What Partner Candidates Need to Know

I recently spoke with a young man at a 12-partner CPA firm who was anticipating being offered a partnership in the next couple of years. He wanted some guidance on whether or not to accept the offer, should it be made. It turned out he had quite a few misconceptions about how someone becomes a partner, what his role would be and what being a partner is all about. For this, I say shame on the firm for not making it completely clear. We spent a couple of hours exploring his concerns and clarifying how becoming a new partner works. We reviewed five areas:

1. If I were to become a partner, a major motivation for accepting it would be to make an impact on the direction of the firm and its management practices.
   Here’s what I told him: One of the biggest misunderstandings about being a partner is that everything is decided by partner voting. Sure, the partner agreement may provide for voting guidelines. In practice, most accounting firms rarely vote on anything. Instead, they reach a consensus. Every partner has the opportunity to suggest an action and persuade the partner group to follow their suggestions. It’s naïve to think that a new partner in a 13-partner firm would be able to drive major changes in the firm right away. He could try, and his new partners should be open to listening. But while his interest in introducing change is important (and many new partners lack initiative in this area), making immediate significant changes in the firm should not be a primary reason for accepting the partner offer.
2. I’m still young and just started raising a family. I can’t afford a buy-in that is hundreds of thousands of dollars.
   Here’s what I told him: In the olden days, a new partner buy-in was determined by multiplying a predetermined – and sometimes arbitrary – ownership percentage by the value of the firm, which consists of accrual basis capital plus a goodwill factor of around one times revenue. For a $15M firm, capital is likely to be $3M and goodwill $15M, for a total valuation of $18M. Under this archaic method, a 5% ownership stake would cost $900,000. Baby boomers gladly paid it, but the following generations have been unwilling and unable to pay the buy-in. Fortunately, many years ago, CPA firms changed their buy-in methods. Instead of determining the buy-in amount by multiplying an ownership percentage times the firm’s value, firms have simply decided on a buy-in amount that is much more affordable, often in the range of $75,000 to $150,000. In addition, the buy-in doesn’t have to be paid all up front. Instead, it’s paid over several years as a deduction from the new partner’s bonus, which (hopefully) increases every year. Therefore, there is virtually no cash flow burden on new partners. Today, new partner buy-ins are quite reasonable and should not be an obstacle for staff accepting a partnership offer.
3. I’m worried that the promotion to partner is heavily impacted by production metrics such as Finding, Minding and Grinding. My metrics as a manager are nowhere near those of established partners.
   Here’s what I told him: It’s true that many firms establish production thresholds that must be met before becoming a partner. But at most local firms, these thresholds are fairly achievable. Firms understand that their production metrics are unlikely to equal those of the existing partners, and if their compensation system is fair, they will ensure new partners are not making less than they did as a manager. Equally important as production metrics are soft skills such as leadership skills; developing great client relationships; and supervising, training and mentoring of staff. These should also be considered as part of a partner’s overall compensation.
4. I’ve talked to people outside the firm, and I’ve been told that most CPA firms allocate partner income based on a strict production formula. I’m concerned that my production numbers will take years to grow to the point where my compensation increases meaningfully.
   Here’s what I told him: Smaller firms (say five partners and under) mainly use compensation formulas. The more forward-thinking of these firms deviate from a strict interpretation of the formula for a period of years to factor in other performance factors, thus enabling the compensation of new partners to rise appropriately. Firms with ten or more partners use a compensation committee to decide the compensation of each partner. Performance factors include not only production metrics, but important subjective factors such as firm management; leadership skills; growing revenue from existing clients; developing and mentoring staff; and achieving formal, written goals.
5. I’m concerned about the downside of being a partner – things like working long hours, liability risk, being liable for my share of the firm’s debt, being asked to pay a buy-in that I can’t afford and being required to share in the payment of buyouts to retiring partners. Maybe I’d be better off leaving the firm and creating my own small firm.
   Here’s what I told him: These fears are largely much ado about nothing. Please, please, don’t think you will be better off as a one- or two-partner firm. Larger firms find it difficult to recruit and retain staff. What staff, if they are any good, would be willing to work for a tiny sole practitioner? If you thought it might be challenging to bring in business as a partner in the larger firm, multiply it times ten as a small firm. As a firm with many owners, you benefit from the collective expertise, skill diversity and wisdom of your fellow partners. In a small firm, the service offerings will be greatly limited, making it difficult to fully satisfy the needs of your clients. You most likely will not be able to afford the technology that your present firm provides. And finally, as a small firm, you will be miserably bogged down with unending administrative details, thus reducing the time you have for client activities. If you think you will be better off as a solo, you are misguided.

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. But firms don’t know how to develop staff into partners. They don’t have an established financial and operating process for bringing them in as new partners or have outdated approaches for doing so. And staff who aspire to be partners don’t have a clue about what it means to be a partner. This book addresses all of these areas and more, including: ►what a partner is these days, ► why it’s unbelievably fantastic to be a partner, ►the path to partner, ► skills that partner candidates need, ►best practices and key concepts in the financial and operating aspects of bringing in a new partner such as buy-in amount, ownership percentage, compensation, capital, and how voting works, ►the non-equity partner position and how it compares to an equity partner, ►what a new partner gets for the buy-in, ►non-compete and non-solicitation agreements, ►and how the firm’s partner retirement/buyout plan works.  

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What Prospective Partners Should Ask

This section addresses what partner candidates should ask – and what the existing partners should be prepared to answer.

• Look at the books and operating statistics of the firm. Analyze the firm’s performance and profitability. Review production metrics of all the partners and determine if they are in line with their compensation and at levels that CPA partners customarily achieve.
• Meet with the managing partner and receive a “state of the firm” presentation. Find out what’s working well and what the firm’s biggest problems are. What is the firm’s vision? Don’t put yourself in the position of thinking, in your first weeks as a new partner, “If I’d known how screwed up the firm is, I would never have agreed to become a partner.”
• What will be my role as a new partner? Will I basically continue as a glorified manager, still working for partners? Will clients I worked with as a manager be assigned to me as a new partner? To what extent will I be expected to build my own client base?
• Does the firm have a partner agreement? Is it written properly? Are there any objectionable provisions in it?
• How does voting work? Will my vote count? Will it be one person-one vote on most matters, or will it be based on seniority or ownership percentage?
• Is there a mandatory retirement policy? If not, is there a danger of the old partners staying around forever?
• How is partner income allocated?
• Review the ages of the partners. Is there a good spread in ages? If there isn’t, is the future of the firm in jeopardy because too many valuable partners will leave around the same time? Can the firm afford the buyouts of multiple partners retiring at the same time?
• What is the firm’s succession plan? Will the firm be looking to sell out in the near future, or does the firm want to remain independent? In two or three years, will I find myself at another firm not of my choosing?
• What are the terms of my new partner buy-in and can I afford it?

What else do partner candidates need to know? Comment below to share your thoughts with us.