Updating Your Partner Compensation Plan
In September, I presented a webinar on this topic as part of the CPA Leadership Institute Webinar program. Here is a summary of that presentation.
Partners are often happy with their compensation until they compare it to what other partners are making. Then they may not understand why certain other partners earn more than they do. A good partnership compensation plan may clear up these misunderstandings and do a lot more.
How Partners Should be Evaluated
Partners should be evaluated on their contributions to the things that can make an accounting firm great:
- Accountability
- Leadership development
- Skilled, motivated staff
- Growth
- Right people in the right jobs
- Production
- Leadership and management
- Quality work
- Great service
The Evolution of Partner Compensation Plans
Partner compensation plans have evolved from:
- What was once considered fair, dividing net income equally among the partners, and was typically decided at inception of firm to
- To decide together and this typically occurred when changes occurred, such as he admission of new partners to
- The development of a formula to deal with grumblings and dissatisfaction to
- The formation of a compensation committee. This is the process ultimately employed by most firms though many may still be somewhere on a continuum that leads to it. And to a certain extent the process used is a function of size.
There are Six Factors in Splitting Up the Pie
- Return on capital
- Finding
- Minding
- Grinding
- Leadership and management
- Intangibles such as:
- Goals. Address the issue of what happens when partners achieve or don’t achieve their goals
- Staff development like developing senior managers and next partners. With the existential problems of recruiting and retention, nothing could be more valuable than the ability to develop and retain staff,
- Client service and satisfaction: Determining how to measure
- Teamwork: Without it the firm is just a group of sole practitioners in the same office.
Three Compensation Themes
- Judgment is always a part of the process--no matter how objective the system is, judgment will always be a part of it.
- Intangibles are an essential part of any system including systems that rely on a formula
- Partners are not alike: You evaluate a rainmaker differently from the way you evaluate a technical expert. The partner compensation system is not the place to fix problems. Problems are dealt with in the evaluation process. The focus in the compensation system is on rewarding good performance. If problems are fixed (elsewhere), performance will improve.
What Systems Firms are Using
The larger the firm, the more likely it is to use a compensation committee. A small percentage of firms with 2 to 7 partners use them. But it is the dominant system in firms with more than 8 partners. Smaller firms are more likely to use a formula system.
The managing partner plays a major role in any system. The committee focuses on performance and contribution (who is really moving the firm forward both in terms of tangible and intangible factors?) It’s not that the committee does not look at metrics and objective data but they are not pushing it into a formula.
Open v Closed System
A significant majority of smaller firms have open systems, i.e., the partners know what other partners are earning. A small majority of firms with 8 to 12 partners have open systems. But firms with more than 12 partners are not likely to use an open system and the overall trend is towards closed systems.
Linking it All Together
There is a trend to do more and more goal setting, planning, and developing of core values. There is not as great a trend to do partner evaluations but larger firms are beginning to focus more on it. However, partner compensation is not generally tied in to these two things and that has to change for a firm to get to the next level.
Best Practices Trends:
Summary of trends in best practices:
- Movement from formulas to committees
- From tangibles to intangibles, even with formulas
- MP is key in all systems
- Performance based
- Focus on strengths, not fixing things
- Premium for new business
- Heavy dose of judgment
- Not all at risk, i.e., there will generally be a fixed salary or draw, and the compensation system deals with net income in excess of that
- Larger firms closing the process
- More focus on what the firm need partners to do
- Less focus on chargeable hours and book of business. Partners have a lot less chargeable hours than 15 years ago.
Problems With Formulas
- Promotes empire building; detracts from teamwork
- Difficult to move work to others
- Tends to motivate people to be the same
- Doesn’t value leadership and management and intangibles
- Difficult to reward team sales
- How do you decide what is measured and what weights are assigned?
- How are “good of the firm activities” measured? For example, a partner may perform well in serving not-for-profit clients, but are they as good for the firm as other industries?
If You Do Use Formulas
Here are three examples of methods that use formulas with modifications:
- Finder, Minder, Grinder
- After allowing for intangibles and return on capital and management finder gets 35% (but only for a number of years, say, 3, so the finder is motivated to go out and bring in more), minder gets 35%, and grinder 20%
- 20/50--(But is there too much focus on personal production?)
- 20% of book of business
- 50% of personal production
- Still carve out for management, capital, and intangibles
- Six Factors
- $2500 for each year as partner up to 15
- 25% of production and management time (budgeted)
- 6% of billings in book
- 15% of new business for 48 months
- Deduct 50% of write offs (AR and WIP) over 12%
- Plus 50% under 7%
- 10% of income for achieving goals
- Any balance is equal
Compensation Committee Best Practices
- Communication and understanding of the process is critical
- Linkage of firm goals to partner goals to compensation must be clear
- MP is the quarterback and liaison with the partners. MP may not want to have all the say
- Partners must know how they contribute and what behavior and results will be rewarded
- Partners must respect and trust committee members
Committee Structure and Process
- 3 to 5 members
- Voted in
- Staggered terms
- Sometimes it’s the executive committee or board that also serves as the compensation committee
- MP is permanent member
- Responsible for bonus and next year’s salary or draw
- Meets once a year
- MP prepares a package for each partner for consideration by the committee. Too cumbersome to have each committee member doing it.
- Communication of results is critical
Summary of What is Considered During the Partner Comp Determination Process:
- Achievement of Goals
- New Business
- Charge Hours (heavily weighted?)
- Book of Business (heavily weighted?)
- Profitability of Book
- Working Capital Utilization
- Staff Utilization
- Staff mentoring and development
- Firm leadership activities
- Good of the firm activities
- Teamwork
- Movement of clients to others
- Client service/satisfaction
- Upward evaluations
- Partner cross evaluations
- Non binding slip of paper
- Extenuating circumstances
- MP discretionary pot
- Weighting of criteria
- Partners nearing retirement, If you want them to perform a successful transition, don’t cut their pay
Challenges
- Should there be a right to appeal? The answer is no, but partners should have the right to ask questions and get explanations
- Should the partner group approve the final decision? It would be unworkable without going through the entire process and that is unrealistic.
- Aren’t compensation committee members determining their own compensation? Yes they are, and there is no way around it. They may be asked to leave the room when the committee is discussing them
Blog Prepared by: Gary Adamson, CPA.
For more information about internal and external succession planning in CPA firms, you can reach Gary Adamson at 765-488-0691 or [email protected].