How Voting Should Work at a CPA Firm

A great deal of the content of this blog was obtained from in-depth discussions with Peter Fontaine, a nationally-known attorney specializing in CPA firm legal issues and business practices. Peter is the founder and managing partner of NewGate Law. He has served as legal counsel for RSM and Arthur Andersen. Fontaine can be reached at (312) 626-2791 or at pfontaine@newgate.law.

Voting is among the more deceivingly complicated aspects of firm governance because:

1. There is a natural conflict between owners’ natural desire to be democratic, fair and inclusive with their justifiable reluctance to unwisely give power to the minority to overrule the majority.
2. It’s awkward deciding when to take a vote and when to informally make decisions by consensus.
3. It can be tricky deciding how many votes it should take to pass a motion, especially at firms with less than 5 partners.

Most firms have told us over the years that they never take a vote; instead, they reach consensus.
This makes a lot of sense. But something needs to be in the partner agreement to address when a formal vote is required and how the voting should work. This is the focus of today’s blog.

The term “voting” refers to formal provisions, in writing, in a partner agreement. The term “partner” refers to equity partners.

Two key variables

CPA firms come in many shapes, sizes and types. Their method of voting is heavily dependent on two key variables:

1. How many partners? Voting concerns and preferences at a 3-5 partner firm are quite different from an 8-partner firm which is quite different from firms with 15-20 partners. The smaller the firm, the more likely their partners will want major decisions made with the consent of all or most key partners.
2. The extent that the firm has dominant partners vs. a firm lacking this domination. “Dominant” can mean: (a) founders, (b) those that produce at a level well above others and (c) those who are much more senior than the others. It’s quite natural that dominant producers will not want to allow a situation where the minority rules.

It depends…

The choices for the majority of firm governance practices are fairly limited and clear. Examples: Term of the managing partner, duties of an executive committee, grounds for dismissal of a partner. But the overarching aspect in deciding how to vote is “it depends”. Not very satisfying, we know. But common sense must prevail because it’s ultimately up to the partner group to agree on how it wants voting to work.

A few years ago, upon being engaged by a firm, we asked what made them decide to hire us. They said: “We initially discussed joining a CPA association for guidance on managing our firm. We took a vote and the result was 5-2 in favor of joining an association. We rejected that idea and instead, reached a consensus to hire a consultant”. Even though their partner agreement provided for their initial vote, based on majority rules, to pass, they decided instead to decide by consensus. So, their voting was decided by “it depends”.

More specifically, voting “depends” on the key variables listed in the earlier paragraphs. For example:

• If a firm has 3 partners, they may decide that major decisions need to be unanimous. Or they may decide that a 2-1 vote will pass a motion. It depends on what the partners want.
• If a firm has 7 partners, it may decide that a supermajority vote on certain key issues is 67%, 75% or 80% (we’ve seen all three). 67% requires 5 votes out of 7 to pass. 75% requires 6 of 7 votes. It depends.
• If a firm has 5 partners and one is a dominant founder, MP, and producer, they could vote one-person, one vote, or decide-in addition, that no vote passes without the dominant partner approval. This provides founders with the assurance that the other partners can’t approve or reject major decisions against their will such as doing a merger or changing the partner agreement. Once again, it depends.

Majority vs. supermajority voting

Virtually all firms have these two categories of voting. Majority votes are for most issues; whether or not to take a formal vote depends on what the partners want. Examples: Changing software, hiring a consultant, awarding bonuses to staff, etc.

Supermajority votes are reserved for critically important issues such as changing the partner agreement, admitting a partner, doing a merger, expulsion of a partner, capital expenditures over a certain dollar amount and removal of the MP.

Firms feel that due to the critical importance of supermajority issues, a motion to pass must have a much higher level of support than a mere majority. Common supermajority percentages are 67%, 75% and 80%. The most common is 67%.

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The math of voting

Firms’ voting practices often depend on the number of partners:

• At a 5 partner firm, a majority motion passes with a slim 3-2 vote. Does the firm want to pass a vote with that slim of a margin?
• At a 7 partner firm, a majority motion passes with a 4-3 vote. Is this what the firm wants?
• At a 6 partner firm, a 67% supermajority is a 4-2 vote whereas a 75% level requires five partners to vote yes. What does the firm prefer?

As you can see, there is almost an endless number of scenarios. Every partner group must agree on the voting thresholds. Further complicating matters, voting provisions often need to change as the number of partners increases and the presence of dominant partners changes (some may eventually retire) or both.

Requiring unanimous votes

This can be another tough decision. This dilemma is limited to small partner groups, generally 5 or less and especially 3 or 4. Let’s take the case of a 3-partner firm. On the one hand, it’s understandable that the partners might decide a unanimous vote is needed for critical decisions like admitting a partner or merging. On the other hand, requiring unanimous decisions enables one partner to block the other two. For this reason, firms are advised to avoid, wherever possible, requiring unanimous votes. As a practical matter, if a firm is considering the promotion of a manager to partner, with two favoring and one opposed, and they can’t resolve the issue, this could be indicative of deeper problems in the partners’ relationship and could eventually lead to a break-up.

Veto power

Most firms have a natural inclination to be democratic and inclusive, voting on a one-person, one-vote basis wherever possible. The firm’s partners, including dominant ones, want their other partners to feel like a “real partner” and that their vote counts.

At small firms with a dominant partner or two, voting gets tricky. On the one hand, as said earlier, partners have a natural inclination to be democratic. To do otherwise can result in a feeling of disenfranchisement by junior partners. On the other hand, it would be foolish for the dominant partners to allow a block of lower-producing partners to out-vote them on critical issues like compensation and mergers.

There are two ways for dominant partners to protect themselves against adverse votes:

1. Specify that for specific types of votes, in addition to the majority or supermajority being reached, the dominant partners, by name, must approve. This essentially is veto power.
2. Specify voting on the basis of ownership percentage instead of one-person, one-vote. This of course presumes that the dominant partners, by the nature of their high ownership percentages, control the voting. Voting by ownership percentage, however, presents two problems:
   • Other partners are essentially disenfranchised.
   • There is an inherent unfairness in placing too much importance on ownership percentage

Non-equity partners

Over the years, CPA firms have been changing their definition and use of equity vs. non-equity positions. The bar for making equity partner is higher than ever before. This has resulted in non-equity partners performing at much higher levels than in the past. In recognition of this, a sizeable minority of firms (mostly over $10M) are including their non-equity partners in the firm’s partner buyout plan, albeit at much lower levels than equity partners. A couple of firms we have talked to in recent years have had discussions about giving a vote to non-equity partners. To date, we are unaware of any firms giving a formal vote to non-equity partners. It should be noted that non-equity partners should attend partner meetings and be entitled to express their opinions and influence others, despite not having a formal vote.

Low-equity or buying-in partners

Another practice we’ve run across is that firms give newer partners, a lower amount of sway in voting for the first five years as equity partner. After that time period, their weight is equal to other more senior partners. This serves to give the incoming partners some impact but does not give them the same voting power as more experienced partners right away. Over time, the senior partners recognize that the newer partners do need to have an equal weight vote for the good of the firm and continuation of passing on leadership responsibilities.

Executive committee

The threshold for firms having an executive committee generally starts with seven partners or so. As the number of partners at firms increases, more decisions are made by the executive committee with fewer decisions made by vote of the full partner group. Generally, the decisions that are subject to a supermajority vote are reserved for votes of the full partner group.

What’s your vote? Does your firm have other unique practices on voting matters that we haven’t listed here?