Managing Succession Fundamentals Part 5

Thus far, in this Succession series, we have covered how to pay your partner for his/her value in the firm, pinned down a mandatory sale of ownership date (MSO) so that you can phase partners out of their leadership roles at predesigned times, outlined how to manage transition (the single most abused process in succession) and discussed how to find replacements for the retiring senior partners. Now we will move on to reviewing some do’s and don’ts as they relate to “soon-to-be-selling” and “post-sale-of-ownership” partners, some of whom will likely want to continue to work for the firm.

Let’s start by considering some common problems with the “soon to be selling” owners. Consider this data gathered in the 2012 PCPS Succession Institute Succession Survey. The question was “Please indicate why your firm has paid a retiring partner above or below the originally agreed upon calculation.”

For this question, all I did was include the first response because I will address the rest of them a few paragraphs from now. But to put these in context, all of the responses relative to this question highlight common problems that should and can be avoided by either instituting “mandatory sale of ownership (MSO)” or by having a strong system of accountability driving performance and compensation. With either or both of these, the firm is in a position to retire or terminate partners anytime someone chooses to retire in place, stop performing or just hangs on too long. Based on the data gathered from our survey, 30% of the time, partners wouldn’t retire without the firm sweetening their financial deal. We believe this should be close to zero percent instead of found almost a third of the time.

Now, take a look at the table below. As you can see, 11% of the respondents had to sweeten the deal by an additional 75% to 100% of the original retirement payout formula to get these partners to leave, while 22% had to enrich the retiring owners by more than 100% to get them to go away. When you are willing to pay someone more than twice the agreed-to price to leave, that really highlights the greed of the retiring partner, the intense desire of the remaining partners to motivate a partner to leave, the lack of governance and policies to be able to manage a particular partner, or what we often find which is some combination of these.

You can see for yourself the results from the question “Choose the option that best describes the change in the retiring owner's payout formula (RPF) and overall package from what was originally prescribed:”

Now let’s take a look at the rest of the responses from the question about why firms paid a retiring partner above or below the originally agreed upon calculation.

Just look at these policy issues. If a partner doesn’t:

• adequately transition client relationships,
• work long enough to meet vesting requirements,
• perform at an expected level,
• provide adequate notice before leaving,
• behave ethically, or
• serve as an Ambassador of the firm, but rather competes with the firm,

then all of these conditions should be part of your operating policies and your agreement and should have a negative impact on the retirement benefit amount and payout for the retiring partner. And all of them are occurring statistically in at least 1 out of 10 situations. However, based on our experience, the only reason these numbers are not significantly higher is because many firms have only retired one or two partners,while others are just starting to go through this process for the first time. So don’t let the low statistics lull you into complacency regarding addressing each of these issues.

On the other side, when consider responses like:

• Client base was only of marginal interest to the firm, and
• Partner serviced a unique specialty niche.

While it is logical that these situations should have a negative impact on the retirement benefit, there is a bigger question that should be addressed. That question is, “Why would a partner be allowed to build a client base that was of marginal interest to the firm or build a specialty niche that no one else had an interest in or the capability to continue?” In these cases, this is as much of reflection of the firm dropping the ball as it is the partner doing his/her own thing. In other words, the firm should have addressed this early on by either redirecting the partner’s efforts (there goes that accountability issue again) or requiring that niche to operate within a business plan built around sustainability and continuation.

Our point for covering this survey question is that the responses clearly represent a bunch of don’ts when it comes to retiring partners – and don’t just hope things will work out and everyone will want to do the right thing for the firm. Establish policies early on and enforce them.

So now we’ve seen that other firms frequently have seen negative situations occur when they don’t address them up front in their firm policies or agreements. This next question addresses whether firms are proactively preparing for these occurrences. The question we asked was “Which of the following occurrences will force a change in the payment duration, monthly payment amount, and/or total payout amount of standard calculated retirement pay?”

In a positive trend, 74% of participating firms indicate that competing with the firm after retirement will result in a change in the retirement benefits, compared to just over 50% in past surveys. But only 43% of the firms said that a retired partner’s benefit will be affected by his or her taking staff when they leave. Given the importance of finding and retaining quality staff to every firm, why would any firm put their top people at risk without at least some financial consideration should a past owner woo them away, especially while the firm is paying them a retirement benefit for the value they are leaving behind? By the way, for the record, when owners leave and take clients and/or staff, they normally take the best of each.

