Building value for the partners of small and mid-sized CPA firms

The advisors at ESPOSITO CEO2CEO build firms by overcoming the long-term challenges facing small and mid-sized CPA firms. It’s the ESPOSITO CEO2CEO Difference.

Read these insightful pieces to learn more about the ESPOSITO CEO2CEO Difference:


The Top 10 Barriers to Growth

Many small and mid-sized CPA firms fail to reach their full potential of becoming a standout, high–performing firm due to a variety of common challenges. Presented below are our thoughts for a possible solution:

  1. The Challenge: Heavy dependency upon banking relationships and undercapitalized with their partner group.
    Solution Thoughts: Rather than reliance upon their banks, in the best of breed, every equity partner is usually 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 every year as a reduction of compensation until the firm’s cap is reached.
  2. The Challenge: Effective governance and the ability to address partner issues including too many partners, ineffective partners and partners who don’t play by the rules. Sometimes the managing partner is a benevolent dictator and sometimes partners just run amuck and do as they please.
    Solution Thoughts: Devising plans much like those of Top 100 firms which have effective Executive Committees who are responsible for approving strategy and evaluating the CEO.
  3. The Challenge: Promoting the largest billers and best business developers as CEO, which has the potential of becoming a lose/lose situation.
    Solution Thoughts: Look deeper at the partner pool to determine the best use of talents, attributes and business sense.
  4. The Challenge: Reaching too low for small acquisitions of $1 million to $2 million practices which are usually short-term plays that have little, if any, stickiness to them. Generally, they are pure and simple, buyouts of retiring partners with questionable quality practices and professionals who may not technically proficient.
    Solution Thoughts: Look at mergers and acquisitions differently. They are strategic and/or talent plays usually larger in size, with some marquee clients and strong talent.

  1. The Challenge: An unwillingness to recognize that heavy reliance on compliance work is not the future.
    Solution Thoughts: Plan to increase advisory/consulting work which generally produces higher margins.
  2. The Challenge: The difficulty in perpetuating the firm due to a bulging partner deferred compensation plan. Many plans have no caps on distributions to retired partners and many others are too expensive particularly when they include a payment for accrued capital as well as a deferred compensation plan.
    Solution Thoughts: Develop new deferred compensation plans with market payouts, terms and caps.
  3. The Challenge: The ability to recognize that not all partners can be/should be/want to be equity partners who are required to perpetuate the firm.
    Solution Thoughts: Define what an equity partner “looks” like (i.e., what are the criteria and core competencies). Also help mentor young partners candidates through a Partner Candidate Development Academy.
  4. The Challenge: Develop a meaningful succession plan that can smoothly transition leadership.
    Solution Thoughts: Too many firms don’t have a meaningful succession plan that ensures an orderly transition of leadership. When this is the situation there is a high probably that the firm will not stay independent over the long haul.
  5. The Challenge: Taking on revenue for the sake of bulking up – not for profit.
    Solution Thoughts: “Low hanging fruit” is easy to win but hard to divest. Also too many firms hold on to “D” clients that don’t produce profit, take-up capacity and are void of learning experiences for the staff.
  6. The Challenge: Partners are uncomfortable with trying to go after larger, more profitable clients. Many are also uneasy in servicing these larger, more complex clients.
    Solution Thoughts: If a firm wants larger, more complex clients, it also needs qualified partners to attract and/or service them. Defining the core competencies of future partners will help improve the probability of a firm to move “uptown” with its client base and future partner group.

Better or Bigger?

While conventional wisdom tells us that “better is better”, we believe that is plain and simple nonsense when it comes to mid-sized CPA firms and a convenient excuse for a less than stellar growth trajectory by a firm’s partner group. We believe this because we look at “better” through the lens of the marketplace for both existing and prospective clients and talent.

Our Observation: There is no doubt in our minds, that to the marketplace, bigger is better, and that means that size sells and matters. Make no mistake about it! Your existing and prospective clients and people respect big and more importantly; buy big and known brands. The supposition is that if you are big, you must be good. If you are big, you must have client and people credentials that are impressive, and those credentials attract better quality prospects and people. If your firm is big, it is an easier "client buy" than if your firm is “better.” Even though your firm might be better, if the marketplace doesn’t recognize your brand, there is always going to be buyer skepticism in making the sales pitch. Ever hear of the old saying: “be safe, it will be difficult for anyone to criticize you if you buy IBM?” The same is true with accounting, tax and advisory services. With more notable clients and a brand that is known for certain niches, your firm has pricing power when it comes to fees and that translates into better profits per partner. At the end of the day, isn’t that the scorecard for measuring success: profit per partner?

