Partner Compensation Therapy Session: Part 1

This blog series is patterned after a terrific TV show from 2010, “In Treatment.”  The show brought us inside a psychologist’s office as he conducted weekly sessions with various patients.   Gabriel Byrne was masterful as the psychologist. 

In this two-part series, the patient is 56-year-old Pat, the oldest of 8 partners in a $10M CPA firm, located in a major city.  Pat’s firm is 30 years old and has seen better days.  Several partners have retired in recent years.  Income per partner is $280,000; Pat earned $310,000 last year.  In the dialogue below, MR is the therapist treating Pat for anguish over proposed changes to the firm’s partner compensation system.

MR: So Pat, tell me what’s going on.

Pat: I’m having lots of trouble with my partners.  With every passing day, we argue more and more.  I feel like an outcast in my own firm because no one ever agrees with me.  It’s very depressing; I can’t sleep at night.  I dread going to work in the morning.

MR:  I’m sorry to hear this.  Given your long tenure with the firm, this must be hard on you.  Can you tell me how all this got started?

Pat: We had a partner retreat a month ago, right after the tax season.  Our firm’s performance has been slipping for several years; revenues have been flat.  The retreat’s theme was strategic planning – how to turn around our firm.

MR: Sounds like a good start to a retreat, what happened at the retreat that made you so upset?

Pat:  We did discuss a lot of things and came up with many great ideas that I think will help our firm.  But the proposed change that got me upset was that they want to change the partner compensation system.

MR:  Why do they want to change it?

Pat:  They feel that our current partner comp system is motivating the wrong behaviors.  That there are not enough rewards for doing what the firm needs the partners to do.

MR:  Can you be more specific?

Pat:  Well, our current system is very simple and it has served us well for 20 years. We use a formula with just two factors:  50% based on book of business and 50% on billable hours.

MR: Isn’t this method affectionately called an “eat what you kill” system?  As I understand it, each partner is responsible for their own production, as if you were all solos practicing under one roof, sharing staff and overhead.  Those that excel at “killing” eat the most and those who are less skillful at production are paid less.  Proponents of this system believe it motivates partners to be hungry and provide for themselves, thereby strengthening the firm in the process.

Pat:  I’ve heard the system described that way and I never liked the term.  It sounds crude and implies that we are greedy, selfish and short-sided, but it is what it is.

CPA Partner Compensation:  The Art and the Science explains ►Partner comp 101, ► the 12 systems used by all firms, ►how to design your firm’s system, ►open vs. closed systems, ►the role of “book of business,” ►differences between large and small firms’ systems, ► the MP’s compensation, ► trends and controversies and ►overall best practices. 

Purchase a copy for your partners.

MR:  Why does this formula appeal to you?

Pat:  Because it’s based on the simple idea that firms are profitable when their partners bring in lots of business and work lots of billable hours at high billing rates.

This kind of comp system recognizes that, as accountants, we like numbers and formulas.  That’s our language.  Formulas are objective.  We are free of subjective elements that can be second-guessed. As a result, there are no disagreements about compensation because the numbers are what they are.

MR: You say the system prevents disagreements.  But I’ve seen otherwise. Partners at other firms using formulas tell me they eventually grew disenchanted because they did, in fact, argue endlessly about the flaws in the systems.  Here are some of the issues firms struggle with when they use a formula to allocate partner income:

• How many factors should be in the system? Two?  Five?  Eight?  What should they be?
• How should each factor be weighted? Pat, you say 50-50.  Why not 60-40?  40-60?
• Partners are smart people; they learn how to game the system, mainly by hoarding work. The all-too-common result is the partners do what’s best for them before what’s best for the firm.
• Formulas ignore important intangibles such as managing the firm and mentoring staff.

Pat: You raise good points.  Over the years, these points have been raised, but we never acted on them.  I guess there were enough of us older partners to outvote the younger ones.

MR: Well, as Chad & Jeremy sang, “that was yesterday, and yesterday’s gone.”  Your firm is well along the way to becoming a second-generation firm.  You are now the only “older” partner and your other partners are younger, some much younger.  CPA firms are managed differently today than they were 20-30 years ago.

I’m hearing from you that your other partners feel that the firm needs to take a fresh look at how it operates.  And they feel that the firm’s partner comp system needs to motivate the right behaviors.  We’re about out of time now, but this sounds like a great place to start our session next week.