip in determining who should become a partner, essentially re-defining promotion criteria every time they discuss the subject. Don’t you owe it to yourselves to spend one paltry hour formalizing, in writing, critically important criteria to consider in making this decision? Perhaps equally important, you can show it to staff and refer to it in mentoring sessions to clarify what it takes to become a partner. Staff at 90% of all firms under $15M haven’t a clue what it takes to become partner.
Should a candidate serve first as a non-equity partner before becoming an equity partner? One way firms use the non-equity position is to provide a training ground for equity partnership. Staff people with 10-15 years experience commonly acquire most of the skills required for partnership except for two critical, often elusive talents: bringing in business and leadership skills.
Answers to the following questions determine “leadership skills”: Will clients delegated to them be OK with calling the new partner first instead of the origination partner? Does the new partner have the credibility with both partners and staff to be accepted as a leader, leading by example? Can the new partner help drive the firm? Will the new partner be a difference-maker at partner meetings or a bump on a log? Can the new partner resolve conflicts?
At some firms, non-equity partners can remain so for life. At others, the expectation is that non-equity partners will devote the time spent in this position to (a) acquire the skills necessary to become an equity partner and (b) decide if they are truly cut out to be a partner.
Eliminate the term “ownership percentage” from your vocabulary. The term “ownership percentage” wreaks havoc at firms in three major ways: (1) Determining the buy-in amount by multiplying a new partner’s ownership percentage times the value of the firm. The problem is: how is the ownership percentage of the new partner determined? There is no rational way to do this. (2) Allocating income and computing buyout payments based on ownership percentage. These approaches are unfair to the partners because their relative ownership percentages usually have little correlation to their relative performance. (3) Voting based on ownership percentage, which essentially disenfranchises new partners because their vote is so small compared to partners with much higher ownership percentages.
Best way to deal with all of this: Don’t use ownership percentage to determine anything.
Large buy-ins are out of vogue. Years ago a new partner’s buy-in was determined by multiplying a newly-awarded, arbitrarily-decided ownership percentage times the value of the firm (capital PLUS goodwill). This approach results in a buy-in amount of hundreds of thousands of dollars at most firms, an amount that young partners cannot afford and are not willing to pay. Firms today disconnect ownership percentage from determining the buy-in amount. Instead, they arbitrarily decide on a buy-in amount for all incoming partners. For many firms, this amount is $75,000-$100,000, regardless of firm size.
That being said, there is no law preventing a firm from requiring 6-digit buy-ins. The current Rosenberg Survey documents that 11 firms out of 348 had set their buy-ins set $500,000 or more. If this is what you want and you can get it, more power to you!
The value of a CPA firm should be its accrual basis capital PLUS goodwill. This value should not be “given away.” Bringing someone in as an owner of a profitable, viable business, for little or no buy-in, makes no sense.
New partner compensation should be based primarily on contribution to the firm’s growth, profitability and success each year, relative to the existing partners. A CPA firm operates differently than many other organizations in this respect: The value of the firm, today and tomorrow, as well as the profitability of the firm, today and tomorrow, is linked strongly and directly with each partner’s efforts to maintain and build the firm every year.
Our monograph, How to Bring In New Partners, is a step-by-step guide for firms looking to bring in new partners, including useful checklists, templates and guidelines based on current industry best practices.
4 Comments
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I really like this article. I am not a partner but a manager. I have no clue what it takes to become a partner at the firm. The partners would never share any information regarding buy-in etc. It’s really hard to plan for the future when you don’t have all the facts in front of you. Since the firm was formed only 2 people became partners but it seems like they have very little decision making abilities. Should I be asking for this information from my firm? It just seems like it’s a big secret. I would be really disappointed if the time arrives and I would be asked for a large buy in. If there is no ownership percentage how the decisions are being made? I’m just all new to it. Thanks
Partners tell me that staff don’t seem to want to be a partner. This is not entirely true. Staff tell me they want to be a partner, but first, they want to know what it means to become a partner. It’s perfectly reasonable to be reluctant about making a huge financial move (becoming a partner) until you know what the deal is.
Unfortunately, many firms are secretive about how to make partner. A forward thinking, growth oriented firm that wants to develop its young people into leadership positions needs to be counseling its staff, especially its stars, early and often about what it takes to become a partner and what the incredibly lucrative benefits are. This includes telling them how the buy in works.
One of the most misunderstood aspects of being a partner is the way decisions are made at the firm. Most of my clients tell me they never take votes. They discuss the issue at hand. They look for consensus. And they make decisions. How do partners impact decisions? By persuasively stating their case and getting other partners to follow their lead.
I believe “Ownership Percentage” is important. Our firm requires new partners to buy at least a 10% position. We use your recommended formula of accrual capital plus Goodwill. New partners use their annual bonus to purchase their interest in the company.
Income is allocated–25% based on ownership and 75% based on performance. Voting is based on ownership but each member of the executive committee has one vote.
Before becoming a partner, you must first go through our Partner-in-training program. Usually one year.
I’m sure there are a lot of ways to bring in a new partner, but this one has worked for us.
Rob – thanks for taking time out during the tax season to write me your excellent comment. There’s an old adage everyone is familiar with: “If it ain’t broke, don’t fix it.” If all of your partners are truly happy with your system, and it doesn’t alienate future partners, including those who join the firm via merger, then who cares what other firms do? By all means, keep using your system.
The operative words above are “if your partners are truly happy…” I have found that partners frequently think they know what their other partners are feeling, but the reality is, they don’t because, for various reasons, the other partners won’t voice their true feelings on matters, especially if there is a strong, dominating MP.
My experience in working with firms is that when ownership percentage plays a strong factor in compensation and buyout, invariably, some partners are overpaid and some underpaid.
When firms have large buy-ins (the result of multiplying ownership percentage times the firm’s capital + goodwill), we have found that the resulting buy-in requirement, often $400,000 or more, discourages staff and prospective merger partners, from wanting to be a partner.
If voting is based on ownership, then the newer partners will feel that their vote doesn’t matter because it’s so small.
I like your policy of having each partner serve a year in a partner-in-training program. Makes good sense.
A best practice in CPA firm management doesn’t mean the practice is always right for every firm. Firms need to embrace practices that are right for them.