CPA Firm Partner Agreements – Top 10 Weaknesses
Marc Rosenberg, CPAThousands of CPA firm partner agreements haven’t been updated for 20, 30 years or more. At some firms, this oversight is due to a lack of time. At other firms, the issues neglected are somewhat sensitive so the partners avoid addressing them. At most
firms, it’s a little of both. Here are 10 partner agreement areas we see neglected time and time again.
- Partner retirement provisions are hopelessly behind the times or simply ignored. Most prominent by far, are notice of intent to retire and specific client transition procedures for a pre-retirement partner. Other neglected areas include vesting, limits on annual payouts to all partners and mandatory retirement.
- New partner buy-ins are too high. They have come down considerably in the last 20 years. 80-90% of all firms, large and small, now specify buy-ins of $150,000 or less.
- Many agreements still specify that ownership percentage plays a huge role in income allocation, retirement benefits and voting. Today, the impact of ownership percentage is much less than it used to be.
- Agreements fail to restrict partners from drawing compensation that is higher than their income allocation percentage.
- Voting that is driven by ownership percentage disenfranchises new partners, contributing to their feeling of not being a “real” partner.
- Grounds for expulsion are not detailed enough. Most agreements even fail to include a provision for dismissing a partner who is unable or unwilling to perform as a partner. Without this provision, a firm may not be able to dismiss a partner for performance reasons.
- Many agreements have no non-solicitation provisions.
- Many agreements do not specify how to compensate a disabled partner who is not working.
- Some agreements contain an excessive amount of verbiage describing the system used to allocate partner income. The best agreements are almost completely silent on this because firms change their systems so often.
- Few agreements provide for non-equity partners and (non-CPA) principals.There is so much material on each of the above that I could easily do a separate post on each. If you’d like me to expand on any of these issues, please comment below or give me a holler.
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In regard to item #1 above, I’m wondering if we are too out of sync with the rest of the world. Decades ago our firm dramatically reduced our deferred compensation (70% of average of 3 highest years of compensation), and I believe that has helped us survive as an independent firm now for over 70 years. No big buyouts forcing us to sell out or creating an exodus of younger folks. We accrue our deferred compensation as well thus we really are paying for it ourselves as we go since it reduces our current accrual basis earnings. However, at 70% is our deferred compensation much lower than the norm? And is it also unusual for the deferred comp. to be accrued? Thanks for your thoughts.
A 70% goodwill valuation is perfectly reasonable. The national average is in the upper 70s. Nothing wrong with erring a bit on the conservative side; it makes an easier sell to the younger partners who will write your retirement checks.
On the matter of accruing deferred comp, I’m not exactly sure what you mean. If you are actually funding the deferred comp, that’s very unusual for firms under $20M. Though its more common for firms over $20M to fund their deferred comp, it’s still not the norm. If you are accruing the deferred comp, and this means that a lower amount of income is distributed to the partners in cash, and the difference retained in the firm as capital, that sounds like funding to me.
Funding deferred comp is like so many practices in firm management: just because most firms do a certain practice, that doesn’t mean it’s “right.” If your partners are comfortable accruing the deferred comp, then there is nothing wrong with it. There are two main reasons why firms don’t fund their deferred comp: (1) It’s very expensive and (2) most firms find that they can afford to pay deferred comp out of current earnings, so they are reluctant to fund it in advance.
Please expand on non-equity partners and pricipals. We are thinking seriously about doing something in this area.
Drivers are people whose talent, leadership skills, personality and work ethic enable the organization to achieve excellence. All organizations need drivers to excel beyond the competition, to exceed being average. Sports teams, governments, charities, orchestras and yes, CPA firms – all need drivers. An organization that lacks drivers will slide to average and may eventually fail.
In a CPA firm, drivers are partners who bring in business, keep clients because of great service, lead others and develop staff into leaders. Drivers “drive” the firm’s revenues and profits.
An equity partner is someone who drives the firm. But firms need a second type of partner to be successful – those who have the skill and personality to play a leadership role in servicing and retaining clients, but haven’t yet attained the “driver” level. Many firms call these important people non-equity partners. The two most common reasons to have non-equity partners are (1) to provide younger CPAs with an extended track to equity partnership, thus providing them with the time to develop their skills, including business development and (2) to retain critically important staff who otherwise might leave the firm, but lack the skills to be an equity partner.
Many firms make the mistake of promoting staff directly from manager to equity partner, without first considering the intermediate stage of non-equity partner. To clients, staff and the community, a non-equity partner is a “partner.” Non-equity partners attend partner meetings, manage a client base, have access to the firm’s financial records (excluding partner earnings) and are eligible for a share of the firm’s profits in the form of an incentive bonus.
The 2011 Rosenberg Survey showed that 78% of firms over $20M have non-equity partners, 61% of firms from $10-20M have them and 39% of firms under $10M have them. We strongly encourage the non-equity partner concept and the creation of the position in the partnership agreement.
Bob, I would be happy to talk more about non-equity partners over some pasta and a bottle of Montepulciano D’Abruzzo. My treat!