Managing Succession Fundamentals Part 4

To recap, in my past three columns, you have decided how to pay the partner for his/her value in the firm,you have pinned down the mandatory sale of ownership date (MSO) so you can phase that partner out of his or her leadership role in the firm, and you have covered the single most abused part of the succession process, which is client transition. It is now time to discuss how to find replacements for the retiring senior partners.

As we mentioned previously, the most commonly asked question on this topic is “How can we find people with the same technical skills, management ability, client service capacity, and vision for the firm’s future as those who are leaving?” The simple answer is “You won’t, so stop looking for that exact combination.”New partners simply can’t have the same level of skills as a partner with fifteen to thirty years of experience. They might have different skills, and might even have better skills in some areas, but they won’t match up competency area by competency area with the departing partner. Partners coming in from another firm won’t likely be a great fit skill for skill either. While they have experience as a partner, that doesn’t necessarily mean it is good experience, and based on our observations over the past three decades, they usually come over carrying some heavy baggage. If they were highly regarded in their own firm and tagged as future leadership, the odds of them switching camps are pretty small. So that means they were likely discontent in their current organization, with standard reasons such as they were being overlooked for key roles in their old firm, they were being pushed out due to lack of performance, compliance, teamwork,etc. For all these reasons, we believe looking for an exact replacement is a poor succession strategy.

Therefore, we propose that firms consider a different strategy all together. The simplest way to put this is,“Build your organization so that you can accomplish more with less.” For example, let’s say you have ten partners, with each managing on average a one million dollar client book of business. Let’s also consider that you have two partners who are going to retire in the next three years. Now, you tell me: which would be easier? Would it be easier to find two new extremely talented managers or principals ready to step into the retiring partners’ shoes (if you have them ready which few do, then you have a solution), or use the next three years to develop a deeper support structure so that each of the remaining partners can carry a greater client load (maybe boost the average client book size to $1,250,000 per partner)? Or consider pushing the remaining eight partners to carry an average of $1,100,000 and push all “C” level clients in those eight partner books (determined based on firm parameters) down to managers to manage.

The point I am trying to make is that in many cases, we don’t have a partner shortage problem to fix when senior partners retire! Rather, the problem is often that our current partners are managing far too small a book of business because we have a structure that relies too heavily on the partner being the main technician doing the work. It is not uncommon to find some partners in firms with less than two million in revenues to max out at around $400,000 in managed revenues and in firms from two million to forty million, we see some partners maxing out at around $800,000 in managed revenues. If your firm’s business model is to add a new partner every time you grow an additional $800,000 in revenues, you will find with each passing year that it not only gets harder and harder for you to make more money, but being top heavy with partners creates more accountability and governance chaos than it is worth.

By the way, it is for this reason that so many firms with four to 20 partners have created powerful executive committees. They do it to offset the fact that they have allowed people to become partners over the years who do not perform as partners. So rather than deal with this issue head-on, they empower a small group of partners who they believe do fill the role of partner to make all of the decisions for the group. And this strategy works well until the firm reaches a certain point of success and a size where there are too many under-performing partners who slowly gain enough power to overthrow the system. Anyway, I digress. Back to the issue or replacing senior partners.

There are four potential capacities or functions that we have to be ready to replace when a partner retires.

They are the:

• Technical competency of the retiring partner,
• Chargeable capacity of the retiring partner,
• The time it takes to build new relationships between the existing clients and the new partner being transitioned to manage them, and
• The time it takes to then maintain those client relationships that the retiring partner was managing.

For your largest and most important clients, who is the most logical to take over these accounts? The answer for this is usually pretty easy. It is either one of the soon-to-be dubbed senior partners in the firm – hopefully someone with at least six to ten years left before their planned retirement or one of the younger partners who already works on those accounts and has a great existing relationship with the owners or executive-level management in those client accounts. Recognize that, for vast majority of firms, the 80/20 rule or something approximating it applies to their revenues. We commonly find that 80% of a firm’s revenues come from 20% of their relationships. Or it could be as concentrated as having 50% of their revenues coming from 5% of their relationships. The point here is that a small group of relationships make up a large part of the firm’s income, so the right person to take over those relationships is almost never a newly appointed partner. The problem isn’t who should take over the key accounts, but rather creating more capacity, or freeing up capacity, so that existing partners can step in and manage those important relationships.

