PCPS Succession Institute 2016 Succession Survey Results for Multi-Owner Firms Part 4

This article summarizes selected results of the Private Companies Practice Session (PCPS) and Succession Institute (SI) 2016 Succession Planning Survey (the full survey results available through the PCPS Resource Center).  This is the fourth such survey conducted since 2004.   Part 1 of this column series covered the results for Solo Practitioners and Sole Proprietors.  Part 2 covered Demographics, Succession Plan Status, Ownership Retirement projections, and Firm Infrastructure.  Part 3 started with Mandatory Retirement and concluded with the calculation of the original valuation of the retirement benefit.  We pick up this column, Part 4, sharing tables and commentary summarizing the results and our conclusions reviewing how firms might adjust the original valuation benefit based on actions or inactions of the retiring partner.

Have any partners received retirement payout above or below the agreed upon benefit calculation?

Generally, the overwhelming majority of firms make no exceptions to previously agreed-upon terms covering retirements when a partner leaves.  This year’s total of 15% of firms making exceptions is consistent with that of previous years (10% to 15%).

Why has your firm paid a retiring partner above or below the originally agreed upon calculation?

For those 33 respondents that indicated that their firm had adjusted the retirement benefit, consistent with the previous survey, about one-fourth (24%) of adjustments to retirement pay are due to improper transitioning of clients, while another one-fourth are caused by inadequate notice (12%) or unethical behavior of the departing partner (12%).  From 2008 until 2016, the respondents who indicated they had adjustments because of inadequate vesting has increased from less than 6% to 21%.  Our belief here is that more firms have formalized their vesting policies, which in turn has saved the firm’s a great deal of money and conflict (and another example of succession process likely being put in place whether or not formal succession plans exist)!

On the plus side, about 12% of the respondents (with this number being similar at 13% to 15% in past surveys) adjusted the partner retirement benefits due to the partner’s exceptional performance.

As we have noted in past survey reports, we find that many variances from stipulations in documents exist because too many succession practices are "personal expectations of owners to do the right thing" rather than "specific agreed-to practices with accountability to do the right thing."  The retiring owner and the remaining partners all intend to be fair when it comes to exit arrangements.  The problem is rarely that either side doesn’t want to be fair, but as we often find with divorce, the problem rests in each side’s definition of "fair."

Without specific agreements in advance defining what is "fair," including consequences and accountability outlining how variances from "fair" will be remedied, succession challenges almost always occur.  This is a key reason why we believe there is such a large gap in percentages of firms with succession plans in place (44%) versus firms expecting succession challenges in the next decade (84%).
Note the dramatic drop regarding "partner wouldn’t agree to retire without the additional incentive." In 2008, this was 12%, rising to 30% in 2012 and down to zero in 2016. This is remarkable because we run into this all of the time where a partner is being asked to retire and the remaining partners have to sweeten the pot to get them to go voluntarily. Mandatory sale of ownership, stricter/tighter vesting requirements, penalties for taking clients and staff, and partner accountability tied to compensation are all examples of how to minimize the number of partners well positioned to hold the firm hostage in demanding additional benefits.

What best describes the change in the retiring owner's retirement benefit from what was originally agreed upon?

There appear to be no significant concentrations of amounts paid below or above originally agreed-upon amounts, nor do there appear to be significant trends within the overall range of adjustments from original amounts.  However, among the 25 respondents to this question, after an increase in the overall percentage of firms paying more than what was agreed upon between 2008 and 2012 (53% in 2008 and 63% in 2012), there has been a decrease in the percentage of responding firms reporting paying an amount greater than what was originally agreed upon in 2016 (36%).

If you look at the broad picture over the last three surveys, the percentage of firms paying less than agreed-to (47%) versus more than agreed to (53%) in 2008 was about even.  In 2012, about 30% paid less, but about 70% paid more, most likely meaning that partners were not being held accountable for shortcomings in their transition activities.  However, in 2016, a dramatic shift occurred as 64% were paid less, and only 36% were paid more.  About the only way deductions occur from the standard agreement is when firms formalize and clarify what retiring partners will be held accountable to accomplish.  These statistics support the trend that we have been suggesting throughout this survey report that even though firms are not formalizing their succession plans at an increased rate, they are making real headway and improvements to their succession processes.

Occurrences Changing Retirement Amount or Duration

This section includes questions to help us understand the retirement benefit for retired partners and what might impact that payment amount either up, or more importantly, down.

This year, 57% of the 244 firms responding to this question indicated that competing with the firm after retirement will result in a change in retirement benefits.  Although this is down from the previous survey’s total of 74%, it is in line with survey responses from 2004 and 2008.  Ideally all firms should be insisting that competing with the firm after retirement will negatively affect one’s retirement pay.

