[IMGCAP(1)]CPA firms are challenged today by an unprecedented pace of change and intense margin pressure, with no reason to believe the end is in sight.

There are too many competitors and a shortage of qualified talent (particularly in the tax area). It certainly isn’t the good old days before the financial crisis when the Big Four were the greatest referral sources for midmarket firms, and SOX created so much demand for services that pricing power was at an all-time high. Many firms were figuratively printing money and were afraid to answer the phone because they would have to turn away new business as production and utilization exceeded 100 percent of capacity.

As if that weren’t enough, firms are also trying to put their arms around evolving business and operating models, changing from a traditional accounting firm model and partner/staff pyramid to a professional services firm model that mandates a flatter organization. It’s obvious management consulting and advisory services are where a CPA firm’s growth and margins are today as midmarket clients continue to outsource noncore, but nevertheless critical, business processes in an attempt to improve EBITDA and working capital.

On top of all this, the presidential election could result in arguably overdue tax reform to stimulate the economy and job creation. Many believe we will at least see an enhanced jobs tax credit. Significant tax reform might change the traditional CPA firm partner/staff pyramid model (sometimes sadly inverted and upside down). Last but not least, firms will soon be facing competition from disruptors such as Google and Microsoft as they buy market share by slicing and dicing real-time financial data that also deliver value from immense databases that benchmark best practices in a quest for enhanced market valuations.

What are CPA firms to do in this fluid environment? An absolutely essential first step requires firms to take a hard look at their partner numbers (what they are versus what they should be). To that end, we would like to share some financial guidelines commonly used by both the Giant Four firms and the Next Six. This is not to suggest these are the guidelines small and midsize firm should adopt, but it probably is beneficial for midmarket CPA firms to have an insight into what’s going on at the larger sustainable brands in order to benchmark against them. This, in and of itself, could help you determine if your firm is over-partnered in these challenging times.

In the first instance, best practices indicate the partner to staff leverage should move to 5 to 1, perhaps 7 to 1, depending on your geography and service mix. In addition, many of the larger firms have two groups of partners: non-equity and equity. In many cases, there is a 50/50 split between the two categories.

Non-Equity Partners
The key question to be addressed with every non-equity partner is: “Does the enterprise value of an existing or potential partner contribute towards perpetuating and growing the firm’s business, maintaining technical excellence and driving client and staff retention?” Beyond this threshold question, a non-equity partner/candidate needs to demonstrate a track record of performance in a number of practice areas, not the least of which is business development.

The mandate, with the exception of those partners tasked with quality control, is that: (a) an existing partner has to annually originate a combination of new business and cross-selling in the minimum amount of $150,000, and (b) a partner candidate needs to demonstrate a minimum amount of $450,000 over the three years preceding partner consideration.  If these criteria aren’t met, underperforming partners are coached with the understanding that if improvements aren’t achieved, they will be counseled out of the firm.

Equity Partners
Most of the larger firms have “stretch” revenue and earnings guidelines (ratcheted up annually) for determining their desired number of equity partners. Something similar to what is presented below is currently being used at these firms:

• Revenue per Audit/Tax Equity Partner: $2,000,000
• Earnings per Audit/Tax Equity Partner: $600,000
• Revenue per Consulting Equity Partner: $3,000,000
• Earnings per Consulting Equity Partner: $1,300,000

These guidelines are just that—guidelines—not bright lines. If they aren’t met, firms put up a red flag and decide what they need to do about it. In addition to the financial guidelines, the key question that is then addressed is: “Does the enterprise value of an existing or a potential equity partner significantly contribute towards perpetuating and growing the firm’s business, maintaining and enhancing technical excellence, and driving client and staff retention, and has this value been demonstrated by a track record of steady and increasingly improved performance?”

The mandate, with the exception of those partners tasked with quality control, at many of the larger firms is that an existing equity partner must demonstrate a track record of creating new business originations, and by achieving actual results, net of losses, in the minimum amount of $250,000 each and every year. Further, there needs to be evidence that the partner is consistently cross-selling new products and services to existing clients. Again, if these criteria aren’t met, underperforming partners are coached with the understanding that if improvements aren’t achieved, they will be counseled out of the firm.

This analysis might appear foreign to some firms and perhaps harsh to many others. Please understand, we are not looking to offend any firms. Rather we hope to open eyes to the realities of our business. If your firm isn’t actively addressing this issue, we suggest that you are looking at the world through rose-colored glasses. In addition to being over-partnered, your firm probably is facing a number of undesirable outcomes, including:

• You have too few, if any, younger staff and the inability to keep what you have busy.
• “All stars” leave the firm as they don’t see an opportunity to advance.
• Staff members are stuck on repetitive, boring client assignments with little, if any, on-the-job training.
• Costly labor loads result in unacceptable margins.
• Partners do compliance work, not consulting, and don’t develop new business.
• Your firm has inadequate talent at the right levels necessary to develop future partners who can perpetuate the firm.

All of these outcomes can be effectively dealt with if you do a gut check, understand your reality and your probable future, and deal with it with proper prudence. We know it’s tough out there, but things are not going to get better if you put your head in the sand. We have a great profession (yes, profession, not industry) built upon the cornerstones of trust and integrity. Let’s capitalize on the “market permission” we enjoy and the franchises we have developed. Let’s grow our firms in a way we can be proud of. Remember, hope is not a strategy. A strategy is a strategy.

Dom Esposito, CPA, is the CEO of Esposito CEO2CEO, LLC, a boutique advisory firm consulting with small and midsized CPA firms on strategy, practice management, mergers and acquisitions. Dom was voted one of the most influential people in the profession for two consecutive years by Accounting Today. He has written a book, “8 Steps to Great,” a primer for CEOs, managing partners and other senior partners, published by www.CPATrendlines.com. Dom welcomes questions and can be contacted at desposito@espositoceo2ceo.com or (203) 292-3277.

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