CPA Firms’ Overemphasis of Ownership Percentage
1. Many clients use ownership percentages to drive important matters. CPA firms reason: “If our clients do it, why shouldn’t we?”
2. Related to #1, many CPA firm clients are companies who derive a major portion of their growth, profitability, overall success and value from branded products, plant, equipment, proprietary processes, patented technology and the goodwill/market recognition that comes from these assets. It’s understandable that one’s ownership percentage in these businesses should strongly impact financial and governance issues.
CPA firms are different. Their primary asset is the partners’ ability to bring in and retain annuity clients, every year, to perform a highly technical service from scratch, every year and thereby, earning clients’ trust and respect, every year. The growth, profits and success of a CPA firm occur because of the owner’s work effort and skills to create these benefits every year. CPA firms need to reinvent themselves and continue peak performance every year to remain successful.
3. It’s a power grab and/or an opportunity to avoid accountability. It’s so much easier to take 30% of the firm’s profits because one is a 30% owner instead of earning it. It’s so much easier for one to commit transgressions of firm policies (take excessive time off, have delinquent billing and collections, give oneself a waiver on business or staff development) safe in the knowledge that one can never be held accountable for those indiscretions due to the protection of a lofty ownership percentage.
One of the strongest arguments to minimize the importance of ownership percentage in CPA firms is simple: Fairness. It’s simply not fair to overly rely on the use of ownership percentage to decide many critical financial and governance matters. Heavy emphasis on ownership percentage is guaranteed to cause tremendous acrimony among current and future partners.
Our book, CPA Firm Partner Retirement / Buyout Plans is a must-read for firms that either need to revise and update their existing plans or need to write a new agreement. The book addresses ► what CPA firms are worth ► what partners must do to get their buyout money ► how to value a firm’s goodwill ► the acid test of a well-conceived retirement plan ► 6 methods of determining an individual partner’s buyout ► vesting ► notice and client transition requirements ► mandatory retirement ► non-compete and non-solicitation covenants ► how to prevent your plan from becoming a Ponzi scheme and other issues
Firms get twisted up in the illogic and unfairness of using ownership percentage and find themselves trying to solve unsolvable problems using old school methods. They need outside-the-box thinking.
Here is an illustration. Contrast the performance of the following two partners:
There are five major partner issues that firms should resist connecting to ownership percentage: Can there be any possible justification for Partner A’s compensation and buyout being twice as high as Partner B’s?
- Allocation of partner income. Should be based primarily on each partner’s performance, not their ownership percentages.
- Calculation of partner buyout. Should be based primarily on what partners have contributed to the firm’s profitability and success, usually measured by relative partner income, not ownership percentage.
- Should be one person, one vote for the vast majority of issues (most firms tell us they rarely take formal votes). If voting is based on ownership percentage, new and younger partners feel disenfranchised because older partners “control” the votes.
- New partner buy-in. Should be determined as a fixed amount, independent of ownership percentage. Use of ownership percentage to determine new partner buy-in often results in an enormous buy-in amount that new partners are unwilling or unable to pay.
- Allocate proceeds of a firm sale. Should use the same method as in partner buyout. Why use performance-based measures to decide buyout and ownership percentage for firm sales? This makes no sense. They really are the exact same transaction.
By determining the outcomes of the above based on performance (income allocation, buyout, sale proceeds), partner role (voting) or fixed amount (buy-in), partners are likely to agree that the result is fair. An added – and perhaps even bigger – bonus is that this fairness reduces the divisiveness that can come when too many important matters are tied to ownership percentages.