Similar to the previous survey, only about 40% of firms said that a retired partner’s benefit will be affected by his or her taking staff when they leave.  Given the current demographic trends and importance of finding and retaining quality staff, it would seem that any firm would want some financial consideration provided when staff are taken.  Normally when owners leave and take staff, they almost always take the best people.  This is why we suggest that they pay you for using your firm as their recruiting service.  In the rare instance when an owner leaves and takes one of the people that is fairly marginal, we would suggest that you simply waive that penalty for the particular person (or they might leave them with you).

Similarly, only 38% of respondents this year, close to the 42% from the last survey, indicated that early retirement will result in an adjustment to a retiring partner’s benefits.  In the agreements we help our clients create, almost all early retirement possibilities incorporate a reduction from the full benefit.

This year we added new alternative response choices to this question, including lack of proper notice of two years or less, one year or less and six months or less.  Following are the responses chosen for each notice term:

• Lack of proper notice – 2 years or less 18%
• Lack of proper notice – 1 year or less 16%
• Lack of proper notice – 6 months or less 10%

Only 44% (18% + 16% + 10%) of all firms responding will reduce benefits for lack of notice, and within that total, we believe that the 26% (16% + 10%) looking at one year to six months or less will realize only nominal benefits from such brief periods of advance notice.  We believe that retirements should require two years’ advance notice to receive whatever benefit you are entitled to.  As a matter of record, in the partner agreements we use, if you don’t give at least two years’ notice you are not even entitled to early vesting options for retirement.

If you don’t protect the firm from owners departing without notice as well as discourage them from departing in their prime, you will not only be creating a financial burden for your firm, but you will make it much more difficult to create a viable succession plan, and therefore long-term sustainability.  You want to make sure your system motivates all of the owners to stay long enough to fulfill the succession role many of them were admitted into the firm to fill (in other words, we have not seen firms admit a new young partner in hopes of that new partner retiring prior to when the senior partners plan to retire).  Given that new partners are intended to help transfer out senior leadership, it is far more difficult to build a future organization when anyone can leave at any time without serious financial consequences.  You can’t create an orderly departure plan under these circumstances.

This year’s survey included other new answer choices for this question in addition to those dealing with advance notice required.  Some of the more notable findings show that:

• Caps on total annual retirement payments are in place; 39% of respondents
• Loss of retiring partners’ clients will result in adjustments; 26% of respondents
• Merger or sale of the practice will generate adjustments ; 21% of respondents
• Uncollectable receivables, WIP; liabilities incurred are taken into account; 17% of respondents

At 15% of the firms, nothing will change the amount payable to the retired partner.  This may be due to the agreements with retired partners being somewhat miserly to begin with, although in our experience that usually is not the case.  Rather, a poorly drafted agreement is the underlying cause.

Which of the following occurrences will force a change in the payment duration, monthly payment amount, and/or total payout amount of agreed upon retirement benefit?

Under what conditions is a partner entitled to receive retirement benefits (payments)?
In findings similar to those from the previous survey, at about two-thirds (63% in 2016 and 66% in 2012) of the 249 firms responding to this question an owner is only entitled to retire and receive retirement benefits when they’ve met the vesting requirements—which could be age only, years of service only, or a requirement for a combination of both. On the other hand, at the remaining one-third of the firms an owner can leave at any time, which makes it almost impossible to plan for the firm’s future or success.  Because we added more answer options this year, other responses are not comparable to past years’ findings.

Generally, the smaller the firm, the more likely people become fully vested the day they become a partner (38% for firms with less than 8 FTEs as compared to an overall average of 20%, as compared to 8% for firms with 201 FTEs or more).  Conversely, the larger the firm, the more likely that partners need to meet some combination of age and service requirements (38% for firms with 201 FTEs or more, as compared to an overall average of 25%, as compared to 8% for firms with less than 8 FTEs).  As we have pointed out in the past, this could present a learning opportunity for smaller firms who have set their sights on growth.  Without setting clear vesting requirements, including age and years of service, a firm can end up with a revolving door for partners at the most inopportune time.  Couple that with the absence of penalties for competing upon leaving the firm mentioned elsewhere in this report, and a firm will have far more risk than it should be exposed to.

What is the minimum number of years of service required for partners to receive FULL (100%) retirement benefits?

Of the 213 responses, the preponderance of the answers fell into immediately on becoming a partner (23%), 10 years (23%) and 20 years (20%).  The next highest response rates were at 5 years (8%), 15 years (9%) and more than 20 years (9%),

In a related question, respondents were asked at what minimum age owners can retire and receive full retirement benefits.

What is the minimum age allowable for owners to retire and receive full (100%) retirement benefits?