Business Combinations

Principally because of the difficulty in growing organically at an acceptable rate and because of the ever-increasing pace of baby boomer retirements, business combinations continue to happen at a very hectic pace. We believe that significant business combinations are coming, but when we speak to CEOs and other senior managers at the Top 100 and other fast-growing firms, it is apparent that many, if not most of mergers/acquisitions fall significantly short of growth and profit expectations. Some even wind up in divorce, with costly break-up costs as morale drops, synergies fail to materialize, and key partners and potential partners leave for other opportunity. For every merger that actually happens, handfuls of mergers do not. Over the years, ESPOSITO CEO2CEO has integrated numerous merger combinations, and has helped firms avoid the pitfalls often associated with pursuing a transaction.

Our Observation: Because pursuing a business combination transaction is a time-consuming undertaking, a transaction that falls short of expectations can be very expensive. It is helpful to examine the top reasons why transactions fall short of expectations and why potential mergers/acquisitions don’t materialize.

  1. Irreconcilable culture clashes or differences at the two firms.
  2. Egos of senior partners.
  3. Different views on governance, autonomy and accountability moving forward.
  4. Concern about it “may not work,” so “why take the risk?”
  5. A larger firm deciding that the pain to integrate is greater than the gain to be realized by the transaction, and is not willing to invest the time and effort to make it work.
  6. Lack of effective leadership taking partners through the decision tree from initial transaction identification to transaction consummation.
  7. Too many partners are willing to torpedo the transaction.
  8. Disagreement among the merged-in partners about how to cut up the practice payment (deferred compensation).
  9. Amount of retirement obligations at both the larger firm and the merged-in form or at either firm.
  10. Dissimilar retirement and compensation plans at the two firms.
  11. Valuation and other deal considerations outlined in the term sheet.

Irreconcilable culture clashes or differences at the two firms are identified as the primary reason why transactions fall short of expectations or don’t materialize at all, and valuation and other deal considerations are identified as number 11 on the list. While many people believe deals fall apart because of economics, our experience is different. That is not to say that economics are not important, but financial considerations are usually flushed out quickly, and if there isn’t a meeting of the minds, deal discussions can shut down quickly. We find that valuation and other deal considerations can be successfully negotiated if the two firms believe that 1+1+3 and that they can have greater success in the marketplace if they are together. On the other hand, culture clashes or differences may not be initially apparent, and can take time before they surface.

The Importance of Strategic Plan Execution

Many CPA firms do not have a living, breathing strategic plan that enables them to successfully navigate through their next two or three years. That in and of itself is not surprising, since most CPA firms are basically small and mid-sized businesses with the same generational challenges faced by most small and mid-sized family and privately owned operating companies in all sectors. After all, the 100th largest CPA firm in the U.S. is only at around $40 million in annual volume. In our view, the lack of a well-executive strategic plan is a potential death blow to a small or mid-sized firm. It will eventually be difficult for these firms to be competitive due to undistinguishable client service, insufficient growth that helps retain talent, and an inability to attract and retain young superstars who will perpetuate the firm into the next generation. Planning is the first step, and actually executing the plan is imperative to success. For those firms that actually do undertake and exhaustive strategic planning exercise but don’t use it as a living, breathing tool that holds partners accountable through a performance management and compensation system, it is merely an “exercise” that eventually sits on a shelf gathering dust in partner offices – and a major missed opportunity. Why have so many firms found it difficult to convert strategy into action? Why have many failed to achieve successful implementation of their strategic plan?

Our Observation: We have found that failure to effectively execute on a strategy most often occurs because it is very easy for partners, including the firm’s CEO and senior management, to get distracted and make excuses for their inability to deliver. The biggest partner excuse usually cited is the demand of client service and, no doubt, some of that is real. It is not unusual however, for partners to “hide” behind that premise, while the real reason for execution failure is the perception that the CE doesn’t take the implementation process seriously. We often hear “The plan is nothing more than a theoretical exercise that will never come to fruition.” If the boss isn’t paying attention to follow through and individual accountability, why should the line partners? Implementation of actionable goals that are part of a strategic plan is oftentimes uncomfortable for partners as it takes them out of their comfort zone. Strategic execution failure comes down to an organization’s inability to muster up the necessary fortitude to translate strategy into results. It usually starts with the discipline (or lack thereof) exhibited by the CEO and senior management.

