12 Practice Management Blunders: Part 2 of 3

Providing consulting services to CPA firms is a great job. We get to work with dozens of successful, hard-working firms every year, which puts us in the enviable position of observing best practices and practices that are, well, not so good. The latter enables us to share with firms how to make changes that will improve their practices.

We see 12 practices over and over again that are either ineffective, poor choices or misguided. In this three-part blog series, we share these practice management blunders with you. This is Part 2.

View Part 1 of the series to read about blunders 1-3 here.

4.  New Partner Buy-ins are Prohibitively Expensive

The CPA profession has enough problems keeping staff and developing them into firm leaders, there are plenty of reasons staff don’t want to be a partner other than a big buy-in. This is made all the worse when some firms tell these young people that they have to come up with buy-ins of $500,000 or more.

Many years ago, baby boomers were asked to pay a buy-in of hundreds of thousands of dollars – in a lump sum, no less – and when the boss said “Jump,” the baby boomer would ask, “How high?” Today, younger people say, “Why jump? I’ve got a better way.”

In the olden days, the buy-in was computed by multiplying the new partner’s ownership percentage by the sum of the firm’s goodwill and capital. The usual result was an extraordinarily high amount. This changed when, increasingly, younger people were neither willing nor able to pay the large buy-ins.

Thankfully, for many years now, the vast majority of CPA firms have substantially reduced the buy-ins by disconnecting the buy-in from ownership percentage. The most recent Rosenberg MAP survey shows that the average buy-in was $165,000.  74% of all firms had buy-ins below $200,000. The buy-in is now a fixed amount at the firm’s discretion and is seen as ante to get in the game. In the past, the buy-in literally was to acquire a nice chunk of the firm’s significant value. Today, it allows them a seat at the table and a chance to vest in the future growth in the firm over time, instead of needing to show up with a suitcase full of cash to buy this value upfront.

5.  Using Ownership to Determine “Everything”

One of the more intuitive practices in compensating the owners of any business is to use ownership percentage (or relative share amounts) to drive processes such as compensation, buy-out, new partner buy-in and voting. Many clients of firms do it this way, so it would seem to be a reasonable way to go.

But using ownership percentage to drive these CPA firm processes is a big mistake. We’ll explain why by reviewing the four major impacts that ownership percentage could have on partner issues:

• Partner income allocation. One of the more fundamental practices in business is to compensate people – owners or employees – for their performance. If a firm allocates partner income primarily on ownership, the system will not be performance-based, which can encourage the firm’s partners to coast because they have no incentive to do more.
• Partner buy-out. Basing most or all of a partner’s buy-out on ownership shuts out the newer partners from participating and benefitting from their contributions to growing the firm (not just bringing in business but many other things). Newer partners wonder how they can increase their ownership other than by buying equity from existing partners at prices that are unaffordable to most. Of all firms with five or more partners, 70–80% calculate buy-outs based on performance (a multiple of compensation or AAV), commonly measured by relative compensation. This, of course, assumes that the comp system is fair and performance-based.
• New partner buy-in. The old school method, long abandoned by most firms, was for existing partners to decide on an ownership percentage to be awarded to a new partner and to then multiply that percentage by the sum of the firm’s capital and goodwill. This almost always resulted in a buy-in amount of many hundreds of thousands of dollars or even over $1 million, a sum which new partners were neither willing nor able to pay. The system for most firms today has shifted to deciding a relatively nominal buy-in amount ($75,000 to $175,000 for the vast majority of firms), thereby disconnecting the buy-in amount from ownership percentage.
• Voting. Another big shift from past years. If firms vote based on ownership percentage, they disenfranchise new partners whose votes are too small to affect the outcome. The vast majority of firms today use a one-person, one-vote/majority rules system for most issues and a supermajority vote on a small number of critical issues such as electing the MP, merging with another firm, promoting someone to partner and expelling a partner. It should be noted that the vast majority of firms never actually vote. Instead, the partners discuss an issue and decisions are made by acclimation.

So, firms are urged to minimize the impact of ownership on the above processes to avoid being unfair to many of their partners.

CPA Partner Compensation: The Art and the Science explains ►Partner comp 101 ► the 12 systems used by all firms ►how to design your firm’s system ►open vs. closed systems ►the role of “book of business” ►differences between large and small firms’ systems ► the MP’s compensation ► trends and controversies and ►overall best practices.

Purchase your copy today!

6.  Setting Partner Billing Rates Too Low

Since the inception of The Rosenberg Map Survey 24 years ago, we have tracked the correlation of various performance metrics and ratios of CPA firms to their profitability. Near the top of the list – every year – is partner billing rates. There are several reasons for this (note that we focus on partner billing rates because the rates of staff members are in sync with the partner rates):

1. The obvious one is that high billing rates produce higher fees and profits.
2. High partner rates usually indicate that a firm delegates as much work as possible to staff. This way, partners’ billable hours are limited to partner-level work, which can be billed at (higher) partner-level rates. Low rates often mean that the partners are doing staff-level work and thus are setting their rates at a blend of partner and staff rates. They feel (quite rightly) that they cannot charge partner rates for performing staff-level work.
3. High billing rates are a good way to filter out undesirable clients, who (a) may be looking for the cheapest prices without regard to quality, and (b) are too small to afford high billing rates.
4. It’s a way of monetizing self-confidence. Partners with high partner rates believe they are worth every penny of their rates.

One final observation: A significant number of partners at firms under $20 million or so are not effective at business development and don’t like doing it. They reason that if their fees are cheaper than the competition’s, they will gain a competitive edge. When we see firms brag on their websites or in sales pitches that they are “affordable,” this really means cheap.

Firms should strive to have their clients say this about them: “They’re expensive, but they’re good.”

7.  Manage By Committee

Let’s differentiate a management committee vs. an executive committee:

• Management committee – consists of most or all of the partners, and each is assigned administrative duties in areas such as recruiting, training, technology, marketing, HR, internal accounting, or office management. Firms that manage by committee usually do not have a high-level COO or firm administrator on board. The MP usually does not have a lot of authority and very little oversight ability over the other partners in their administrative roles.
• Executive committee – functions like a board and usually consists of far fewer than all the partners. The MP is always chair. The firm usually has a high-level COO or firm administrator to perform most of the firm’s admin duties, thus keeping the partners away from administration.

Smaller firms – say under $10 million – mistakenly adopt the management committee approach. Why, you might ask, is this a mistake? Managing by committee:

1. Waters down and delays decisions.
2. Places partners in the position of prioritizing client vs. admin duties; client issues win almost every time. Admin duties are done when a partner has no pressing client matters to attend to or in their spare time. Guess how that works out.
3. Is often adopted because partners often feel that they (a) can perform admin duties better than a professional administrator, and (b) they save the firm the cost of administrators by doing the admin work themselves. What a joke!

The compensation of most partners at firms over $5 million averages between $500,000 and $800,000. Administrators are paid between $75,000 and $175,000. Quite a difference. Why strap partners who earn a lot more money for the firm than administrators do with admin work that takes them away from client matters? Makes no sense. Partners should do two things and two things only: manage their clients (and prospects) and manage their staff. Well-managed firms keep their partners out of admin. Don’t misunderstand: administrators are very valuable to their firms, but partners don’t have to be the ones to do that work.

Stay tuned for Part 3 where we explore even more practice management blunders.