Of the 202 responses, 25% allow full retirement benefits prior to age 60.  15% can get full benefits at age 60, with 8% more receiving this privilege at 62.  17% have to wait until age 65 for full benefits, with 4% earning that right at 66, and 3% more at 67.  The alarming statistic is that 17% of respondents were eligible for full benefits at whatever age they became a partner (immediately on becoming a partner).

A few firms across all size ranges seem to allow retirement at full benefits upon attaining a minimum age of 55 years old or less, with the largest firms being the most supportive of early retirement (60 years old and younger).  The smaller the firm, the more likely they would allow someone to earn full retirement benefits immediately on becoming a partner (Fewer than 16 FTEs averaged 31%, with less than 8 FTEs at 29% and 8 to less than 16 FTEs at 33%).  The most popular age to earn full retirement benefits for firms with less than 101 FTEs was age 65.

One has to question the wisdom of allowing full retirement (or even a significant portion of the partial retirement benefit) at age 62 or younger, given the capacity that the firm has to replace when a partner leaves in terms of technical expertise, client and referral source relationships, time and production at the firm.  As touched on earlier, we believe that the years between 55 and 65, given relatively decent health, are some of the best years an owner has to give to the firm.  A partner’s tenure on this earth has allowed him or her to meet a lot of people and build extensive networks, their friends (usually also around their age) are now in control of companies rather than just influencers, their experience gives them an excellent ability to act in the Trusted Business Advisor role, and so much more.

What is the minimum age allowable for owners to retire and receive partial retirement benefits?

Of 184 respondents, 47% (28% + 12% + 4% + 1% + 1% + 1%) (42% in 2012) of the owners are allowed to take early retirement and still receive partial benefits at less than 55 years of age.  Another 24% of the firms allow partial benefits at age 55.  These types of vesting and partial benefits policies will make it difficult for many firms to maintain the critical mass of intellectual capital needed to compete effectively.  We believe there are generally two reasons why giant organizations the size of the Big 4 (or even the top 20 CPA firms for that matter) would be motivated to allow partners to retire early.   First, partners in the largest of firms make a great deal of money, so replacing senior partners with younger partners is a way to hold down costs.  Second, partners in larger firms are far more easily interchangeable without any negative consequences for the clients, making it more logical to trade out expensive partners for cheaper ones.  This is because clients hire these firms due to their reputations, their vast array of service offerings, their ability to work globally, and their capacity to deliver talent and human-power to a project, rather than clients being loyal to a specific partner as is often the case in smaller firms.

However, firms of all sizes (especially those smaller than the top 100 largest firms) that have adopted minimum partial vesting earlier than 55 years old might want to reconsider it.  28% (13% + 5% + 1% + 4% + 2% + 1% + 2%) of firms start partial vesting at 60 years of age or older. We recommend starting partial vesting at 60 with full vesting at 65 years old.

Non-solicitation and Non-compete Policies and Penalties

When partners leave, can they take clients, staff, receivables or work-in-progress without penalty?

In a new "select all that apply" question, we asked firms this year if partners can leave and take clients, staff, receivables or work-in-progress without any penalty.  Although it is encouraging to see from the following table that 64% (99) of the 154 respondents likely have some form of penalties in place (64% responded they do not charge partners for taking clients, staff, accounts receivables and/or WIP so we are assuming the rest do charge partners for one, all or some combination of these), we believe this number should be closer to 100%, especially as it relates to taking clients and staff.  A firm should not be in the business of spawning competitors; extracting penalties for taking clients and staff helps avoid that and in turn creates a greater degree of sustainability for succession planning purposes.

It is concerning from a firm sustainability perspective that 31% of the firms allow partners to leave and take clients at no cost or penalty.  And just as bad, especially given how difficult it is to find experienced staff, it is concerning for 23% of the partners to be able to leave and take the firm’s best staff with them at no cost or penalty.  What this actually converts to in practice is that every partner ends up building his/her own silo practice and anytime the firm tries to hold them accountable to agreed-upon strategy or processes, they always have the easy-out option of just picking up their marbles and going home.  Our experience is that in order to build a profitable sustainable firm, partners need to have a little more skin in the game than this.

Who is required to sign a non-solicitation, non-compete or employment agreement?

In this "select all that apply" question garnering 397 responses, 44% of the firms make everyone sign a non-solicitation, non-compete or employment agreement.  To us, this is a great indication of firms taking appropriate steps forward to protect the firm.  On the opposite extreme, 25% of firms don’t require anyone to sign similar agreements.  In declining order, Partners (at 39%), Managers (23%), Principals and Directors (21%) and Supervisors (at 15%) are required to sign.  We can’t explain the difference between 44% requiring all people to sign and 39% requiring partners to sign except for the fact that some respondents might have skipped selecting any other responses after selecting the answer that everyone is required to sign.  On the other side, we can’t assume that the 44% that require everyone to sign is in addition to the 39% that require partners to sign.  So, we simply have to look at these statistics for exactly what they are, which is an indication as to the commonality of non-solicitation, non-compete or employment agreements.

