Business Succession Planning for Professional Service Companies
Professional service companies like accounting, architectural and engineering, and law firms present a whole new set of challenges when dealing with succession planning issues. While the organization as a whole could be sold to an outside party, this article will concentrate on perpetuating the existing entity.
Create an economically feasible plan for admitting partners/shareholders to the group.
Most ambitious employees are looking for a way to improve their economic and emotional status in an organization which usually means desiring to become a partner/ shareholder. Working under the assumption that the employee has met all the criteria and expectations of what it takes to be an owner (strong technical skills, great team player, and successful business developer) an ownership transition/buy-in needs to take into account the following considerations:
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Develop a compensation system that rewards outstanding performance by an individual without destroying the team emphasis for the company.
This is the $64,000 question! Trying to take into account Thomas Jefferson’s famous statement, “Nothing is more unfair than the equal treatment of unequal people”, how do you create a compensation system that doesn’t destroy the team unification process for the organization? This is where there are some definite differences between architectural/engineering firms, accounting firms, and law firms.
Our experience with Architectural/Engineering firms is that compensation often follows a more “equal say, equal pay” type of arrangement because of the partner/employee crossover on a large portion of the work. Return on equity for your investment in the firm is normally a consideration in the compensation formula as are excess administrative functions such as managing director/partner functions or participating on the executive committee. The bonus system is usually subjective and divided up on recommendations of the management committee.
Law firms are a totally different animal. Systems are often very complex with sophisticated tracking systems monitoring who brought the matter in, who is managing the engagement, and who is doing the actual work for the client with different weightings for each of the various functions. The larger firms typically have directors of administration, directors of marketing, and other non attorney types do the majority of administration and day to day management functions for the firm. The consensus among most law firms is that attorneys are not employed to do non-billable work!
Accounting firms seem to have hybrid systems of compensation that are a blending of many of the attributes of both Architectural/Engineering firms and Law firms. The big money is paid to the rainmakers with substantially smaller distributions being paid for account managing and “grinding” functions. However, the larger, more progressive firms are starting to move away from over-emphasizing book of business and pure productivity and rewarding such intangibles as leadership skills, world class service to clients, ensuring multiple relationships with the larger clients of the firm, and just being a good partner-treating people respectfully, living and breathing the firm’s core values, and complying with firm policies.
So what is the answer? The common bond for a reasonable compensation system for all professional practices should include the following:
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Develop a retirement/exit strategy plan that is conservative and does not put unnecessary financial pressure on the remaining partner/shareholders.
The first rule of thumb in any retirement/exit plan is that the retiring owner can only be paid a sum of money that will cash flow effectively for the remaining owners after the retiring owner is gone. What does that mean? In simple terms, if the retiring partner/shareholder was paid significantly more than the other owners in the group and has a significant book of business or a niche skill set that will be difficult to replace, the potential hit could be significant. A large goodwill payout may not work. Any payouts above book value would have to be paid on a contingent basis as to not jeopardize the ongoing cash flow of the business to the remaining partners. These contingencies may include a retained business clause for clients previously brought in by retiring partner, or, a cap on total payouts that the firm can pay out to retiring owners. Accounting firms are more likely to encounter this challenging problem since they are more inclined to make goodwill payouts than the other professional service organizations.
Our experience with Law firms has indicated that most retirement programs have limited goodwill payouts and are predominately asset valuations. This is because lawyers traditionally do not have repeat work like accounting firms that can create an annuity going forward.
Architectural/Engineering firms have various valuation methodologies that may produce goodwill if the firms are extraordinarily profitable; however, the traditional non niche oriented firms often end up with a valuation that is merely asset based.
This publication contains information in summary form and is intended for general guidance only. It is not intended to be a substitute for detailed research nor the exercise of professional judgment. Neither BPM nor any member of the BPM firm can accept any responsibility for loss brought to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.
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