Source: Public Practice

The following includes excerpts from an article by Bill Reeb, reprinted with permission from the Texas Society of CPAs.

In this continuing series about allocating equity among partners (you can read part one here), Reeb presents several scenarios to illustrate the dangers inherent in traditional ownership distribution systems.

In one scenario involving a five-partner firm, senior partner 1 (SP1) retires. His share of the equity ownership is distributed pro rata to the remaining partners, with a 5% ownership interest to a new junior partner. Senior partner 2 (SP2) ends up with 51% of the equity, giving him total control.

This might be good—SP2 may be a benevolent, visionary leader—but it also could be terrible. For example, if SP2 was the more technical partner, the firm might shift to a strong “eat what you kill” approach. Or, if SP2 was the marketing partner, the junior partners may end up in “worker bee” roles on SP2’s clients so that SP2 can look for more business. Neither situation will build a viable organization over the long term.

The system is also poised for abuse. With total control over the firm, SP2 could focus the firm on maximizing take-home pay during the remaining years he wants to work. Even if the firm has a mandatory retirement clause, SP2 may be in a position to change that.

Reeb’s next column will outline a process for reallocating equity to avoid these types of scenarios. It can be painful and often creates conflict, but conflict now is much better and less painful than allowing the firm to shift power into the hands of partners that may damage the firm.

To ready the complete article, click here.

From Texas Society of CPAs, Public Practice, March 2009, www.tscpa.org.

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