Untangling the Knot: Why One Solution to CPA Firm Challenges Can’t Stand Alone

If you decide to run for political office, is it over when you register? Of course not. You need money, a campaign office, staff, the endorsement of a political party and a strategy. If you want to open a restaurant, is it sufficient to hang out a nice sign and be a good cook? Of course not. You need to find a location, start-up costs must be financed, staff must be trained and hired, and a menu must be created and fine-tuned. In other words, challenges or problems in many aspects of business and life are multi-faceted.

The same principle applies to managing a CPA firm. Let me show you.

Firm governance. When a firm is small, say 2–3 partners with 10–15 total personnel, arguably, there isn’t all that much to manage. The focus is on building a client base and earning a living. When decisions need to be made, the 2–3 partners often manage by committee. But as firms exceed 10–15 people, they find it’s time for more formalized management. You can’t have an effectively managed firm without giving serious attention to:

• Will the firm adopt a corporate or partnership governance model?
• How will the firm’s management structure look? Will there be a managing partner? An executive committee? A firm administrator? Marketing, IT and HR professionals? What will be their duties and authorities?
• Who will be the leader? What authority will this person have? What will be this person’s duties?
• Will the firm have a partner agreement?
• Will the firm have a partner buyout agreement?
• How will the firm’s income be allocated to the partners?

Strategic planning. Do a firm’s partners operate as a group of solos under one roof, sharing staff and overhead, with the sole goal of earning decent income in the near term? Or does the firm have a loftier goal of working together to achieve common goals, never better expressed than the popular refrain from Field of Dreams, “If you build it, they will come.” Strategic planning cannot and should not take place in a cocoon.

• It all starts with a partner retreat, where the partners get away from the office, brainstorm what they want their firm to become and how it will get there. Most small firms are incapable of running an effective retreat (too many long tangents, disagreeing on what’s important to discuss, difficulty making decisions and taking action).
• Creating a strategic plan is a waste of time unless the partners are accountable for their roles in achieving the plan and people are compensated for achieving those goals.

Succession planning. A firm’s partners have two alternatives: build a great firm, grow and make good money every year and when the partners approach retirement age, they (1) sell or (2) create a succession plan for perpetuating the firm by developing younger partners to take over. Most partners say they prefer the second alternative but often end up pursuing the first. It’s not enough to merely want succession planning. The partners must create a succession plan and execute it.

• Where will new partners come from? How will they be developed into leaders?
• What role will leadership development play?
• New partners don’t magically appear. Waiting (wishing) for this instead of being proactive is why 60%–80% of all first-generation firms never make it to the second. It all starts with the staff. What is the firm doing to make the firm a great place to work where staff can learn and grow? The firm needs to educate staff on the business of public accounting so that they understand what makes firms successful and profitable and how they can be part of it.
• How will new partners be brought in? What will their buy-in be? How will their ownership percentage be decided? How will they be compensated?
• An integral part of succession planning is a coherent, affordable partner buyout plan. Without this, the firm will have no choice but to sell out in order for the partners to redeem their interest in the firm.
• New partners, either those advancing from the ranks of staff or merger partners, will want to see a partner agreement that is up to date and current with industry best practices.
• Acquisitions are an obvious way to supplement organic growth and partner development. Alternatively, if a firm fails to bring in new partners and lacks a viable exit strategy, then selling into a larger firm must be considered.

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Profitability. Without sustained revenue growth and profitability, firms risk becoming stagnant and are challenged to achieve long-term goals, especially succession planning. But very few firms become profitable (achieving income per partner that is average or better than other similar firms) without devising a means to achieve this end. Firms have to understand what truly makes CPA firms profitable. There are many ways to be profitable, and every firm has a different path to success.

• It starts and ends with effective firm management. This is the engine that drives everything else. Practice development. Leadership development and training. Staff retention. Service quality and quality standards. Partner accountability. Mergers. And, ultimately, firm profitability.
• Revenue growth is the best way to safeguard the firm’s future and profitability. CPA firms have always been a top-line-oriented organization. Increased revenue falls mostly to the bottom line because a CPA firm’s costs present few opportunities to significantly increase profits. Increased revenue creates more opportunities for partners and especially staff and, as a result, creates excitement. Increased revenue creates space for new partners. New clients replace those that drop off. Revenue growth makes the firm a more attractive merger partner.
• To hear that the Dow Jones average is 40,000 means very little unless compared to the previous day, week, month or year. The same is true of profitability and, in general, measuring a firm’s success. That’s why benchmarking is critical. There are two highly credible national benchmarking surveys in the market, one of which is The Rosenberg Survey. Benchmarking is helpful in three ways. First, it identifies the firm’s strengths so that they can be exploited. Second, it identifies areas for improvement so that corrective action can be taken. Third, it shows how the better firms are performing, thus providing ideas for improving profitability.

CPA firm partner compensation. Nothing is more sensitive to partners than their compensation, not only in terms of a dollar amount but how it compares to what other partners are receiving. Thomas Jefferson said, “There is nothing more unequal than the equal treatment of unequal people.” Allocating partner income may not be the best way of achieving partner accountability, but it is a good one, nonetheless. But properly allocating income involves several considerations.

• Profitability and growth. This can’t be repeated often enough. I can’t tell you how many firms hired us to help them devise a system for allocating partner income, only to find that they have a bigger problem – their profits are in the tank! If the size of the pie (total firm profitability) is too small, then it’s very difficult to come up with a new partner comp system. I tell these firms that they must focus on profitability and put partner comp on the back burner. Once this is achieved, devising a new partner compensation system becomes possible.
• Performance-based compensation for the partners. CPA firms use one of 2 or 3 systems. The common denominator of these systems is that they are performance based. They reward partners based on what they have done to make the firm successful and profitable – and abandon emphasis on non-performance factors such as ownership percentage, seniority and pay-equal.
• When firms reach a size of at least five partners, but usually 6–7, the Cadillac compensation system in the CPA industry is the Compensation Committee. This is widely considered the most effective system because it allocates income based on performance and makes use of the judgment of the firm’s most credible partners to make compensation decisions.

Conclusion
CPA firm solutions cannot be pursued or solved in a vacuum. They always require active attention to several highly integrated areas. Yes, this is not as easy as some naïve firms initially think. But it’s not rocket science either. It is possible to walk and chew gum at the same time.