Making the partner comp system work

We’ve been getting lots of questions about partner compensation lately. I guess it’s not surprising considering how many firms are considering M&A at a time when a record number of boomer partners are retiring, and it’s never been harder to retain talent. Historically, firms have based partner compensation on each partner’s book of business or revenue contribution to the firm. But now they’re wondering if the “me first” system is still the best way. 

Kristen Rampe, managing partner of practice management specialists at Rosenberg Associates, told me on a recent podcast we did together that she’s seeing a shift toward a “one firm” mindset. That’s when the firm operates more like an integrated corporate structure, rather than as a collection of solo partners operating in silos under the same roof. Rampe said that when your comp system is aligned with the things you’re trying to do as a cohesive firm, you’ll go a lot further. When firms come to her group for advice about partner compensation, she said it’s usually because they’re dealing with conflict over the comp system. Those areas of discord tend to stem from one of three issues:

1. Partners don’t understand the comp system.
2. Partners don’t feel the system is fair.
3. Partners don’t feel there’s transparency about how their compensation is determined. 

None of those scenarios above is good for morale, teamwork or retention. Worse, those bad vibes can spill into partners’ interactions with clients and their teams. “Many firms tell me: ‘Only two of us really understand how partner comp is calculated,'” added Rampe. “When only a few partners or possibly a high-level admin is doing the calculations and/or keeping the spreadsheets, that’s not exactly transparent,” she added. So, how do you determine fair partner compensation in a unified, one-firm system? 

According to Rampe, you want a system that rewards partners for doing what’s best for the overall firm, but also trickles down to partners’ individual pocketbooks. While it’s challenging for many firms to look beyond a partner’s book-of-business during compensation meetings, Rampe said those that get over that mental hurdle quickly see the merit of rewarding holistic behaviors such as:  

• Upholding the values of the firm;
• Being accountable;
• Doing the things that help the firm reach its strategic goals;
• Mentoring a manager to become a partner so they can pay their buyout when they leave;
• Managing the firm toward better profitability and efficiency; and
• Recruiting top talent.

Granted, this shift is easy. But how much of a hassle is it to have partners who are frustrated with their comp system? Think about how much time partners spend grumbling, speculating or forecasting about their yearly payout, whether in partner meetings or side conversations. “Well, I don’t like this,” they murmur, or “I don’t think that’s fair. Why is Jim always taking home more money, when I did all this great stuff in this category?” Shouldn’t all that high-priced brain power and expertise be put to better use?

Making the comp system transparent is where Rampe says she sees the biggest results for her clients that are moving away from rewarding partners solely on how much revenue they bring into the firm. 

However, Rampe concedes many firms are struggling to let go of long-standing compensation formulas because CPAs love numbers. They’re generally more comfortable using a system that quantifies performance so they can arrive at a single “right” answer without any gray areas or judgment calls. 

“You input the data, multiply A times B, and there’s your number,” said Rampe. 

But she said there’s rarely a single “right” answer when it comes to partner compensation.  More and more firms are realizing the formula-only approach usually leaves someone feeling overlooked or insulted by the outcome. Is that a risk you can afford to take when retention challenges are at an all-time high? Instead, Rampe has found several other compensation methods helpful:

Alternatives to the compensation formula system  

1. Paper and pencil: Each partner writes down how much they believe they should make and how much the other partners should make. Then a trusted individual (including a high-level admin, or an outside individual) averages all those numbers to come up with partner comp for each person.

2. Compensation committee: This is a great option for firms of all sizes, even for those with only two or three partners. 

3. Managing partner decides: For smaller firms, or for firms with a strong trusted leader, the managing partner alone decides how the firm’s partner compensation will be determined. 

4. All partners decide: This system is similar to “paper and pencil” above, but here the partners sit in a room and hash out the numbers together, instead of submitting self-evaluations in a silo. 

No compensation system is perfect. But when every partner feels like the system is equitable, they spend less time discussing and obsessing about their comp and more time on the firm’s other important issues. Rampe said more forward-looking firms are taking into account each partner’s managerial acumen, not just their book of business. In other words, partners are evaluated on how well they managed the firm’s overall profitability and talent, not just on how much business they brought in. A partner compensation system that everyone can buy into inevitably leads to better morale and higher profits, not to mention better recruiting and retention.

Incoming partners    

Some firms are reluctant to discuss compensation in detail with new incoming partners because their system doesn’t work very well, or they don’t understand it, or they think it’s unfair. But Rampe said when you have your comp system locked down and everyone’s buying in, you can tell incoming partners with confidence: “Here’s how it works; here’s what we reward; and here’s what it means to be a partner at our firm.”

Rampe said formulas work well when the partners have made roughly similar contributions to the firm. But she said the system tends to break down when there’s not an even balance. For example, you might have three partners who’ve been working together for 25 years with relatively equal books of business, and then a new partner comes on board with a much smaller book of business. If you’re not careful, a traditional formula will say the new partner deserves to be making not only much less than the other partners, but less than they made as a manager at their old firm. Obviously, that’s a problem.

For firms in that situation, Rampe recommends carving out the newer partners and giving them essentially a salary and bonus that’s decided by the more senior partners. Then whatever is left over can be allocated to the senior partners. It’s important for incoming new partners to know from day one what’s expected of them, what their duties and responsibilities are, how they’ll be compensated, and what their buyout looks like. 

Buyout programs

According to Rampe, many buyout programs depend on partner compensation. One of them is the “multiple of comp method,” in which you’re taking roughly two to three times comp to value the partner’s piece of the buyout. So, if your comp system is off, your buyout will certainly be off. Rampe said it’s also important to make sure that partners are not only incentivized for their current performance but rewarded for their past performance when changing the comp system. It’s rare (though not unheard of) to want a partner to be worse off under the new system, when the focus is now on benefiting the whole firm, not just themselves. No one should be forced into false altruism. Instead, it’s better to use growth to fuel the comp system changes and reward those whose contributions have been overlooked.

Rampe said she was working with a firm that used a “pay equal comp system,” with large buy-ins and an equal share buyout. When partners left, their buyout was calculated as the value of the firm times their (equal) ownership at the time. They had a situation in which two partners retired in the same year. One had been managing a $1 million book of business and the other managed a $300,000 book of business. Since the firm’s buyout system wasn’t based on partner performance, not only had the two partners been paid the same amount, but they received the same buyout. People at the firm finally realized that maybe an alternative system would have made more sense. 

With many boomer partners expected to retire over the next half decade, and with all the private equity coming into our profession, compensation and retirement payout structures will continue to evolve. Developing fair, transparent and equitable compensation structures — for all partners — will minimize preoccupation with pay and keep firms focused on their most important objective: helping clients be successful.