The Right Mix for Practice Management

It is critical that firms, regardless of size, have both effective governance and operating models and the right partners on the bus. Without these essential ingredients (often time easier said than done), your firm will find it very difficult in achieving growth at an acceptable rate (6% to 8% per year). As you consider growing your firm, keep in mind that with growth comes larger and more complex governance and operational models. Finding the right partners becomes challenging as well. Firms must always be looking to attract and retain the highest performing partners and rising starts, because without them you will eventually stagnate and ultimately die.

Our Observation: Today more often than not, larger firms (and those that aspire to be larger firms) look to one partner group to govern (usually referred to as an Executive Board, Partner Board, or Executive Committee) and a second group of partners, the Senior Operating Leadership Team, to drive strategy and to oversee the day-to-day operations. To be most effective, these two groups need to complement each other. In fact, in many firms with highly regarded brands, these two groups are comprised of different partners to foster healthy checks and balances within the firm. Unfortunately, all too often, at many of the small and mid-sized firms, we find that these two groups and their responsibilities are vested with just a single governance and operating committee appointed by the CEO. While we understand that it is easy to fall into this trap, we don’t believe that this is a very healthy way to run a firm. Sometimes it creates a mentality of “us versus them.” It also creates a good old boys club that becomes very inbred. This unhealthy environment often creates favoritism (which is terrible for morale), hampers revenue growth (which is terrible for partner wallets), and makes it very difficult to nurture future leaders (which threatens the viability of a firm).

Building Leadership

In his 2008 book “Strategy and the Fat Smoker,” David Maister wrote that we often (or even usually) know what we should be doing in both our personal and professional life. We also know why we should be doing it and (often) how to do it. Figuring all that out is not too difficult. What is very difficult is actually doing what you know to be good for you in the long-run, despite short-run temptations.

This thesis is very applicable to a CPA firm leader. More often than not, what needs to be done by a firm’s managing partner (or CEO) is obvious. While not easy, in the best interests of the firm, he or she needs to make those though decisions. But many leaders fall short of what is required and, in many cases, it is the principal reason why so many firms can’t get to the next level or, worse yet, can’t perpetuate themselves.

Our Observation: We believe that there are obvious, but not easy, things that a managing partner needs to do in today’s world of public accounting to be viewed as an effective leader.

  • Walk and talk the vision, mission and strategy of the firm. Lead by example. “Do as I do, not as I say.”
  • Create an environment that breeds trust, persistency and consistency.
  • Shepherd senior partners and potential all-stars.
  • Create a firm-first (our clients vs. my clients) culture.
  • Be open to service diversification. Move away from the traditional accounting firm model to a professional services firm model.
  • Address ineffective partners on a timely basis.
  • Realize that size (with quality and profits) matters, and explore a merger or two if that is in the long-term best interests of clients, staff and partners.
  • Deliver on the client promise of being a trusted advisor.

We also see that there are firms that spiral out of control, break up or merge as “damaged goods” because while they are aware of the danger signals of inefficient leadership, do not pay attention to the warning signs of:

  • The “inmates are running the asylum.” Disgruntled partners are doing their own thing. The staff sees it and they begin to disrespect partners and are indifferent to firm protocols and policies.
  • The partnership agreement does not require tight corporate governance.
  • The partner compensation plan is not designed to handsomely reward high performance.
  • The firm is undercapitalized and too dependent on bank debt to pay monthly draws and year-end distributions.
  • There is poor quality control and risk management that creates a poor reputation, at best, or mounting litigation, at worst.
  • The firm is unable to attract and retain the next generation of partners.
  • There is not effective and realistic succession plan.
  • There are many ineffective and/or unproductive partners and as a result, the firm metrics are out of whack.
  • Senior partners are not playing as a team. Instead of “firm first,” it is “every man/woman for himself/herself.”

Correcting these issues starts by evaluating the effectiveness of your managing partner, because without an effective managing partner, a firm runs the very real risk of failure. An effective managing partner has to set the tone at the top and, when necessary, make the tough decisions that are required to keep the firm viable. He/she has a very big impact on the firm’s culture, behavior and compensation of the partner group. Being a CPA firm leader requires a person to walk the talk, lead by example, and “to do as I do, not as I say.” It is a very challenging and daunting responsibility. As a leader, every word a managing partner says, and every action taken, has a tremendous impact not only among the partner ranks but throughout the entire firm.