Partner Buyout of 2x Comp Can Be More Lucrative Than 3x Comp

QUESTION FROM A READER: In your interview of BKD MP Ted Dickman, he revealed that his firm’s partner buyout plan pays retiring equity partners 2x annual compensation paid out over 10 years. Our firm, with revenue of $10 million, pays 3x compensation. In the past five years we have retired two partners, each of whom received about $1.5 million spread out over 10 years. We are going to retire another two partners in the next two to five years, each of whom will probably receive roughly $1.2 million. Overall, our income per partner is $350,000.

From my perspective, our smaller firm has a much better retirement deal. Am I missing something?

Great question: Short response. Assume two firms:

• Firm #1 – $50M revenue; average partner income = $750,000; buyout plan pays 2x comp.
• Firm #2 – $10M revenue; average partner income = $350,000; buyout plan pays 3x comp.

Firm #1’s average partner buyout, at 2x comp, = $1,500,000. Firm #2’s average partner buyout, at 3x comp, will be $1,050,000. So, this is how 2x comp can be more than 3x comp.

More in depth response: Top 20 firms like BKD are significantly more profitable than the typical local firm. One reason is that their bar for making partner is higher. A second is that they are usually better managed than typical local firms, and this superior management usually translates to higher profitability.

BKD’s Dickman did not share his firm’s income per equity partner (IPP). But many top 25 firms have IPP between $600K and $900K, considerably higher than typical local firms. So, a buyout of 2x compensation at a BKD-type firm can easily exceed 3x compensation at a typical, local firm whose IPP might be $350K, like that of the reader’s firm.

Mr. Reader, your firm is very fortunate to have survived (and I hoped thrived) the loss of senior partners over a several year period. The keys to doing this successfully are:

• Great mentoring and development of staff as leaders, which leads to…
• Continually bringing in talented younger partners, resulting in a wide age range among the partners.
• Solid growth, year after year, so that when today’s younger partners retire, the firm will have an even larger, young partner group to share the buyout payments.
• A buyout plan where “the math works.” This means that the money saved by the firm by no longer compensating the retiring partners, EXCEEDS the buyout payments plus the cost of adding staff to perform the retiring partners’ work. If this works right, the remaining partners actually make more money than before the retirements. Caveat: This scenario becomes problematic if the “retired” partners continue to work, controlling their clients and earning high compensation.
• Retention of the clients of the retiring partners. This means that the firm requires effective, proactive client transition by the retiring partners to be eligible to receive buyout payments. We call this provision “no transition, no goodwill.”

A final point:
Once firms exceed the $15-20M revenue mark, the bar is higher for making equity partner than at smaller firms. Local firms’ criteria for making partner tends to be less stringent than at Top 20 firms, as they more frequently promote managers to partner as a staff retention tactic.

The way the math works: Firms with fewer partners in relation to their revenue will tend to post higher IPP.

To craft an industry-competitive buyout plan that will enhance future profitability, consult our monograph CPA Firm Partner Retirement/Buyout Plans.