IN OUR OPINION, PERSPECTIVE #106 — March 30, 2020
(A Continuing Series for Leading CPA Firms)
“Rebooting for a New Normal – Experiencing both Tight Liquidity and Very, Slow Organic Growth – The Perfect Storm”
“Willingness to change is a strength, even if it means
plunging part of the company into total confusion for
a while” —Jack Welch
Clearly, we are all experiencing unprecedented times as we tackle the Corvid-19 virus that is threatening the health and well-being of our lives. Keeping our families healthy is our #1 priority. In addition to our families, the leadership of all small and midsized CPA firms is focused on assisting their partners and staff as they navigate through these difficult times.
Once things settle down and human and financial damage has been assessed, a path forward will become clear to all of us. Soon, we will know what the “new normal” looks like and how we need to adjust our lives accordingly.
While the health and well-being of human life is of utmost importance, leadership of small and midsized CPA firms must also keep their eyes on the financial health of their businesses as:
- Billable hours and production have slowed down considerably and, more than likely, will result in firms see excess capacity beyond historical experiences.
- Work inefficiencies are significant and will increase as employees stop and start deliverables at a much more frequent pace.
- Clients will have a natural tendency to hold onto their cash which, in turn, will slow down cash receipts to their CPA firms.
- Organic growth, which has been difficult to come by before the pandemic, will be even more difficult to achieve as clients slow down or, worse yet, eliminate discretionary spending including professional services.
- Employees will consider a new position that does not require a significant amount of time at firm or client offices including out of town overnight trips.
In Our Opinion, this “new normal” and the inevitable cash crunch, requires small and midsized CPA firms to reboot with a focus on several important strategies and tactics:
- Make sure that partners are adhering to WIP and receivable policies and protocols. Now is not the time for partners to extend payment terms to clients without making a very good “extended credit case” in collaboration with the firm’s leadership.
- Keep a healthy mix of partner cash capital vs. bank debt. If your firm is not adequately capitalized with partner cash capital, be very cautious in running to the bank to pay partner monthly draws. This is one of the ways firms have crashed and failed in the past. Once the dust settles with the virus, this might be the time to evaluate the capitalization policies of your firm – keeping a healthy balance between partner capital and bank debt. In the best of breed, every equity partner is required to put a minimum amount of cash capital into the firm upon admission and, as the years’ progress, continue to put in cash capital each and every year as a reduction of compensation until the firm’s required capital amount is achieved.
- Stay tough with effective governance and make those tough decisions that are in the best interests of the firm. Don’t fall into the trap of being the benevolent leader in the “new normal”. Don’t stop addressing partner issues such as too many partners, ineffective partners, and partners who don’t play by the rules. Many of the Top 100 firms have effective Executive Committees who are responsible for approving strategy, making sure that plans are executed in a timely fashion, and evaluating the CEO including setting annual compensation adjustments.
- Tighten your acquisition criteria and slow down small deals of $1 million to $2 million practices that are usually a short-term play that generally has little, if any, long term value. Small acquisitions often are, pure and simple, buyouts of retiring partners with low-quality practices and professionals who are not as technically proficient as they need to be. The best of breed shy away from small acquisitions unless there is something very compelling being presented. These firms look at mergers and acquisitions through a different lens. They are strategic and/or talent plays usually larger in size with some excellent clients and some excellent people.
- Take a hard look at your unfunded partner deferred compensation plan. In light of what is going on with the new business environment, your plan might be bulging and difficult, if not impossible, to fund. Maybe it’s time to make some changes in the amount of the plan and the payout period. Consider a tighter cap on distributable income available to retired partners and eliminating “double-dipping” when accrued capital payouts are added to deferred compensation payouts. The larger more successful firms have traditionally had a cap on distributable income available to retired partners of about 12% and do not pay retiring partners their share of the accrued capital on top of a deferred compensation amount that is generally paid over ten to 12 years. Maybe it’s time to consider an 8% cap and a 15-year payout. Don’t be surprised if the marketplace resets deferred compensation plans below recent experiences.