Just as bad, only 42% of the firms indicated that early retirement would result in an adjustment to a retiring partner’s benefits. We not only believe that an effective policy in this area should have a tiered vesting schedule that reduces the retirement benefit for leaving early, but that the early vesting privileges should only be accessible with a minimum of two years’ advance notice. Remember that one of the central reasons for bringing in younger partners is so they can buy out the senior partners when it is time for them to leave. In many cases, we find poor policy design in this area which actually will allow the younger partners to leave before the older ones, thereby turning the succession plan upside down. The good news is that there is an easy fix to this as long as you put it in place years before a partner is ready to retire. When you consider some of the major issues introduced here, such as:

• Competing with the firm after retirement.
• Taking staff.
• Early retirement.
• Egregious misconduct in the community.
• Uncollectible accounts receivable or work in process,
• Loss of retiring owner’s clients if improperly transitioned or if purchased on a retention policy

our question is simply “Why aren’t all of these responses close to 100%?” rather than the group of them currently averaging about 30%.

Regarding involvement of retired owners in the firm, we asked this question: “Which of the following best describes the involvement of retired owners in the firm?” Here were the results of the responses to this question:

In our opinion, the right answers to this question are:

• Retired owners should have no involvement or influence in firm operations; they should not be members of leadership groups, nor should they be attending board/management meetings.
• Retired owners should be active in the community and acting as an ambassador for our firm as long as they are being paid a retirement benefit.
• Retired owners should not manage client relationships (except it is not uncommon for firms to allow a nominal amount of revenue to continue to be managed by the retired owner, made up of clients which are 1) specifically identified, 2) very small clients (no large clients), 3) long-term friends or family of the retiring owner and 4) not deemed important to the firm.
• Retired owners can still work on some of their old clients, but only as a manager because another partner handles the relationship.
• Retired owners are on an annual contract with the firm, with specific allowable activities they can perform and that has to be renewed each year.

Now if you compare the right answers to the answers that we captured in the survey, as you can see, there are a number of policies that need to be put in place right away to protect the firm and position the retiring partner to continue to provide value in retirement.

The larger the firm, the more likely it will be that some retired owners continue to work with the firm under annual contracts, performing specific, delineated duties. This is a good practice. The smaller the firm, the more likely the retired owners can continue to do what they’ve always done, but simply work less hours, and the more likely they will be involved in or influencing firm operations. These are bad practices. So all firms should take a lesson from the playbook of the larger firms who, while they will find a specific role for talented owners to continue to work, simply don’t allow retired owners to be part of or influence leadership.

When it comes to compensation of retired owners, the statement the respondents completed was, “Our firm’s compensation system:”

By this time in the process, the retiring owner should:

• have properly transitioned his/her clients,
• no longer be managing clients (all clients who were assigned to them prior to retirement, except for the possibility of a few very small, nominal clients, should now be managed by the partners who were designated by the firm to take over the various client accounts)
• not be involved in the leadership of the firm or attending, unless invited to a specific meeting, any leadership meetings
• not be competing with the firm by setting up shop somewhere else
• be under an annual contract with specific terms and duties described. The contract should automatically expire each year. Without a renewal, the retired owner will know that their tenure working for the firm is over. Common acceptable terms of this contract are:
  • Percentage of billings (working in the role of a technical manager). This percentages usually ranges from 25%-40%. Paying the retiring owner in excess of 40%, which is often found in smaller firms, is excessive and provides the retiring owner not only a partner-level cut of the fees billed, but all of the profit from the work they are doing.
  • To be very clear, when a retired owner is paid a percentage of personal billings, it is only on the work they are individually doing, not on the project or client’s billings.
  • Percentage of first year’s business for new clients, or in rare circumstances, new services. This number should be in the 10% to 20% range. Some firms will pay 10% for two years, some will pay 10% - 15% for one year, but we believe that 20% in one year is too high. On the other hand, 10% for one year is normal and reasonable (adjusted for actual collections).
  • Hourly agreed-to pay for specific performance. In other words, specifically identified activities (networking, internal training, working specific referral contacts identified by the firm, involvement in charitable events/boards, etc.) can be paid on an hourly basis or set up as duties to be performed within a small stipend or salary each year. This would not be paid at the owner’s billing rate, but at a much lower internal rate.
  • Other perks should be considered, such as paying for identified continued CPE, licensing fees,office (however, a manager-level office rather than a partner’s office), expenses, etc.

As you can see, between the survey questions and the commentary in this article, there are a great deal of policies that need to be put in place, significantly updated, and/or implemented with greater accountability to better position the firm for both the seamless retirement and management of the relationship after the retirement of an owner. No matter how painful these discussions might be today, they are not nearly as painful and economically damaging as they will be if you wait until someone is ready to retire. When the discussions are early, or at least four or five years away from someone retiring, although the arguments and emotions can run high, the conversation is more about what is fair and reasonable from a business perspective. Once you get a year or so away from an owner retiring, the dialogue begins to feel like the discussion is more about what the person retiring deserves rather than what is fair and sustainable for the firm. So, have these conversations now and work them out!!!

In my next column, I will start putting all of this together into what your succession plan should look like. Until then … have a great remainder of your summer!