March 4, 2019

IN OUR OPINION, PERSPECTIVE #78 — MARCH 4, 2019

(A Continuing Series for Leading CPA Firms)

STRUGGLING TO ACHIEVE MARKET PARTNER COMPENSATION? AVOID THE TEMPTATION TO “SPRINKLE”!

“Compensation experts say that any system, if it is to stand up over time, must pass two tests: internal equity (whatever the rules are they must be applied in a consistent manner) and external equity (do compensation rewards reflect the economic realities in the open market?)”.                                                                         —David Maister

For the most part, Managing Partners at a large number of the best run Top 100 firms below the Giant Four do an excellent job in splitting up their compensation pies.

Their partner compensation system rewards performance and, at the same time, nurtures rising stars with lots of potential. Goal setting and evaluation tools are used to develop an understanding about each partner’s qualitative indicators (talent development, strategy advancement, client relationships, technical capabilities and distinctions, personal attributes, office leadership, mobility and communications) and quantitative indicators (business development and profitability, total dollars billed, total hours managed, realization rate and personal billable hours). These tools enable the Managing Partners to classify their partners into certain buckets that often look like these:

• BUCKET #1 — Major relationship builders and rainmakers with few billable

                          hours but a unique ability to “feed the system”. These are the       

                          franchise players.

• BUCKET #2 — Rising stars with lots of potential.
• BUCKET #3 — Average performers who continually hit single and doubles.
• BUCKET #4 — Ineffective partners who need to be outplaced.
• BUCKET #5 — Solo operators and free spirits who have a tendency to roam off                          

                          the Ponderosa.

• BUCKET #6 — Hardworking back office partners with many billable hours but

                          only marginal contributions on a macro basis.

When the time comes to dividing the compensation pie, these tools and partner classifications enable Managing Partners at many of the best small and mid-sized CPA firms to place a lot of emphasis on paying for performance (particularly partners in Bucket #1) and, at the same time, nurturing the rising stars with lots of potential (Bucket #2). We have found, however, that even at the best run firms, it is not unusual for Managing Partners to sprinkle some compensation from partners in Buckets #1 and #2 to partners in Buckets #3, #4, #5 and #6.

Why does sprinkling, even at the best run firms, occur?

We believe the answer to this question lies in the benevolent views of the Managing Partners who often look beyond the numbers and allocate partner compensation, at least in part, with the hope of keeping harmony among the partners. We also have come across some Managing Partners who have deep seeded beliefs that their partners are earning more money than they ever dreamed of; therefore, sprinkling some dollars around won’t even be noticed. Others believe that many of their partners aren’t motivated by additional compensation so there is not harm in doing some spreading or spraying. Finally, others just sprinkle some portion of partner compensation simply to avoid confrontation with certain partners. And while some small amount of sprinkling is certainly understandable in good years (i.e., “there was plenty of money to go around so there wasn’t any harm in sprinkling some dollars to keep everyone happy; after all, it does take a village.”), we believe sprinkling, if any, should be kept to an absolute minimum. And when tough years come rolling in (and there always are tough years) and there isn’t enough money to go around to adequately compensate the franchise players and the next generation of all stars, we not only would strongly discourage sprinkling at all costs, we would encourage Managing Partners to redistribute some compensation away from partners in Buckets #4, #5, #6

(and perhaps Bucket #3) and shift it over to partners in Buckets #1 and #2.  After all, the franchise players are making things happen today and the next generation of partners will be making things happen in the future. Without them, the firm would not perpetuate.

But this Perspective isn’t only directed to the best run small and mid-sized CPA firms. It is also directed to those firms that are not clicking at full throttle; struggling to grow and currently not achieving average equity partner compensation (market currently is about $625,000 at the Top 100 firms below the Giant Four; about $467,000 at the Top 300 firms). We have found that there is considerable equity partner compensation compression at the underperforming CPA firms. This is happening, in part, because these firms don’t have the right mix of partners — not enough who fall into Buckets #1, #2 and #3 and too many partners who are classified in Buckets #4, #5 and #6. Changing the partner group obviously is a much bigger challenge that needs to be dealt with.

In Our Opinion, if your firm is struggling to achieve its full potential, we strongly encourage you to take a hard look at the low hanging fruit — your partner compensation system. At all costs, we recommend that you don’t sprinkle dollars away from your franchise payers and high potential all-stars. In fact, if anything, we encourage you to redistribute dollars away from partners falling into Buckets #4, #5 and #6 to partners falling into Buckets #1 and #2, and perhaps, Bucket #3. If some of your low performing partners (particularly those partners falling into Bucket #4 and Bucket #5) don’t understand that it is absolutely necessary for the firm to compensate the franchise players and high potentials as close to market as possible, ask them to leave — and hope that they do. They probably shouldn’t be with you anyway.

IN CONCLUSION

At the end of the day, the partner compensation pie is a zero-sum game. Small and mid-sized CPA firms that are not achieving average market compensation of about $625,000 at the Top 100 firms below the Giant Four (about $467,000 at the Top 300 firms) have the huge task of changing their mix of partners to include more franchise players and partners with high potential. That should be their long-term goal. It takes years to fix but history has shown us that it certainly can be done. In the meantime, the short-term task is to get as much compensation into the partners who are creating the cash flow today and those who will create the cash flow in the future — even if that

means you have to take dollars away from other partners. The last thing any Managing Partner wants to do is to lose their highest performing partners over compensation but we have seen it happen over and over again. Warning — don’t sprinkle! Other than making you feel good today, there is no upside!

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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.