Pay-Equal Transition Issues for Founder-Led Firms

When two or three partners start a CPA firm together, it’s common to simplify how income is allocated. Often ownership percentages are split equally (e.g. 50/50, or 33/33/33) and total compensation or excess profits may be split the same way or with a small, fixed variation (e.g. $50k stipend to the managing partner, then 50/50).

This works well for many years. Founding partners trust each other and recognize that while they each have different skill sets or talents, those talents are equally valuable. If this weren’t the case, they wouldn’t have formed a partnership.

This equal splitting of total compensation or excess profits eliminates complicated calculations. It reduces tension around “my client” vs. “your client”, and evaluating performance on intangibles becomes unnecessary because of a high degree of inherently shared values. Each partner knows their place, and collectively, they get the job of running the firm done.

When firms consider bringing in a new partner, it’s common to want to continue this beautifully low-stress system. After all, it’s worked for 10, 15, 20 years or more, and I don’t know of a lot of CPAs looking for more work to do anyway. So if it ain’t broke…

When do we need to fix it?

The challenge is your new partner candidates are talented but have not contributed to the firm in the same way you have. How to change a historically successful pay-equal system is not always clear.

While we have seen some accounting firms continue to pay newer partners “equally” with senior or founding partners, one of two situations typically arise:

• There’s a corresponding shell game of reductions in income to pay to senior partners and other tactics that complicate the system. This often erodes the feeling of “being a partner” that your incoming leaders wish to have.
• Senior partners eventually realize that it doesn’t make sense for a new partner to make the same as one with 15 years of business-building.

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.

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The system needs to change. Here are your next steps:

1. Determine if you will have a single system for all partners, or if founding partners will have their own compensation arrangement separate from newer partners. A cautionary note: having two systems essentially creates two tiers of partners. And then you have to figure out how or when to dismantle this as the senior partners each retire, or when to bring newer partners into the “senior partner” system. There are ways to create a single system that does acknowledge and compensate senior partners for their historic and current contributions to the firm.
2. Select a system that makes sense for your firm. Here are a few popular options for firms with 3-5 partners including one or more new partners:
   • A production-based formula. Formula systems may have flaws (primarily that there is no formula that will give you “the answer” to how income should be allocated), but for many firms the clarity is helpful. Ideally, firms should also have a carve-out for intangible performance that is harder to determine using system reports.
   • A small compensation committee. It may seem unusual, but we’ve seen smaller firms choose a two-partner compensation committee (CC), with the CC being comprised of the founders. This allows them to continue to share equally between the founders, as long as that remains appropriate, and also set base and bonus amounts for incoming partners that align with their contributions to the firm.
   • MP decides. This works best when one of two founding partners is retiring, leaving one remaining. The MP has the authority to set compensation as they see fit. Of course, this system and the compensation committee must be trusted by the partner group. If the trust isn’t there, you may be better served by a formula, paper and pencil, or all-partners decide system.
3. Communicate your partner compensation arrangement to partner candidates. If your future partners are thoughtful about their change in status, they’ll want to know how they’re going to be compensated. Have a clear conversation with them and share written plans of how income will be allocated among equity owners at your firm. This transparency builds trust within the partner group and provides needed information for incoming partners to evaluate whether the arrangement works for them.

Partners want to know how they can impact their compensation. Be clear with them what actions, behaviors, and metric achievements will cause them to increase their income, and correspondingly, what will contribute to a smaller allocation.

But what about ownership percentage?

I know – we just talked about some firms’ successes in using ownership percentage for founder-led firms. The difficulty with using ownership percentage as a firm transitions to the next generation is that while the percentages granted to new partners may correlate with their expected contribution to the firm at the outset, typically, performance varies over time.

This is especially true when you have a group of partners who did not do the initial forming of a firm together. One partner may wish to work only 40-50 hours a week to raise a family or pursue a hobby; another partner might be driven to put in 60, 70, or 80 hours a week on the regular. Are they equally good people? Yes. Do they contribute to the firm in the same way? No.

Bottom line: Make sure the way you compensate your partners correlates with how they add value to the firm.