A Tale of Partner Compensation

We are big believers in the case study method of learning. So, we have created a set of facts (a story) for a mythical CPA firm (although the facts below are a composite of actual experiences) that we will use in reviewing the art and science of allocating partner income.

The story

1. $20M firm. 13 partners; income per equity partner is $450,000. Partner ages: 52 to 60. There are two managers ready for a partner promotion.

2. They have used a compensation formula for a long time. The partners’ direct quotes explain why:

1. • “It’s a formula and, as accountants, this appeals to us because of the numbers.”
   • “We like having no subjectivity; this way, no arguments, no bias, no secrets.”
   • “We want partners to service a large client base and rack up substantial billable hours; that’s how CPA firms make money. Using a formula to allocate income is consistent with this.”

3. The formula works as follows:

1. • 30% based on billings.
   • 30% based on billable hours.
   • 20% based on ownership percentage, which varies widely by partner.
   • 20% based on the MP’s subjective judgment; but for years, this tier has been allocated evenly to all partners.
   • The MP has the largest client base by far of any partner.
   • Partner buyout is based on the size of the retiring partner’s client base.

4. Disenchantment with the present system has arisen:

1. • Arguments over the formula’s components and their weighting.
   • Some partners are coasting, content with their income.
   • Partners are motivated to do what’s best for them and not the firm.
   • Some partners are hoarding work and don’t delegate work to staff because they benefit from hoarding under the formula.
   • New partners don’t fit into the formula because their billings are too small.
   • Many clients appear on one partner’s billing run but are managed by another partner.

The climax

The overarching points are:

1. This firm needs to mostly or totally abandon the formula.

2. Regardless of the income allocation system chosen, they need to differentiate between Finding (business origination) and Minding (client base managed). When they do this, the following problems get eased:

• • Clients can be transferred between partners without penalizing the delegator.
  • New partners fit better into the formula.
  • Each partner’s client run will only include clients they actively manage.

3. The MP’s subjective tier must never be equal or based on ownership percentage. These are non-performance-based methods. Instead, this tier should be allocated based on the sound, credible assessment of the partners’ performance by the MP or a compensation committee. Performance intangibles and achievement of goals should be an important part of this process.

4. The MP needs to focus more on firm management and reduce his/her client duties.

5. The buyout should be determined using the multiple of compensation method, not based on billings. With the latter, partners will never transfer clients to other personnel.

6. Overall, the firm needs to adopt the one-firm concept.

7. Doing all of the above will increase partner accountability.

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. 

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Debunking myths about partner compensation formulas

Accountants like compensation formulas because they love anything with numbers. CPA firm partners are senior executives with many high-level skills and duties. No successful executive in ANY endeavor can be properly evaluated based solely on numbers.

Formulas are beautiful. Because there are no subjective factors, there are no arguments. Patently untrue, as witnessed by our 20 years of helping dozens of CPA firms move away from the pain caused by their formulas. One of the main reasons firms abandon their formulas is because there are arguments—arguments over what the factors should be, how they are measured and what the weighting of each factor should be.

Subjectivity in allocating partner income is synonymous with bias and unfairness. First, the term “subjective” gets a bad rap. Subjectivity isn’t synonymous with bias or unfairness. It doesn’t mean arguments. It means that good, sound judgment is made in evaluating partners. Again, the success of high-level executives in any endeavor can never be measured without some subjective judgment. Second, if a firm has a properly empaneled compensation committee composed of the firm’s most trustworthy, credible, fair-minded partners, the negative connotations of “subjectivity” are greatly minimized.

CPA firms make money when their partners do a lot of client production. That’s why the formula works—because it rewards partners when they make money for the firm. Many top firms believe that what partners do with their non-billable time is more important than what they do with their billable (client) time. Firm leadership/management and outstanding staff development/mentoring can have just as big an impact on the bottom line as client production.