- Recognize that not all partners can perpetuate the firm (the definition of an equity partner) – a particularly important acknowledgment in a slow-growth environment when it is very difficult to grow revenues and profits. In the old days, when people were admitted into a partnership, they were immediately admitted as equity partners because that’s the way it always was. Some firms continue with this outdated practice. As a result, they become top-heavy and burdened with heavy retirement obligations and a clogged pipeline for future partners. Many Top 100 firms have recognized this business challenge years ago. Today these firms are moving toward a 40% equity/ 60% nonequity mix which is much more realistic in a slow-growth environment.
- Take a hard look at your lease obligations. Is all the office space you have really necessary in light of our ability to effectively deal with telecommuting? Perhaps it is time to renegotiate those leases – the amount of space that you need, the length of time of the leases and the terms of the leases? Leverage with the landlords has changed as we are experiencing a new paradigm.
- Understand that there is a path to organic growth during this very trying time, but it isn’t a quick fix. It’s more like a long and winding road! In fact, it is a seismic shift that is difficult to achieve without discipline, commitment and accountability. It’s finding “alpha” (growth) within your existing client base which, in turn, creates new clients and an enhanced reputation. This path is often overlooked as many CPA firms merely seek to perform the tasks at hand (the barest minimums) while striving for technical quality (not a differentiator but a basic requirement). That is why we often hear that “all CPA firms look, feel and sound the same. It is very hard to tell them apart” and “our CPA firm didn’t deliver their audit report until the very last day of our bank’s deadline or my CPA firm didn’t deliver our tax returns until October 15 and, on top of that, we were stunned by the magnitude of our final payment to the IRS?” Consider:
- “Going beyond” client expectations by providing a better client experience every time a service is rendered. By embracing this path (initially starting, perhaps, with the most significant clients), a firm creates client preferences and a bond that translates into a favorable word of mouth. Here are two tactics:
- Bundling services and delivering them to through industry specialization:
Many firms have two, perhaps, three functional lines (accounting/auditing, tax and advisory) and are organized, recruit, train, and deliver services this way. If a client uses all three services, it more than likely works with three different partners. One of the common client complaints is that the three different partners don’t appear to communicate with each other (and chances are they don’t because there is no encouragement or incentive to do so). The focus is placed on the quality of the technical services, i.e., inside the firm instead of on the client. The approach is “we” oriented not “client outcome” oriented.
The bundling concept requires a different client service approach by designing and delivering services to suit client needs, wants and expectations, not around a firm’s operating preferences. In our view, this can be best achieved through industry specialization that provides insightful and personalized accounting, tax and advisory advice by understanding the nuances of the industry environment and tailoring services to assist in meeting business objectives. It also identifies “best practices” and benchmarks clients as they seek to improve.
The fruits of industry specialization are delivered to clients with tried and true tools that demonstrate that your firm not only performs quality attest services but also is a valuable business advisor. For example, when a client is owned by a private equity group or any other investment vehicle, a tool the EBITDA/Working Capital Improvements Memorandum can be used. This tool is designed as a unique by-product of attest services. Upon conclusion of your firm’s work, the firm shares preliminary thoughts with senior management of the portfolio company as well as with an outside investor about how to improve EBITDA and working capital and, therefore, valuation. If there is a desire for your firm to assist with the implementation of your suggestions, your firm, of course, would be happy to do so — understanding that there are certain limitations, particularly with public companies. This tool demonstrates that your firm understands the business objectives of a private equity group, i.e., to purchase the portfolio company for X, increase its valuation by increasing EBITDA and working capital, and then selling the portfolio company for a multiple of X.
2. Seeking client input and feedback to help determine where clients perceive value (usually around creating, enhancing and preserving wealth) and where they don’t. The Distinctive Client Service Plan ensures the highest quality service by focusing your client service team on exceeding client expectations. This tool is an opportunity for the client and the client service team to collaboratively define expected standards of performance for the various aspects that your firm will provide. Once established, the standards serve as precise indicators of advice, information, and communication your client will receive throughout the professional relationship. The process includes:
- Determining service criteria.
- Setting performance standards.
- Evaluating results and seeking client input and feedback.
In anticipation of tight liquidity and very slow organic growth, leadership at small and midsized CPA firms have a window to reboot strategies and tactics head on. All of the “new normal” issues can be adequately addressed although some will take several years before they are fully corrected. The good news is that many small and midsized CPA firms have already started a process to recognize many of these issues and are successfully dealing with them.
Is your firm one of those firms or is your firm going to miss the reboot opportunity by keeping your head in the sand?
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.