Should Your Non-Equity Partners Get a Buyout?
A reliable staple of CPA firm practice management is the payment of buyouts to equity partners of CPA firms. When partners retire, withdraw, die, or becomes disabled, they are paid a retirement benefit equal to the value of their interest in the firm. (Actually, 87% of firms provide for partner buyouts and 13% are silent on this.) In multiple-partner firms with average profitability, the buyout is often $1M, give or take, paid over ten years or so…quite substantial.
What is the foundation of this practice?
- A CPA firm is a going concern that survives the exit of its owners, thus avoiding the need to liquidate the firm every time a partner leaves.
- The value of the firm is validated every year by routine CPA firm sales: the vast majority of CPA firm sales prices is 80-100% of revenue. So, firms feel justified in adopting a similar value for partner buyouts. In practice, internal valuations are almost always lower than external sales prices because firms like to be conservative.
- Retiring partners are justified in receiving this substantial buyout because they made significant contributions to the creation of the firm’s value over decades of service. The value is created by bringing in and retaining annuity clients, establishing a “cash machine” that posts profits of 30-40% of revenue, developing and retaining a staff that services the clients, creating proprietary systems, techniques, acquiring the expertise for performing the work and generating a stellar reputation in the marketplace.
The dawn of the non-equity partner.
First, let’s define a non-equity partner (also called an income partner) and to do this, we must begin by defining an equity partner: An owner who creates, maintains and increases the value of the firm in substantial ways, mainly by bringing in clients, forging world-class relationships with those clients and providing leadership in the firm, all of which generate considerable profits – the latest Rosenberg MAP Survey shows that the average equity partner income of multi-partner CPA firms is nearly $500,000.
A non-equity partner is someone who has been a valuable, loyal, high-performing team member for many years. But their contributions and value to the firm are not quite at the level of equity partners, usually in the areas of business origination and leadership. Equity partners drive the firm; non-equity partners rarely do, though at some firms, the line between the two positions can get blurry.
We don’t know when the non-equity partner position was first used, but CPA firms have had them for decades. In the past 10-15 years, accounting firms’ use of the non-equity partner position has more than doubled. Today, according to The Rosenberg Survey, roughly 55% of multi-partner firms have this position. The larger the firm, the heavier the use of the non-equity partner; nearly all firms over $20M have non-equity partners. Many Top 100 firms have more non-equity than equity partners.
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.
The bar for promotion to equity partner.
As the usage of the non-equity partner position has increased, the bar for promotion to equity partner has risen. An old-school practice was for firms to use the promotion to partner as a staff retention tactic; firms had long-time, valuable managers they wanted to retain long-term, but they lacked business development and leadership skills. To prevent these people from making career decisions to leave their firms, they were promoted to partner.
The mistake firms made was to promote them directly from manager to equity partner. The practice in recent years has been to promote them to non-equity partner instead. They may be eventually promoted to equity partner or they be permanent non-equity partners.
With this approach, the substantial profits generated by the firm’s drivers – their equity partners – and the lucrative buyouts upon retirement are reserved for the equity partners – until recently.
Why firms are starting to pay buyouts to non-equity partners.
“The first step toward change is awareness. The second step is acceptance.” (Nathaniel Branden).
As the non-equity partner position evolved, one can see how partner buyouts were limited to equity partners. Equity partners reasonably asked, “Why would we ever want to pay a buyout to someone who is not an owner and didn’t create the firm’s value?”
But attitudes are changing. With the bar for equity partner higher than in the past and growing acknowledgment of the important role that non-equity partners play at firms, there is a small but growing movement to grant buyouts to non-equity partners. Here are a few reasons why some firms are paying buyouts to non-equity partners:
- With the bar being raised for equity partner, firms obviously have fewer equity and more non-equity partners. Many of today’s non-equity partners would have been equity partners in days past and therefore, would have been eligible for buyouts. So it makes sense not to totally deprive them of buyouts just because the bar for equity partner was raised.
- Non-equity partners, if they truly function as partners (and not glorified managers), play a critically important role in the firm. Even though they don’t contribute to the increase in value of the firm at the level of equity partners, they are still immensely valuable. With highly effective non-equity partners on board, this frees up the equity partners to devote more time to business development, firm management and staff development, all of which drive the firm’s profitability, success and value. This can be recognized by giving non-equity partners “a piece of the action.”
- It’s easier for a non-equity partner to leave a firm compared to someone tied up with a partnership agreement. Providing a buyout opportunity to non-equity partners gives them another good reason to stay and retention for this group is key. The vesting and client transition provisions in your buyout will protect the firm in the event of an early departure.
Caveat: As stated earlier, there are many types of non-equity partner. At some firms, generally smaller than larger firms, non-equity partners function more as managers than partners. In reality, they aren’t expected to bring in business, manage client relationships and develop staff into partners. Most firms exclude this personnel from participating in the buyout plan.
Results of our poll:
In January 2021, we surveyed 44 firms (virtually all between $5-$35M):
- 10 firms provide buyouts to non-equity partners.
- 24 firms have non-equity partners but do not provide buyouts to them.
- 10 firms do not have non-equity partners.
Major results of our poll:
- Of the firms with non-equity partners, 29% of the firms paid buyouts to them.
- The buyouts are considerably lower for non-equity partners, generally 33% to 50% of what equity partners receive.
- The larger the firm, the more likely that non-equity partners receive buyouts. Very few firms under $10M have this practice.
At firms that pay buyouts to non-equity partners:
- All non-equity partners participate.
- Half of the firms require 5-10 years as a non-equity partner before eligibility kicks in.
- Vesting is the same for non-equity as equity partners.
- Interestingly, 40% of the firms offering buyouts to non-equity partners require a small buy-in.
So, what are you waiting for?
The reaction we get to this practice is undoubtedly the same as with most major changes in civilization at the onset: Bewilderment. Outrage. Disbelief. Raised eyebrows. As more and more firms recognize the important role that non-equity partners play in creating and increase the value of firms, the payment of buyouts to non-equity partners will most likely become more common.
Have you considered paying a buyout to non-equity partners? Let us know in the comments below.
As partners approach retirement age, they naturally focus on who can take their place and eventually write their retirement checks. Prospective new partners often have a lot of questions about what becoming a partner entails. Many firms either aren't sure how to bring in new partners or have outdated approaches for doing so.Learn More