You have heard it many times before. Worse yet, you are living in the moment. Today, many small and midsize CPA firms are being challenged by slow organic growth coupled with an unprecedented pace of technological change, intense margin pressure, 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 (circa 2002 through 2006) when the Giant Four firms were the greatest referral sources for mid-market firms and SOX created significant demand for services. 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 wasn’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 has become obvious that management consulting and advisory services are where a CPA firm’s growth and margins are today as mid-market clients continue to outsource non-core, but nevertheless critical, business processes in an attempt to improve EBITDA and working capital.
On top of all this, soon firms will 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 add from immense databases that benchmark best practices in a quest for enhanced market valuations.
How are firms addressing these challenges?
Many of the Giant Four and the Next Six are embracing artificial intelligence and are aggressively trying to grow both organically and through mergers/acquisitions. I applaud those efforts, particularly as firms such as CBIZ, Crowe, BKD and CLA rapidly transform themselves into professional services firms by making big bets on additional advisory and consulting capabilities and services. At the same time, the Giant Four and the Next Six are continually evaluating partners and, when necessary, counseling out unproductive partners.
Many small and midsized CPA firms are slowly transforming their firms into professional services firms. Kudos! And the AICPA is launching an artificial intelligence effort to help small and midsize CPA firms compete. Again, kudos! On the other hand, these firms are very slow (if they are acting at all) in counseling out unproductive partners.
Small and midsize firms need to take a hard look at their partner numbers (what they are versus what they should be) and decide if it is time to pull the trigger on unproductive partners. It’s long overdue at many firms.
To that end, I would like to share some financial guidelines that are commonly used by both the Giant Four and the Next Six. Now, I’m not in any way suggesting that these are the guidelines that small and midsize firms should adopt. Not at all. Instead, it is probably beneficial for small and midsize CPA firms to have an insight into what’s going on at the larger sustainable brands, so they can benchmark against them as they struggle with the decision to pull the trigger on unproductive partners or not:
Best practices indicate that the partner to staff leverage should move to 5 to 1, perhaps 7 to 1, depending on the geography and service mix.
When evaluating nonequity partners, the key question to address is: “Does the enterprise value of the nonequity partner contribute toward perpetuating and growing the firm’s business, maintaining technical excellence and driving client and staff retention?” Beyond this threshold question, a nonequity partner needs to demonstrate a track record of performance in a number of practice areas, not the least of which is business development. The mandate, for those nonequity partners other than those in quality control, is to annually originate a combination of new business and cross selling in the minimum amount of $150,000. 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. To provide a soft landing, many firms permit departing partners to leave with a small number of clients that have been services in the past.
When evaluating equity partners, the key question that is addressed is: “Does the enterprise value of the equity partner significantly contribute toward 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?” Most of the larger firms have “stretch” revenue and earnings guidelines (ratcheted up annually) in determining their desired number of equity partners. Something similar to what is presented below is currently being used at these firms:
Revenue per audit or tax equity partner: $2,000,000
Earnings per audit or 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 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.
If your firm isn’t actively addressing underperforming partners, 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:
- 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 are stuck on repetitive, boring client assignments with little, if any, on- the-job training;
- Costly labor loads resulting in unacceptable margins;
- Partners doing compliance work, not consulting, and not developing new business;
- Inadequate talent at the right levels, which is 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. 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.