April 27, 2020

PERSPECTIVE #108 — IN OUR OPINION, April 27, 2020

(A Continuing Series for Leading CPA Firms)

IS YOUR FIRM OVER -PARTNERED? IT IS PROBABLY TIME FOR A GUT CHECK!

An organization’s ability to learn, & translate that

learning into action rapidly, is the ultimate

competitive advantage”.         — Jack Welch

Today, with the pandemic causing serious economic damage, mid-market companies are struggling as they try to get back to pre-virus days. As a result, small and mid-sized CPA firms are being challenged with both growth and with right-sizing their headcounts.

As if that wasn’t enough, firms are also trying to put their arms around evolving business and operating models — changing from a traditional accounting firm model and partner/staff pyramid to a professional services firm model which mandates a flatter organization. While it is important to carefully monitor headcount, utilization and realization, it has become very obvious that management consulting and advisory services present the best potential for growth and margins as mid-market clients continue to outsource non-core, but nevertheless, critical business processes in an attempt to maintain respectable EBITDA and working capital.

What are small and midsized CPA firms to do if it appears that they might be over partnered?

In Our Opinion, now is the time to do a careful analysis or gut check, and if action is required, make the necessary moves.

An essential first step requires firms to take a hard look at what their partner numbers are versus what they should be and if there is a healthy mix of both equity and non-equity partners. To that end, we would like to share some financial guidelines that are commonly used by both the Giant Four and the Next Six firms. Now, we are not in any way suggesting that these are the guidelines small and midsized firms should adopt. Not at all. We understand that small and midsized CPA firms serve small and mid-market businesses while the Giant Four and the Next Six serve larger entities. Partner and staff leverage and financial models necessarily differ. Nevertheless, we believe that it is beneficial for small and midsized CPA firms to have an insight into the larger firms if for no reason beyond benchmarking. This knowledge could help you determine if your firm is over partnered and if you have the right mix of equity and non-equity partners.

Let’s start the analysis with a hard look at equity and non-equity partners. Many of the larger firms have two groups of partners; non-equity and equity. In many cases, there is a 50/50 split between the two categories and in some cases more like a 60/40 split (60% non-equity).

NON-EQUITY PARTNERS

The key question to be addressed with every non-equity partner is: “does the enterprise value of an existing or potential partner contribute towards perpetuating and growing the firm’s business, maintaining technical excellence and driving client and staff retention?” Beyond this threshold question, a non-equity partner/candidate needs to demonstrate a track record of performance in a number of practice areas, not the least of which is business development. The mandate, with the exception of those partners tasked with quality control, is that: (a) an existing partner has to annually originate a combination of new business and cross-selling in the minimum amount of $150,000, and (b) a partner candidate needs to demonstrate a minimum amount of $450,000 over the three years preceding partner consideration.  If these criteria aren’t met, an underperforming partner is coached with the understanding that if improvements aren’t achieved, he/she will be counseled out of the firm.

EQUITY PARTNERS

Something similar to what is presented below is currently being used at the larger firms in determining equity partner headcount:

• Revenue per Audit/Tax Equity Partner — $2,000,000
• Earnings per Audit/Tax Equity Partner — $600,000
• Revenue per Consulting Equity Partner — $3,000,000
• Earnings per Consulting Equity Partner — $1,300,000

These guidelines are just that — guidelines — not bright lines. If they aren’t met, firms put up a red flag and decide what they need to do about it. In addition to the financial guidelines, the key question that is then addressed is:” does the enterprise value of an existing or a potential equity partner significantly contribute towards perpetuating and growing the firm’s business, maintaining and enhancing technical excellence and driving client and staff retention and has this value been demonstrated by a track record of steady and increasingly improved performance?” The mandate, with the exception of those partners tasked with quality control, at many of the larger firms is that an existing equity partner must demonstrate a track record of creating new business originations and by achieving actual results, net of losses, in the minimum amount of $250,000 each and every year. Further, there needs to be evidence that the partner is consistently cross-selling new products and services to existing clients. Again, if these criteria aren’t met, an underperforming partner is coached with the understanding that if improvements aren’t achieved, he/she will be counseled out of the firm.

IN CONCLUSION  

Are you over-partnered? Do you have the right mix between equity and non-equity?

We are very aware that the above analysis might appear foreign to some firms and perhaps very harsh to many others. If your firm isn’t actively addressing its partner headcount, however, we suggest that you are looking at the world through rose-colored glasses. In addition to being over-partnered, your firm probably is facing a number of undesirable outcomes including:

• Too few, if any, younger staff and the inability to keep what you have busy.
• “All-stars” leaving the firm as they don’t see an opportunity to advance.
• Staff are stuck on repetitive, boring client assignments with little, if any, on- the- job training.
• Costly labor loads resulting in unacceptable margins.
• Partners doing compliance work, not consulting, and not developing new business.
• Inadequate talent at the right levels — necessary to develop future partners who can perpetuate the firm.

All of these outcomes can be effectively dealt with if you do a gut check, understand your reality and your probable future, and deal with it with proper prudence. We know it’s tough out there, but things are not going to get better if you put your head in the sand. We have a great profession (yes profession; not industry) built upon the cornerstones of trust and integrity. Let’s capitalize on the “market permission” firms enjoy and the franchises developed. But remember, hope is not a strategy. A strategy is a strategy.

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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.