CPA Firms’ Mad Dash for Non-Equity Partners

Once upon a time, most CPA firms promoted staff directly to equity partner with impunity. Law firms have long been ahead of CPA firms in the use of the non-equity partner position (also called “income partners” and we use both terms in this post), but CPA firms have caught up. Ten to fifteen years ago, perhaps 20-30% of CPA firms of all sizes had non-equity partners; today, that has doubled to just under 60%. As is the case with virtually all management practices, there is a huge difference between what the Top 100 firms (#100 has revenue of $45M) do and practices at the other 44,000 firms in the U.S.

• Top 100 firms – 90% have non-equity partners
• $10-20M – 73%
• $5-10M – 53%
• $2-5M – 20%

Why CPA firms’ use of the non-equity partner position has increased

1. Why does any business offer ownership in its business to employees? Because as employees, they are already making major contributions to the growth, profitability and success of the business and they will further drive the business as an owner. It would be foolish not to offer ownership because these valuable people will go elsewhere to make their fortune. Until CPA firms discovered the non-equity partner position, they were overly generous in bringing managers directly into the ownership ranks.
2. For decades, one of the main reasons that firms made someone a partner was as a staff retention tactic. It has long been common for firms to have managers on board who are highly competent technicians, productive, loyal people who toiled at their firms for 10-20 years. Firms feared they would lose these valuable people unless they made them partners. So they did. Despite being highly valuable people, they often lacked two critically important skills that firms need from their owners: bringing in business and leadership.

But then the income partner position started gaining traction. So firms now have an alternative to making all partners equity owners – promote the managers to income partner instead. The income partner position can be permanent or a way-station to equity partner.

3. Related to #2, firms have set the bar higher for becoming an equity partner. Equity partners earn considerably higher levels of compensation (both current and deferred) than non-equity partners because they are primarily responsible for the sustained growth and profitability of their firms. Many firms reason that as long as non-equity partners are paid handsomely and provided with advanced levels of challenge and responsibility and shown the love, there is no need to over-compensate them with the privileges of ownership.
4. Common sense prevailed. How many other businesses make all their valuable employees owners? Most don’t (banks are a great example). CPA firms learned that as long as those promoted to income partner are “treated” like partners (more on this later), are well-compensated, given substantial client responsibility and challenging work, the need to make them equity partners is greatly reduced.
5. The avalanche of mergers has resulted in the employment of partners at the sellers who either don’t qualify to be equity partners at the buyer or are too advanced in age to be owners.

As a reality check on the wisdom of having non-equity partners, look at what many international firms do. A look at MAP surveys of international firms shows that it’s common for firms in Asia, Mexico and certain European countries to have a substantially higher amount of revenue per equity partner than their American counterparts. Practices in Canada and the U.K. are similar to the U.S.

So, what role do non-equity partners play at their firms?

We can’t tell you how many times we have discussed the adoption of a new or innovative management practice at a CPA firm, only to hear them say “we tried that and it didn’t work.” But when I probe to find out why the practice failed, inevitably, we find that the practice didn’t fail because it was a bad idea.  Instead, it’s because the firm didn’t “do it right.” Such is the case with the non-equity partner position.

Our book How to Bring in New Partners is written for firms fortunate enough to have staff with the right stuff to be a partner.  This book addresses all of these areas and more, including: ►how do firms develop staff into partners and when are they ready ► should we have non-equity partners ► what is the process for bringing in a new partner ► how do new partners get compensated ► what should the buy-in amount be.

Purchase your copy today!

How do non-equity partners function at CPA firms? Very similar to equity partners. They:

• Manage a client base (whether they originated it or inherited it), often the same clients they served as managers.
• Evolve, over the near term, away from working for equity partners.
• Mentor, train, and develop staff.
• Sign-off on client reports.
• Attend partner meetings and partner retreats.
• Receive the firm’s financial data (except partner comp info).
• Don’t directly share in the profits of the firm, though they often receive an incentive bonus, which indirectly is sharing in the profits.

An emerging practice is to include income partners in the firm’s partner buyout plan, albeit at a much lower participation rate (around 1/3) than equity partners. Today, roughly 30% of firms over $10M are doing this.

Finally, while NE partners may not officially vote, they DO have the ability to influence other partners, the same as equity partners. Very few firms these days take formal votes on anything.

More interesting alternatives

On occasion, we have come across firms that have a large number of owners, but many of them function in substance more like a non-equity partner. Typically, at these firms, there are a small number of dominant, founder or senior partners, and a number of what we’ll refer to as low-equity partners. The key nuances of this type of structure are:

• All partners are owners (so it’s not a case of being truly “non-equity”)
• At some firms, the low-equity partners do not share in the firm’s partner compensation system or the sharing of the larger profits of the firm. They instead receive a salary and possibly a discretionary bonus, determined by the senior partners.
• At some firms, the low-equity partners do not consistently sign a partnership agreement. The problem here is that typically a firm would want their low-equity and non-equity partners to be subject to many provisions of the agreement (e.g. non-solicitation, duties and expectations, etc.)
• At some firms, the low-equity partners have equal voting rights. Watch the fun when they start to outnumber the high-equity partners.

The kiss of death to the non-equity partner position

We said earlier that many firms tell me that certain management practices were tried and “didn’t work for them.” Too often, the problem isn’t the efficacy of the practice; instead, the firm didn’t implement the practice properly.

The only way the non-equity partner position works is for firms to treat their non-equity partners as “real partners.” Non-equity partners must be seen by clients, staff, referral sources and the community at large as partners. The only people who should know that these people are non-equity partners are the equity partners.

The moment the firm or its partners do things that broadcast to stakeholders that non-equity partners are any different than equity partners, this concept fails because it makes the non-equity partners feel like staff or second-class citizens and that their promotion was gratuitous.

Does your firm utilize the non-equity partner position? Has it worked well for you?