July 22, 2019

PERSPECTIVE #88 — IN OUR OPINION, JULY 22, 2019

(A Continuing Series for Leading CPA Firms)

WHAT DOES IT TAKE TO BECOME AN EQUITY PARTNER

AND

HOW TO DETERMINE THE FINANCIAL DRIVERS?

“Future equity partners, more than ever, will need to possess enterprise

value that significantly contributes to perpetuating and growing the firm,

maintaining and enhancing technical excellence, and driving client and staff

retention. This value must be demonstrated by a track record of steady and

increasingly improved performance”.                                —Dom Esposito

We have found that small and midsized CPA firms are very inconsistent in defining what it takes to become an equity partner whereas competency standards at many of the larger firms are applied on a fairly consistent basis. We have also found that firms of all sizes (small, midsized and large) are very inconsistent in determining and measuring equity partner financial drivers. In some cases, extremely complex structures, cumbersome and difficult to work, are in place.

The purpose of this perspective is to summarize:

• What it takes to become an equity partner at many of the larger CPA firms, and
• How to apply simple, yet effective ways, in determining the financial drivers such as capital accounts, rights, ownership and what has been earned upon retirement.

WHAT DOES IT TAKE TO BECOME AN EQUITY PARTNER?

At the larger firms, an individual has to demonstrate that he/she can consistently help perpetuate the firm by exhibiting skills and abilities in the most important competencies summarized below:

1. Client Relationships and Client Service Excellence:

• Demonstrating strong business acumen and judgment.
• Becoming a trusted business advisor so clients seek counsel on multitudes of business matters.
• Developing sustained long-term client relationships by continuously creating business expansion and business referral opportunities.
• Managing client relationships and engagements with the highest level of integrity.
• Providing clients with the highest level of consulting and advisory services.
• Turning client relationships into long-term personal relationships so clients have the perspective of viewing the firm’s services as invaluable.

2. Technical Capabilities and Distinctions:

• Exhibiting and recognized as a “go to” person for technical competence and quality that is sought internally and externally.
• Developing technical excellence in others.
• Having an acute sense of risk assessment and risk management.
• Staying abreast of industry developments and professional standards.
• Attracting business based on expertise and demonstrating the ability to monetize that expertise.

3. Personal Attributes:

• Demonstrating integrity in actions. As an example. if faced with a challenge of a serious issue in an engagement where he/she strongly disagrees with a partner, raising that issue with firm’s management.
• Demonstrating a strong team orientation that recognizes the importance of creating and leading highly effective work teams.
• Instilling a culture of client service excellence.
• Driving others to see the importance of helping their team members to ensure professional development and client service.
• Earning the respect of partners and team members.
• Creating a positive first impression.
• Contributing and/or leading an important firm and/or office and/or practice area initiative.
• Demonstrating a commitment to quality in everything done (including services performed, work products, staff evaluations and leadership commitments).
• Demonstrating the resilience and agility to operate in dynamic environments.
• Maintaining composure and managing stress during times of intense pressure while successfully managing staff and meeting client delivery expectations.

4. Staff Development:

• Leading teams and demonstrating effectiveness in mentoring and coaching.
• Attracting great talent and, through sustained development, turning above average players into “A” players.
• Serving as a role model.
• Being a team player, taking part in firm activities, with a genuine willingness to help out.
• Being recognized as being a part of the “glue” that keeps the firm/office/practice area together.

5. Business Development:

• Originating new business (brand-new client relationships that are not current clients) of an amount that is established by the firm as a minimum threshold.
• Demonstrating the ability to cross sell and expand business in a consistent fashion over several years.
• Contributing to or participating in:
  • Writing articles.
  • Speaking engagements.
  • Networking forums.
• Effectively networking; listening for the opportunity and closing a sale.
• Maintaining a strong network that generates leads and converts those leads into business.
• Sustaining track record of developing new opportunities for the firm.
• Being an active leader in various associations and business groups and regularly attending industry and community meetings.
• Contributing to the growth culture of the firm by prioritizing practice development and communicating this priority to others to help build practice development skills.
• Continually expanding existing client opportunities by cross-selling other services and service providers.
• Being “famous” for introducing other firm resources/expertise to existing client relationships.

