Why Most Firms Have a Big Gap Between Highest and Lowest Paid Partner

The challenge to us

Several managing partners have recently asked us what spread between the highest and lowest paid partner is appropriate. We use the term “partner” to mean equity partner.

First, some facts

The latest Rosenberg Survey showed the ratio of highest to lowest paid partner:

• Over $20M – 3.9 to 1
• $10–$20M – 2.6
• $5–$10M – 2.1

These figures reflect the fact that the highest paid partner substantially outperforms the lowest paid partner. We’ll define “partner performance” later.

Overarching statements about partner compensation

1. Whether it’s actors in movies, athletes in sports, salespeople selling widgets, or partners in CPA firms, some will always outperform others and, in some cases, by a large margin. This gap doesn’t mean that the lower performers are lazy or weak; it simply means that some partners contribute more to the success of the firm than others. Only by a rare quirk of fate would all partners in a CPA firm perform at the same level or close to it.

2. Partner performance factors that are critical to firm excellence are:

• Managing the firm – that is, truly managing, not being an admin partner. Being a visionary. Executing the vision. Innovating. Holding partners accountable for their performance and behavior. Helping partners improve their performance. Achieving or exceeding targeted revenue and profit goals. What’s missing from this list? Administration, because COOs, who earn much less than managing partners, should tend to those chores.
• Bringing in business – the award winner for the performance factor that is hardest for partners to do.
• Managing and growing a large client base.
• Helping staff learn and grow – staff advance under the partner’s tutelage.
• Achieving specific, written goals.

A good comp system recognizes partners’ importance in each of these areas.

Why some firms like to narrow the comp gap

We’ve seen all of the following actions by some firm partners to keep the gap narrow. Sometimes, it’s intentional. Other times, it’s the result of indirect bias.

1. A high percentage, 85%–95%, of total income is pay equal. This tactic is frequently used by firms whose profitability is below industry norms. The partners reason that a partner’s comp should be comfortably higher than that of the highest paid manager or non-equity partner. Unfortunately, the firm barely earns enough to compensate the partners much above what managers earn.

If 85%–95% is pay equal, only 5%–15% is available to reward performance, which is often unsatisfying to the go-getters.

2. Many of the firm’s partners feel that they all work hard and are good at what they do. This translates to the first tier of partner comp being a pay-equal tier, or something close to equal for all.

3. Some partners, in their heart of hearts, don’t really want a big spread from high to low. They get a little bent out of shape that top performers out earn them by such a wide margin. Predictably, the lower performers are the ones that want a narrow spread.

4. The weight given to various performance factors is out of whack. The items listed earlier in this blog are not given enough recognition, and less important factors such as billable hours, admin time and ownership percentage are given too much credit. The income allocation is unfair and unreasonable because the weighting system is deeply flawed.

5. There is a classic disagreement among the partners: non-business-getting partners who perform a great deal of client work and manage a large client base argue that they are just as important as partners who bring in business. These people feel: “Yeah, it’s important to bring in business. But where would the firm be if it didn’t have people like me doing the work?”

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 ● operating a compensation committee ● linking partner compensation with strategic planning ● data used to evaluate partner performance ● compensation nuances ● trends and controversies ● case studies ● overall best practices. Purchase your copy today! 

How to achieve an appropriate spread from high to low

The appropriateness of the spread is directly proportionate to the differences in the partners’ performance. We once consulted with a $12M firm with IPP of $800K. The founder/MP was paid $2.4M, and the other five partners’ comp ranged from $400,000 to $800,000. Keep in mind this was in 15 years ago dollars. The gang of five felt the gap was too big. The MP founded the firm, managed it, created a unique, high-demand specialty that enabled the firm to be incredibly successful, hired the other five and…originated $10M of the $12M of revenue. The MP deserved every dollar he was earning, if not more. The other five were earning well above average compensation and needed to recognize the astonishing contributions of the MP to the firm’s success as well as their own individual success.

Footnote to the above: The MP treated the other partners like dirt. That’s why the five partners felt the MP was overcompensated.

When large spreads become unfair

Nearly 80% of firms with seven partners or fewer allocate partner income using performance-based systems such as compensation committee, formula or MP-decides. Roughly 5% use systems based primarily on relative ownership percentage, rather than performance.

Our experience over 20 years of working with firms on partner comp matters is that a partner’s ownership is almost never a good gauge of relative partner performance. In these scenarios, partners with high ownership percentages are sometimes outperformed by those with low ownership percentages. This is when large spreads become unfair, with the under-compensated partners feeling resentful.

What percentage of total partner income should be at risk by the partners?

At most firms, the lion’s share of total partner compensation comprises a base and a bonus. The base may be determined in any number of ways and is usually fixed throughout the year. This money is, for the most part, not at risk. The bonus recognizes unusually strong performance, exceeding performance expectations, or achieving written goals or is simply an allocation of the firm’s income when it exceeds budgeted profits. The bonus may be considered “at risk.” The base is usually much larger than the bonus.

What’s a fair spread between base and bonus? Like many questions in CPA practice management, it defies a single answer. The biggest factor that determines the base-bonus spread is the firm’s profitability.

In the latest Rosenberg MAP Survey, the average income per equity partner was nearly $600,000. Dozens of firms’ IPP was a million or more. Firms that earn $1M per partner can afford a larger bonus target and still pay quite substantial bases. A common range for bonuses in very profitable firms is 25%–40%, which one can say is at risk.

Conversely, if a firm’s IPP is only $250,000, the partners usually aren’t willing to put much of that income at risk. These firms may target a bonus of 5%–10%, if that.