Bringing in a New Partner: Changing to Today’s World

We know all too well that the #1 challenge in the CPA profession is finding and retaining people. Drilling down, the interrelated issues are:

• The declining number of accountants
• High school and college students’ reduced interest in accounting majors
• Partners being too busy to mentor staff and focus on this
• The challenge that firms have faced since the dawn of humankind – retaining and developing the staff you Our profession’s turnover rate is a frustrating 20%.

CPA firm partner earnings are at an all-time high and rising rapidly. But this is matched by rising frustrations caused by the above issues.

What can we do?

Firms are adopting major new strategies and tactics:

1. Thinking outside-the-box when recruiting. Examples are hiring graduates with non-accounting degrees and outsourcing/offshoring.
2. Making the process of admitting new partners less burdensome. Hence, this blog.

All of the questions below are from the same reader.

READER: I understand that promoting staff to partner has changed to a much lower buy-in than in years past. When we admit a new equity partner with a nominal buy-in, how much stock in the corporation are they allocated, and how?

ROSENBERG: First, let’s understand the four ways ownership can impact a partner:

1. Allocation of partner income. Firms have departed sharply from the ages-old practice of basing partner income on ownership percentage (which is, essentially, the stock). Instead, they base income on measures such as production metrics, mentoring and developing staff, managing the firm, and achieving goals. Ownership or stock plays little or no role.
2. Determining the buyout of partners departing due to retirement, withdrawal, termination, disability or death. Most firms now see the partner buyout as a form of deferred compensation and not an inalienable right. Hence, buyout systems are also performance-based, though not nearly as much as income allocation. Ownership plays little or no role.
3. New partner buy-in. It’s hard for anyone under age 50 to believe the way firms used to determine the buy-in. It went something like this. A manager was summoned to the managing partner’s office and told two things: First: “Congratulations! You are now a partner.” Second, the new partner was asked to write a check to the firm that was often several hundreds of thousands of dollars. The amount was calculated by multiplying (a) the value of the firm, by (b) an arbitrarily assigned ownership percentage. For example, if a firm was valued at $15M and the ownership percentage was 5%, the buy-in would be $750,000. For quite some time now, prospective new partners have been unwilling and unable to pay this huge price of entry.To solve this challenge, firms have made two significant changes: First, the new partner buy-in is determined, at the firm’s discretion, to be a more affordable, fixed amount that might range from $50,000 to $175,000, depending on the size of the firm. Second, instead of paying the buy-in all at once, new partners pay over a period of years from their bonuses and increased compensation. This way, it’s less of a financial hardship to the new partner. Corporations may address the stock issue by using a nominal price to value the shares. Some firms keep it simple by making every partner, including new partners, equal owners
   Bottom line: “Ownership percentage” and “stock” have a minimal impact on new partner buy-ins.

4. Voting. In years past, partners often voted based on relative ownership percentage or stock. Firms began to see that this disenfranchised new and/or younger partners; their dramatically lower ownership percentages meant that their vote was dwarfed by the votes of senior partners. Today, many second generation or older firms vote based on one person, one vote. For small firms comprised of both dominant and new owners, it wouldn’t be fair for a block of “minority” partners to overrule or even boot out dominant partners on critical issues, so protective measures are written into the partner agreement.

So, as you can see, stock ownership or ownership percentage is not always used to address the four factors above.

READER: I am still confused as to how to calculate the nominal buy-in. I realize it is at our discretion, but there must be some formula. We will be asked this, so I just want to be prepared.

ROSENBERG: There is no calculation to determine the buy-in amount. It’s decided by the firm at their discretion. It’s large enough that partners feel they have “skin in the game,” a meaningful amount invested in the firm that is at risk, just like any owner of a valuable company. But the buy-in amount is not so large as to be unaffordable. It should be noted that all partners’ capital accounts are redeemed upon departing the firm.

READER: Let’s say I retire and the firm pays me for my goodwill/deferred comp over six years. My client base is $1M. Assume the new partners only pick up what they are currently working on – say, $700k. What happens to the remaining $300k?

ROSENBERG: It gets assigned to other partners at the direction of firm management.

• It often gets assigned to partners with smaller client bases or to managers.
• There is often a trickle-down effect:
  • A few large or sensitive clients of the retiree are assigned to the remaining partners.
  • The remaining partners download some of their clients to those with smaller books or to new partners or managers.

Note: When assigning the retiree’s clients to other partners, including the new one(s), be careful that this doesn’t result in unfair windfall compensation to receiving partners. This is especially tricky if the firm uses a compensation formula.

Tactics for bringing in new partners have changed dramatically. With succession planning at the forefront of so many firms today, there is a heightened interest in developing programs for bringing in new partners. We work with firms to address the following:

What should be the criteria for promoting staff to partner? • How should they be compensated? • What should their ownership percentage be? • What should their buy-in be? • What voting rights should they have? • How do they participate in the firm’s retirement plan? • How do their duties change once they become a partner?

Let’s talk! Contact us to schedule a call.

READER: Who is responsible for determining how the transition of clients occurs?

Rosenberg: The firm should be responsible for devising the transition plan, not the retiree. Ideally, the two parties collaborate. But make no mistake – the firm should manage the process.

Too many times I’ve seen a firm relying on the retiring partner to make the client transitions (and, in some cases, the transfer of specialized knowledge) – and guess what? It never happens.

Key parts of the transition process include deciding:

• Which clients are assigned to whom
• When transitions begin
• How and when clients are informed and introduced to the successor

We like the following game plan:

Step #1: I (the retiring partner) do, you (the receiving partner) watch.

Step #2: You do, I watch.

Step #3: You do, I watch the Cubs game because I’m retired.

READER: How do we prevent the new partners from getting complacent about small client responsibility?

ROSENBERG: Easy. Don’t allow a new partner – or any partner for that matter – to have an undersized client list. That’s why CPA firms have a management team. Why would a firm make someone a partner and allow that person to manage an undersized client base? The firm should make someone a partner only if they are able to manage a reasonably large client base. It may be smaller at first, perhaps as low as $500K. But there should be a plan to get all partners, including newer ones, on a path to $1M or more.

It’s common for existing partners to delegate client responsibility to new partners for clients they worked on as a manager, thereby building up their client base. Again, caution: if the firm uses a compensation formula, it must avoid unfair compensation windfalls to new partners and equally unfair compensation reductions to the delegator.

READER: I like your process.

ROSENBERG: The key to the whole system is making the buy-in affordable and enticing. New partners should see this as a lucrative, painless financial opportunity:

• Easy buy-in with higher take home compensation, in cash.
• Dramatically higher compensation that builds over time. For example, if they were making $150K as a manager, within 10–15 years, they should be able to earn $300–600K, depending on their performance and the firm’s profits.
• Lucrative buyout.
• As famously sung in the hit musical, Hamilton, new partners get “to be in the room where it happens.” Yes, they will have a vote, but that’s not a big deal. More importantly, they will have a seat at the table with the opportunity to persuade their partners’ decision-making.