IN OUR OPINION, PERSPECTIVE #61 — June 25, 2018
(A Continuing Series for Leading CPA Firms)
IS YOUR PARTNER COMPENSATION PLAN LONG IN THE TOOTH?
“Any compensation scheme, if it is to stand up over time, must
pass two tests: that of internal equity and that of external equity.
Internal equity requires that, whatever the rules are, they be
applied in a consistent manner…The test of external equity:
do the compensation rewards in the firm reflect the
economic realities of the open market?” — David Maister
We often have the opportunity to provide partner compensation plan consulting to small and mid-sized CPA firms and it never ceases to amaze us to see how many plans fail to motivate partners and help perpetuate the firm in the year 2018 and in the near term future. We find that some partner compensation plans are very formulaic: as an example, you get X% for how much you bill and collect, Y% for your personal billable hours, and Z% for new business originations. We also find some firms are very socialistic: as an example, every partner gets an equal piece of the firmwide distributable income to partners regardless of individual contribution. And yet other firms are a hybrid with partner compensation bands that are very narrow; as an example, the highest paid partner can earn no more than three times the lowest paid partner. Many of these firms also have an “open” disclosure compensation systems with all partners knowing what each and every partner earns. More often than not, these “open” disclosure compensation systems further dilute the impact of these palns by creating disharmony among partners because of perceptions as opposed to the realities of partner performance.
It’s our view that the partner compensation plans referred to above reflect yesterday’s thinking and, in this tough economic environment for small and mid-sized CPA firms, do not help grow firm revenues and profits.
In Our Opinion, today’s partner compensation plan needs to:
- Be designed to help retain the best of the best.
- Drive revenues and profits growth.
- Reflect an understanding that not all partner services are of equal value to the firm and that different partners create different levels of responsibilities and contribution.
- Be subjective, not formulaic, with all aspects of each and every year’s compensation rewarded resting with the authority and discretion of the firm’s Executive Committee.
- Be performance based and, from time to time, as the firm’s strategy, areas of emphasis, and “hot buttons” change, be flexible enough to mirror those changes.
- Provide a proper matching of a partner’s performance and contribution to the firm to a partner’s level of compensation.
- Be “closed” to all partners on the basis that partners are not really in a position to evaluate partner performances throughout the firm. In these situations, partners are given some general information as to average and median partner compensation – sometimes in compensation bands or ranges. Still other firms give all partners the opportunity to view, in the presence of the firm’s CEO/Managing Partner, what the Executive Committee members earned in the past year.
Presented below are contribution examples of advancing the firm’s strategies, areas of emphasis and “hot buttons”:
- Generating additional revenues from new clients, cross sells and expansion of business.
- Relationships with and delivery of services to clients.
- Mentoring staff.
- Driving adherence to risk management and quality control.
- Identifying potential lateral hires and M&A candidates.
- Identifying opportunities for expansion of capabilities and expertise.
- Creating a presence in the marketplace that reinforces the firm’s brand and identifies new business opportunities.
There is no pre-determined formula as to how these and other contributions examples are weighted in arriving at an individual partner’s total compensation. On the other hand, the subjective, annual determination of an individual partner’s total compensation is made on a partner-by-partner basis with the premise that the responsibilities of each partner and will be discussed one-on one with each partner as part of arriving at a partner’s individual goals for the upcoming year.
The focus of a subjective, flexible performance-based partner compensation plan is measured in the context of the firm’s evolving goals and objectives and profitability budget. The framework to achieve this focus is principally accomplished through a partner compensation plan by:
- Establishing a targeted compensation for each partner, principally based on individual goals for the upcoming year that demonstrate a firm first mentality as opposed to a silo mentality with the understanding that targeted compensation:
- Is the basis for a partner’s monthly draw subject to withholding when partners fail to diligently administer the firm’s policies on billing and collection.
- Is not guaranteed and, at the end of the year, a partner’s total compensation is determined independently without reference to a partner’s target compensation.
- Is based as a percentage (between 75% and 80%) of the firm’s budgeted profits.
- Providing for discretionary and profit allocations that reward partner accomplishments above and beyond expected performance levels and that reward those partners playing a significant role in the firm’s perpetuation.
- Providing transparency to allow partners to understand the criteria upon which performance ratings are based and how the partner compensation plan works.
- Establishing a direct link between goals and results.
- Providing for predictability so that partner expectations are managed and so that partners have a reasonable compensation given performance within the confines of overall firm profitability.
- Providing for evaluation of a partner’s performance by the firm’s Executive Committee plan. Some smaller firms don’t have an Executive Committee. In those situations, the evaluation of each partners performance and contribution is determined by consensus based on a binding confidential vote.
The plan is designed with three levels of distribution:
- Level One which is annual interest paid on cash capital contributions.
- Level Two which are monthly draws.
- Level Three which is the post year-end distribution of discretionary and profit allocations. This distribution is usually made in installments around quarterly tax deposits as cash flow permits.
Many of the today’s most successful Top 100 firms have a partner compensation plan similar to that described above. At the discretion of the firm’s Executive Committee many of these firms also ask their partners for annual comments on how to improve the firm’s partner compensation plan. Oftentime those comments, made by partners on the ground, so to speak, result in plan changes for the betterment of all involved.
Firms are struggling to grow organically in this environment. Sometimes that struggle occurs because the firm doesn’t have the right mix of partners to drive growth. In other cases, that struggle occurs because their partner compensation plan does not motivate the best of the best.
Dom Esposito, CPA, is the CEO of ESPOSITO CEO2CEO, LLC — a boutique advisory firm consulting to leading CPA and other professional services firms on strategy, succession planning and mergers, acquisitions and integration. Dom, voted as one of the most influential people in the profession for two consecutive years by Accounting Today, authored a book, published by www.CPATrendlines.com., entitled “8 Steps to Great” which is a primer for CEOs, managing partners and other senior partners. In Our Opinion, is a continuing series of perspectives for leading CPA firms where Dom and his colleagues share insights, experiences and wisdom with firm leaders who want to “run with the big dogs” and develop their firms into sustainable brands. Dom welcomes questions and can be contacted at either email@example.com or 203.292.3277.