This leads to the next question which is “How do we go about creating additional capacity or freeing up the necessary capacity to handle the client transitions that need to occur?” First, all of the “C” clients, which is our shorthand way of describing the smallest clients the firm serves (who while profitable, don’t have much opportunity to hire us for additional services) should not be transitioned to partners, but rather to managers.

Second, the firm should consider creating two classes of partners (very large firms even more); one being a client service partner, the other being a technical partner. Client service partners should be expected to manage at least 50% to 100% more clients than a technical partner. We tell our clients that are averaging a managed client book size of one million dollars to plan on evolving their habits and skills so they can manage at least $1.5 million in four to five years, and at least $2 million per partner in subsequent four to five years.On the other hand, technical partners, while they might only manage $700,000 to $900,000 of volume,usually provide the backbone for the firm’s processes, filling roles like being the tax or audit department leader, or the quality assurance leader, etc. Technical partners are not expected to manage as large of a client book because of their technical duties. But that limited expectation of developing business and managing a larger client book will also come with limited in voting rights in the firm, as well as lower average compensation than client service partners. Why? It is simple – the scarcest skill in public accounting is someone who can sell new projects and successfully manage large books of business. Or another way to say this is “our profession grows technical CPAs with much greater ease and frequency than CPAs who can manage client relationships.” By creating technical and client service partners, the firm can focus on developing the requisite skills in both roles to adequately create capacity. As a note to consider, a firm mostly should be developing client service partners. And perhaps a firm can afford the luxury of one in four being a technical partner. So if your mix is higher than that, start working on converting some of your technical partners to client services partners (which is often done, but it is a discussion for a future article).

A third area to focus on to create capacity is the quality of clients. Marginal clients don’t make the firm money. They just add to an individual partner’s power base. For example, many firms would actually make far more money if they ran off 15% of their most marginal clients and marginal staff. This move would end up freeing up important partner and staff time to take on the profitable and valuable clients that need to be transitioned from the senior partners.

Another area to consider is to add enough staff at the bottom to actually give you a chance to build capacity,which over time this move will also allow you the luxury of closing competency gaps that tend to exist at various levels in almost every firm. Most firms hire far too few people. For example, let’s say the firm plans on growing its top line $750,000 in the next year. Let’s also assume you are averaging $150,000 per FTE. That would suggest that you would need to add five people operating at full capacity right now in order to perform that additional work over the next 12 months. The problem is twofold. First, most firms won’t hire the five necessary people … they will hire three or four. Second, and even worse, the five needed people doesn’t consider that one or two of the new hires probably won’t work out, that you have one or two people that might presently need to be fired due to poor performance, that one or two good performers will quit due to their life choices, etc. What we commonly see is that most firms don’t hire enough people to actually deliver on the revenues they are or plan to be selling. And because of this, each year, they get more and more behind the eight-ball, being less and less able to create additional capacity because everyone is so busy that no one has time to train, manage, hold people accountable and build a better firm.

While there certainly are more ways than the four ideas mentioned above that can help you create capacity,these at least give you a start to thinking about the issue in a more positive way. When you move partners away from being key technicians to being client relationship managers, their capacity to manage work increases. When you build a stronger support structure of competent technicians below partner so they can take on much of the work the partners are doing now, you not only facilitate the partner role change above but you also create more leverage and profits. When you move your smaller clients out of your partner books and shift them to mangers, you start building the necessary competencies at the manger level to be a future client service partner. As well, you free up more time for partners to spend in front of their top clients which then creates the opportunity for them to uncover new work and more profits. And when you run off marginal clients and staff, you free up capacity at every level, improve morale, while earning at least the same amount of money and maybe even more by working less. This approach to finding replacements for your retiring senior partners is not only more reliable, but the remaining partners will make more money than they ever have even after paying the retirement benefits. To conclude, we are not saying that you shouldn’t add more partners, we are just saying you should promote people to partner when they are ready, add them in the role they are actually going to fill (technical or client service partner), and look at building capacity at all levels in the firm as your best and most reliable solution to fill the void retiring partners create in the areas of technical competency, charge hours and client relationship management.

In Part 5 of our columns on Succession, we will pick-up with some do’s and don’ts as they relate to work retired partners should be allowed to do post retirement as well as how to structure those arrangements.