Pondering the Partner Track

Here are the questions prospective partners should ask — and the responses they better get.

It used to be a no-brainer: When a firm invited a staff person to become a partner, they accepted, no questions asked, and not one iota of hesitation. That’s changing. Over the past three to four years, I’ve been receiving calls regularly from prospective new partners who are hesitant to accept a partnership offer or are concerned about an offer they anticipate is coming.

In part, their hesitation is due to serious weaknesses in the firm observed as staffers, making them question whether they want to become an owner. As a colleague of mine once said, “If you stay in a nuthouse, you’re nuts.”

The other hesitation factor stems from prospective partners getting smarter. Instead of blindly accepting partnership offers as their baby boomer and Gen X predecessors regularly did, next generation leaders realize there are fundamental financial, governance, and legal questions they need answers to before signing on the dotted line. But many of them don’t know enough about how CPA firms operate to ask the right questions — that’s where I come in.

The interesting spin on this is that the following questions aren’t just for prospective partners, they’re also for existing partners who should be reviewing the same questions and answers to ensure their houses are in order before extending their partnerships.

Q: Does the firm have written criteria for making partner?

Prospective partners should want to see this document to determine if they can ever meet the qualifications and requirements of partners. Are the criteria reasonable? By the way, it’s perfectly reasonable, and even appropriate, for there to be a major subjective criterion based on existing partners’ sense of trust and comfort with a prospective partner.

Q: As a new partner, what will my role and duties be?

Beware if the firm wants you to continue functioning as a staff person: (a) working on the partners’ clients without being allowed to act like a partner, and (b) having such a high billable hour target that it prevents you from having time to develop your own business. You’ll never be recognized as a real partner by the other partners and staff if you’re seen functioning as a manager with a partner title.

Q: Does the firm have a proper partner agreement?

As someone who works extensively with CPA firms on their partner agreements, I can tell you that a shocking number of these agreements are antiquated, many inked 10 to 20 years ago, and thus contain outdated verbiage and lack key modern provisions. You would be surprised how many agreements are written with minimal involvement of an attorney or were written by an attorney lacking experience with CPA firms.

Critically important areas to watch for — but are often lacking — include terms for partner buyouts, death and disability, mandatory retirement, duties and prohibitions, grounds for expulsion, and voting rights. No one should agree to be an owner in a business without a properly written and signed partner agreement in place.

Q: Is voting fair?

New partners should understand their ability to impact decisions. As a new partner, it’s likely your ownership percentage will be small. If voting on firm issues is based solely on ownership percentage, you won’t have much — if any — say on decisions, which could leave you essentially disenfranchised.

I generally propose firms follow a “one-person-one-vote” rule when it comes to most partner decision-making. Exceptions to this rule would include voting on mergers and changing the partner agreement. In these cases, voting on ownership interest may be more appropriate.

Q: How is compensation allocated?

Everyone is concerned about their pay, but partner compensation is handled quite differently than for staff. Prospective partners need to understand how their compensation will be calculated and determined:

• The compensation system should be performance-based instead of archaic and unfair methods such as ownership percentage, pay-equal, or seniority.

• If the firm uses a compensation formula, make sure that: 1. It that has a provision to value and compensate subjective performance attributes, like mentoring staff, fostering teamwork, and management, in addition to production metrics. 2. It isn’t excessively skewed towards book of business. Unless you’re a rainmaker, which is almost never the case for new partners, you’ll be precluded from earning a decent compensation level in a system that overemphasizes book of business. 3. It doesn’t base excessive weight on billable hours because this will cause partners to hoard staff-level work instead of delegating it.

Q: What is the firm’s profitability?

Asking how revenues and profits are trending is a straightforward question. After all, why would you want to become a new owner of a stagnant, marginally profitable, or declining business?

Q: Is there a cluster of older partners whose retirements and related buyouts will be overlapping?

When multiple key partners retire at the same time, the future viability of the firm could be threatened. You don’t want to become a new partner only to have the firm sold in a few short years because it can neither survive the talent exodus from partner retirements or the financial impact of their buyout payments.

Q: What is the buy-in amount?

Don’t be mistaken, the invitation to become a partner comes at a cost. What you don’t want to see is an onerous buy-in amount based on ownership percentage times the value of the firm, which usually results in a buy-in totaling several hundreds of thousands of dollars. Instead, it should be a relatively nominal amount, say $75,000 to $150,000. The payments should also be spread over several years so that new partners don’t take home less cash than when they were managers.

Q: Does the firm have retirement and buyout plans in place?

My experience is that two-thirds or more of partner retirement and buyout agreements are poorly conceived. Beware of these common flaws:

• A goodwill valuation that is onerous — the industry average is 80 percent of revenue.

• Payments based on a partner’s book of business.

• Woefully short notice periods — 18 to 24 months is recommended.

• Virtually no client transition requirements.

• Buyout payments that begin while the partner continues to work and control his or her clients.

Q: How do buyout payments impact the income of the remaining partners?

A well-written plan should be structured in such a way that the remaining partners either earn more income or no less than their current income. This is made possible by no longer compensating the retiring partner and using those cost savings to fund the buyout payments. If this doesn’t occur, then the firm’s buyout plan works more like a Ponzi scheme.

Q: Is there a mandatory retirement policy?

While it may seem counter-intuitive to want your firm to have such a policy, mandatory retirements are good for the firm. You don’t want to be a new partner in a firm where the old partners work forever, or their retirement dates are unclear. Without a mandatory retirement policy, talented young professionals will leave because they’ll see no future for themselves when the old guys or gals hang on forever.

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Perennially cited by Inside Public Accounting as one of the 10 most recommended consultants in the country, Marc Rosenberg, CPA is a nationally renowned consultant, author, and speaker on CPA firm management, strategy, and partner issues. His 14 practice management books are available here, and Marc can be reached at 847.251.7100 or [email protected].