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Avoid these traps when dividing partner compensation

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For small and midsized CPA firms, one of the most common complaints among both line partners and senior management involves compensation and annual adjustments.

The line partners complain they cannot clearly align their compensation and annual adjustments with their performance. Senior management complains they have been less than successful in using compensation and annual adjustments as a means of driving firmwide strategy and partner accountability in a meaningful way.

This is unfortunate, as partner compensation and annual adjustments are two of leadership’s most powerful tools. They can affect firm culture, how partners choose to spend their time, and how the firm can drive implementation of its strategic plan.

A comprehensive, tightly linked annual partner goal-setting, evaluation and partner compensation process becomes a bit of a carrot and stick. Firm leadership must make sure it is driving strategy and striking an appropriate balance between current performance and the creation of longer-term enterprise value. Leadership also must have a sharp focus on understanding the market value for:

  • The franchise players;
  • The next generation of leadership;
  • A partner who consistently generates or originates a large amount of new business almost every year;
  • An excellent client relationship partner; and,
  • A solid accounting, tax and advisory technical guru, including those in quality control.

Presented below is a summary of the traps that should be avoided by the firm’s senior management and its executive committee when it comes to dividing net profits among partners.

While it’s certainly important and requires careful consideration, avoid a check-the-box, measurement-oriented approach and process with a very heavy emphasis on short-term measurable criteria such as new business originations and cross-sells, hours billed, average collected rates and total hours supervised. At all costs, avoid a “profit center” approach that creates a profit-and-loss statement by partner where each partner absorbs an allocated portion of firm expenses.

Such measurement methods can be divisive and work against the efficient delivery and cross-selling of accounting, tax and advisory services. They almost always lead to the mentality that “This is my client” (thereby creating silos) as opposed to the philosophy that “This is the firm’s client.” A partner who brings in a new client may not be the best partner to handle that piece of business because of required industry skills or conflicting demands on team schedules. A “my client” mentality also sacrifices the “firm-first” mantra and fails to recognize the many partner contributions that can’t be measured.

My strong preference in awarding annual compensation adjustments is a subjective methodology that considers a partner’s total body of work and how that partner has helped perpetuate the firm on a consistent basis. In many cases, this includes successful implementation of the tasks required to drive implementation of the firm’s strategic plan.

Avoid an approach that is conceptually flawed. If the process is thorough, unbiased and equitable and is perceived to be so, then solid decisions by the evaluators and positive reactions and behavior modifications by those being evaluated can be made. A solid judgment approach has the following characteristics:

  • The partner being evaluated must trust the evaluator or judgments and conclusions won’t feel right;
  • The policies and criteria must be persistently and consistently applied to all partners;
  • Judgments should only be made after all pertinent data has been evaluated; and,
  • Judgments need to be easily explained and understood.

Use a delicate and sound judgment approach and process including active oversight participation by the firm’s executive committee; thoroughly understanding the underlying factors supporting evaluations and proposed compensation adjustments.

Make sure the partner doing the evaluation is the direct report for the partner being evaluated — not someone who isn’t working on the ground with the partner throughout the course of the year.

Make sure the process is heavily grounded in collaborative goal-setting that is linked to the firm’s strategy whereby each partner, in consultation with their direct report -- and, when appropriate, the executive committee — agrees to a set of goals and is assessed accordingly. This approach clarifies what is expected and encourages active planning rather than opportunistic, reactive behavior.

Work hard to avoid the common criticism that the evaluator is incapable of arriving at an equitable decision because they don't have all the facts or will misinterpret facts that are available. Be vigorous in collecting as much information, seeking not only the “hard” facts but also qualitative, subjective views and perceptions.

Provide feedback, which encourages excellence, after the partner evaluation and annual compensation adjustment. Even when an annual compensation adjustment is accepted as equitable, a natural follow-up question is, “What is required of me so I can do better next year”?

When it comes time to evaluate members of the executive committee, make sure the partner being evaluated, including the firm’s CEO, leaves the conference room. This encourages a free-flowing collaborative approach to determine the appropriate compensation adjustment. If the executive committee member remains in the room, open and candid dialogue is stifled and, to avoid conflict, a compensation adjustment might not align with actual performance.

Make sure your partner performance management and compensation plan is flexible and can change over time. For example, in the year 2018, new business originations and cross-selling may be particularly important, but in the year 2019, quality value-added client advice such as EBITDA and working capital improvements might be the focus of the firm. If plan changes are announced and discussed before they are implemented, they will be embraced rather than frowned upon.

Finally, firms should avoid an “open” system of partner compensation disclosures. The larger the firm (particularly if the firm is doing about $15 million or more in annual revenues and/or has more than one office) is, the more important it is to have a “closed” compensation system because partners are often not able to evaluate other partners they do not work with throughout the year. Impressions and gossip often become the basis for reaching conclusions about performance and compensation of other partners. This is not healthy. In some firms, the only compensation disclosures that are open to all partners are the dollars awarded to the executive committee. This is healthy because many partners have the perception that the executive committee takes all the money and trickles down only small awards to the line partners.

Experience has demonstrated that the opposite is true. Oftentimes, the senior partners on the executive committee redistribute their awarded dollars to the younger and/or very high-performing partners who must be taken care of in a particular year. This is common when the firm misses budget and there aren’t enough dollars to go around to appropriately reward performance for partners deserving of more. After all, it is a zero-sum game and the pie is only so large.

A performance management and compensation plan is the leverage that the firm’s leadership has to drive performance and create accountability. Use it wisely. Use it as a means of driving strategy and running the firm, rather than merely a means of distributing the bottom line. You will know when you have a good goal-setting, evaluation and compensation process when partners tell you they believe they were treated fairly after considering all factors. And remember, the larger the firm is, the more important it is for compensation not to be disclosed internally to the partner group.

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