Which groups are charged a penalty for taking clients as part of their non-solicitation, non-compete or employment agreement?

In this "select all that apply" question with 279 responses, 57% of the firms charge everyone a penalty for taking clients as part of their agreements.  In the same order as above, Partners (at 50%), Managers (at 24%), Principals and Directors (23%) and Supervisors (at 16%) charge penalties for taking clients.

Which best describes your non-solicitation, non-compete or employment agreement regarding time frame?

Of the 293 responses, the most common answer to the time frame penalties will be assessed is two-years (at 46%), which is our minimum recommended time frame.  However, that number grows to 59% (46% + 13%) when you add it to those firms requiring more than two years.  While 20% (1% + 19%) of the firms utilize one-year or less for their penalty assessment, we don’t feel that time frame provides enough time, and therefore enough protection, for the partner receiving the transitioned client to build a strong enough relationship to keep them long-term.  The only explanation for the 6% (since anyone that stated that they didn’t sign a non-solicitation, non-compete or employment agreement was removed from this question) of the firms that "don’t prohibit people from taking clients" is that this group requires people to sign an employment agreement that does not address taking clients.

When an employee or partner leaves the firm and takes any of his or her clients, which best describes what the employee/partner will be charged for each dollar of annualized revenue taken?

Out of the 265 responses to this question, the average for all answers was paying $1 on the dollar for each dollar of revenue taken.  The responses were not far off from the previous survey, with the single largest exception of the fact that there was a 9% drop in firms that do not charge for taking clients (from 22% to 13%), which is a great step forward in protecting the firm and putting succession management in place.

The smaller the firm, the less likely it is that the firm will charge a partner for taking clients (22%), and with some exceptions, the larger the firm, the more likely it is that the firm will charge the partner a premium for clients taken (for the largest firm size group of more than 201 FTEs, 23% charge a dollar for each dollar of client revenue taken, 31% charge $1.50 for each dollar taken, 23% charge $2 for each dollar taken, and 8% charge more than $3 for each dollar taken.  However, the key issue to think about regarding this charge is: "Are you in the business of developing owners and then spinning them off as competitors?"  If this is one of your core purposes, then paying a $1 for $1 of revenue makes sense.  Why?  Because an owner can work for you until he or she has developed a quality reputation and an extensive relationship network, all on the firm’s dime, and then under this structure, all that person has to do is pay market value for the clients taken to start his or her own practice.  But if you are attempting to build a sustainable practice with your talented people locked into the firm, then make sure they pay a premium to be able to cherry-pick the clients they want to take with them if they leave.

When a partner or other employee leaves the firm and takes staff, which best describes what the multiple of compensation (salary plus bonuses) the employee/partner will be charged for the staff taken?

Based on the 360 responses to this question, it appears that there has been little significant change since the last survey.  The minor differences between the survey results could be viewed simply as the result of selection bias from one survey to the next.

The responses here generally are consistent with prior years’ results.  They show that smaller firms typically are not assessing damages against people who take staff as often as, or to the extent that, larger firms are.  Even at that, though, many firms in the three largest size categories do not charge for taking staff.  For those that do charge for taking staff, although a few firms are charging less (51% - 75% of salary), and some are charging a bit more, most firms are charging 100% of the departing staff’s salary.

We believe that CPA firms should keep in mind the fact that, if they lose a talented staff member, they will likely have to pay a recruiting service to help find someone right away.  Once a new person is on board, the firm will spend time training the new person.  The firm might even have to go through a couple of people to find an adequate replacement for one that left.  When you look at the numbers, on average, even charging two times salary isn’t likely to be a break even for the firm.

We would all do well to remember that people who leave and take your staff won’t normally be trying to take the mediocre people.  Rather, they’ll be trying to take the best people they can persuade to join them.  Your firm is going to invest money in training your people, developing them, paying for them to build a reputation in your community, and allowing them to use your firm to gain access to quality clients.  It seems only fair that if one of your people, especially managers and above (although we think this should apply to everyone), decide to make a go of it on their own, then they should pay a premium to take the clients or staff that your firm positioned them recruit.

This should be a simple, quick fix that most firms can put in place immediately.  And if you find owners and other professionals fighting it, then it probably is time to ask some direct questions regarding their plans for staying with the firm.

We will pick up at this point in the survey for our next column as the conversation moves to discussing policies for transitioning client relationships and continuing through the challenges firms are trying to address that represent barriers to your firm's effective succession management.  With the number of baby boomers moving into the retirement phase of their lives, this next column is full of information that will help you put together a strong and successful process for retiring partners.