10 common reasons why CPA firms fail

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Many small and midsized CPA firms fail to reach their full potential. Here are 10 reasons why.

1. Being undercapitalized with partner cash capital and too dependent on the bank for working capital. This becomes particularly problematic when monthly draws are paid from the bank line, not from earnings. In the best-of-breed firms, every equity partner is required to put a minimum amount of cash capital into the firm upon admission and, as the years progress, to continue to put in cash capital each and every year as a reduction of compensation until the firm’s required capital amount is achieved. If it is subsequently determined that the firm needs additional cash capital from the partners, such amounts will subsequently be funded.

2. Ineffective governance and an unwillingness to make the tough decisions that are in the best interests of the firm. These include addressing partner issues such as too many partners, ineffective partners and partners who don’t play by the rules. Sometimes the CEO is a benevolent dictator and sometimes partners just run amok and do as they please. Many of the Top 100 Firms have effective executive committees that are responsible for approving strategy, making sure plans are executed in a timely fashion, and evaluating the CEO, including setting annual compensation adjustments.

3. Promoting their largest billers or best business developers to CEO, only to find that being CEO is oftentimes not the highest and best use of a partner’s talents. Other firms are run by committee or the responsibilities are shared by two partners. Generally, these arrangements are also ineffective. To ensure they are getting the best candidates to be CEO, top firms “protect” the CEO with a compensation and severance agreement that ensures employment for two or three years after the person steps down as CEO.

4. Consummating too many small acquisitions that create little, if any, long-term value. Acquisitions of $1-$2 million practices are usually short-term plays that have little, if any, stickiness to them. They often are, pure and simple, buyouts of retiring partners with low-quality practices and professionals who are not as technically proficient as they need to be.

The best of breed shy away from small acquisitions unless there is something very compelling being presented. These firms look at mergers and acquisitions differently. They are strategic and/or talent plays, usually larger in size, with some excellent clients and some excellent people. If everybody plays by the rules, there is a very good chance larger mergers and/or acquisitions will create long-term value for a firm. It’s very dicey with small acquisitions.

5. Failing to recognize that compliance work is not the future and that advisory/consulting work is. If a firm is operating under the old accounting firm model and is doing principally low-margin compliance work, sooner or later that firm will be out of step or, worse yet, out of business. Compliance work today is generating lower margins than it was before the financial crisis. It’s difficult to generate more profits for the partners in this environment, particularly as the cost of doing business continues to increase. Smart firms have begun to realize they need to shift from being compliance shops to a professional services model by beginning to develop advisory and consulting skills such as transaction advisory, cybersecurity and litigation support. It’s where the money is!

6. Bulging, unfunded partner deferred compensation plan that will be difficult, if not impossible, to fund unless a firm is continuously tracking high growth in revenues, profits and young, junior partners. Some of these plans also have no caps on distributable income available to retired partners, and many others are very burdensome when accrued capital payouts are added to deferred compensation payouts. The larger, more successful firms have a cap on distributable income available to retired partners of about 12 percent, and do not pay retiring partners their share of the accrued capital on top of a deferred compensation amount that is generally paid over 10 to 12 years.

7. Not recognizing that not all partners can perpetuate the firm. This is a particularly important acknowledgement in a slow-growth environment when it is difficult to grow revenues and profits. In the old days, when people were admitted into a partnership, they were immediately admitted as equity partners because that’s the way it always was. Some firms continue with this outdated practice. As a result, they become top-heavy and burdened with heavy retirement obligations and a clogged pipeline for future partners. Many Top 100 Firms have recognized this business challenge years ago. Today these firms are moving toward a 40 percent equity/ 60 percent non-equity mix, which is much more realistic in a slow-growth environment.

8. Failing to create a culture that is “firm first” as opposed to a “silo mentality.” Some firms operate as if they were a bunch of independent contractors working under one roof, sharing operating expenses. It is an “eat what you kill” environment that is unable to sustain itself over the long term. The focus is on “I” not “we” and partner compensation is heavily weighted toward personal charge hours and books of business. The firms with staying power, on the other hand, figured out many years ago that they need to operate as a team if they want to perpetuate the firm for the long term.

9. Lacking a strategy with teeth in it. Lots of firms have strategic plans, but the plans are sitting on a shelf collecting dust. They developed a plan at an annual off-site retreat but when they got back to the office, they ignored it and went back to serving clients. It’s business as usual. The best firms use their strategic plans as “living documents.” They hold their partners accountable for executing on their piece of the plan and when it comes to compensation, they take in account results versus plans.

10. Inability to put together a credible succession plan for the most senior positions in the firm. Too many firms promote new partners because they have to get the work out the door, but while these partners serve an immediate role, they provide little, if any, promise they can help perpetuate the firm down the road. It’s hard to get the work out the door and at the same time plan for the future by promoting and developing partners with the potential to lead the firm. While it’s difficult, it must get done and can be done if given the right priority and focus.

If your firm is experiencing one or more of these danger signals, do what’s obvious and address the issues head on. These are common reasons why firms fail or at least fail to reach their maximum potential. All of these issues can be fixed, although some will take several years before they are fully corrected. The good news is that others were smart enough to recognize they had a problem and did something about it. Are you that firm or are you the firm that will continue to keep its head in the sand?

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Practice structure Partnerships Partner compensation Succession planning Strategic planning Strategic plans Dom Esposito