For a large number of firms, the path to partner is an uncomfortable conversation and an unclear situation. If a firm wants to establish a $2 million book level for an equity partner, what does that mean?
What we have learned from dealing with CPAs nationally for over two decades is there is no standardized answer to the equity formula process. The one core fundamental, though, is that not all revenue is equal. This is a key element to keep in mind for this conversation. To clarify, two $10 million firms are likely to not have the same value. That means the equity buy-in process for two similar firms may not be equal either.
Here’s what we have heard from partners and professionals trying to create or understand the path to partnership: Some firms have well-defined systems, but many are struggling to identify and/or communicate their plans to potential succession partners. As an example, what book size is needed? Is that a book the professional needs to create, bring into the firm, manage, or buy into? If a retiring partner has a $1 million book, can they transfer that to the incoming partner to manage? If so, does that fulfill their obligation or do they also need to develop new business? How much new work is also required ongoing?
Let’s examine the math by starting simple. A $10 million firm sells for $10 million. We know all revenue is not equal, but for this example let’s assume a 1x value. Firm A acquires Firm B’s $10 million practice and, to make this really simple, they buy it for $10 million in cash up front. (As a side note if you are willing to buy firms for 1x with cash all up front, please call us because we will find many firms willing to sell under that scenario.) For ease of calculation there are five equal partners, so each would get $2 million. The reality is that the payment would be spread out, etc., but it is still a $2 million value transfer.
Let’s talk buy-in funding. Does the candidate need to secure outside financing to deposit funds into the capital account? How much is required to buy 10% in equity? That 10% is worth $1 million in value in the scenario above. If the current partner book is $2 million each, will a 10% buy-in at $1 million qualify as an acceptable equity partner?
If the candidate does not want to borrow or is not qualified to secure a loan from an outside source, this may force the firm to finance the buy-in, which happens in one of two ways. The firm can issue the candidate 10% in equity today and allow them to pay the loan back over time. In this case, the firm is really gifting equity because the payback will be from equity distributions made. The candidate will also be benefiting from firm growth. If the firm goes from $10 million to $11 million, they now own $1.1 million but may have not paid much to get these benefits. The other option is to slowly release equity in 1% increments once the candidate has paid, say, $100,000 in bonus money. That can take 10 years to get their 10%.
The buy-in process is like the acquisition or merger of a firm. There are many variables, such as firm profitability, growth potential and bench strength, but the key is understanding the firm’s true value to establish the right buy-in process. Yes, there is a little art and science combined to get to this value, but it’s comparable to buying a house. What is the right price for any house? It is what the buyer is willing to pay, and the seller is willing to accept. The price can vary based on demand, location, condition, etc.
Is it worth owning an accounting firm? If you are in a firm contemplating going into the private sector, think hard before leaving public accounting. We see the financial performance of accounting firms daily. Partners in sub-performing firms might put in a lot of billable time, but they still make a good living. Partners in average to high-performing firms make substantial to exceptionally high incomes.
The CFO or controller role inside the private sector can pay well, but there is a cap on what any business will pay for financial leadership and there is often no ownership. The real money in any profession comes in when the financial benefits of ownership are also involved. Ownership with uncapped income potential is hard to find as an executive in most companies. There may be bonus structures involved, but in the end if the company sells, you do not receive a piece of that sale. If your compensation gets too high, you will likely be replaced.
If you want to lead, there is a clear path available for you to do so in the accounting profession. You can lead as a partner in a firm and receive the benefits of your efforts. In the private sector, you may have a leadership title, but without ownership, you are a follower.