6. Office Leadership/Firm Management:

• Making a significant contribution to the management of an office or practice area.
• Demonstrating the ability to think strategically, have a big picture/long view and being instrumental in driving firm strategies.
• Thinking and acting “Firm First”.
• Identifying and retaining top talent by championing a performance-driven culture.
• Building rapport with colleagues and staff.
• Consistently striving to increase one’s level of responsibility – not content with the status quo.
• Consistently displaying a high level of integrity that is apparent with interactions with colleagues and staff.

HOW TO DETERMINE THE FINANCIAL DRIVERS: 

In Our Opinion, upon becoming an equity partner, everyone should be required to cut a check representing his/her cash capital account and, to keep it simple, every equity partner should put in the same amount of capital (usually between $50,000 to $300,000 — depending on the philosophy of debt vs. partner capital to fund operations and investments). Cash capital, representing his/her ownership in the firm, earns annual interest payments and is returned over two/three years after the partner’s retirement.

 

While a partner’s ownership in a firm is determined by the percentage of an individual’s cash capital when compared to the total cash capital in a firm, we believe that basic partner

 

rights (including participating in the firm’s annual partners meeting to discuss general firm business and to vote on partnership agreement amendments and determining the allocation of proceeds upon the sale or acquisition of the firm) should be driven by a heavy weighting of an individual partner’s performance (measured by total compensation) plus the amount of a partner’s cash capital account.

 

Applying a simple, yet effective, methodology in determining basic rights of an equity partner, as opposed to extremely complex, cumbersome and difficult to work structures, is encouraged. Here is an example of what we mean by simple and effective. Let’s assume that a firm has decided to weigh compensation three times more than capital and that there are a total of 1000 votes available to all equity partners. Here is an illustration of how to determine basic voting rights:

• Each equity partner has the right to cast a number of votes equal to the product of 1000 multiplied by a fraction determined by adding:

1. The product of three times a compensation factor (the numerator equal to the partner’s compensation for the two preceding years; the denominator equal to total partners compensation for the two preceding years) and
2. The product of a cash capital factor (the numerator equal to the partner’s cash capital at the end of the two preceding years; the denominator equal to total partners’ cash capital at the end of two preceding year) and by dividing the sum of (a) and (b) for each equity partner by the sum of (a) and (b) for all equity partners.

• Now let’s assume that there are two partners:
• Partner #1 has 10% of the compensation factor and 10% of the cash capital factor. Partner #1 has 10% total compensation and cash capital.
• Partner #2 has 90% of the compensation factor and 90% of the cash capital factor. Partner #2 has 90% of the total compensation and cash capital.
• Partner #1 would get 10% of the 1000 votes or 100 votes; Partner #2 would get 90% of the 1000 votes or 900 votes.

 

• If the firm is sold or acquired, each equity partner has earned an allocation of proceeds from the transaction in accordance with the compensation factor and cash capital factor illustrated above.
• Upon retirement, each equity partner has earned deferred compensation/retirement benefits which usually amount to 200% to 300% of average annual compensation during the three highest out of the last five preceding years payable over ten years after cash capital is returned over the first two/three year following retirement. Vesting occurs over a ten-year period pro ratably.

 IN CONCLUSION 

No doubt about it. Developing future equity partners is important business. We encourage small and midsized CPA firms to develop competency standards and adhere to them. We also encourage firms of all sizes to apply simply financial drivers such as capital accounts, rights, ownership and what has been earned upon retirement rather than some of the very complex structures in place that are cumbersome and difficult to work with.

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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 shares 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 desposito@espositoceo2ceo.com or 203.292.3277.