Wednesday 24 February 2016

How to ensure your firm's equity structure is delivering the best results possible


Any accountant who has been part of one is likely to believe equity partnership structures are not the best way of organising a business.

Recently some of the larger and more visionary firms have been seeking to improve the standard partnership model. And there's mounting real-world evidence that tweaking conventional arrangements can promote greater collaboration, create better incentives, drive stronger growth and result in higher profitability. 

More on that shortly, but first let's recap the downsides of no-goodwill equity partnerships.

Short-termism

Let's look at things through the eyes of Larry, Barry and Harry who have equal equity in a business.

Aged in his thirties, Larry's just made partner. He stands to benefit the most from the firm investing in long-term growth. But he's just bought a house and started a family, so he has no cash to spare. Barry who is in his forties is financially set up. He's keen to scale up the firm while there's still plenty of time for him to reap the rewards of future expansion. Aged in his sixties, Harry is looking to get as much money out of the business as he can as he cruises to retirement. In the above scenario, far-sighted Barry is likely to frequently get outvoted by Larry and Harry to the eventual detriment of the business.

Democratic stalemate

This is what's likely to happen when nobody is incentivised to take on the thankless role of managing partner but everyone wants the power to veto decisions.

Money fights

Larry (wealth management) and Barry (business advisory) are keen on the idea of diversified revenue streams. Yet they can't help resenting Harry (auditing) getting an equal share of the profits while making a lesser contribution towards them. Meanwhile, Harry spends a lot of time feeling underappreciated; he works just as hard as the others, but his audit profit margin is smaller.

Siloism

Harry's got an auditing client who could benefit from some of Larry's wealth management wisdom and Barry's business advice. Does he share the client around? Of course not. There's no significant, direct pay off for doing so and what if one of those opportunists takes over his client?

If a partner isn't going to collaborate with colleagues to deliver better outcomes for clients, it's time to encourage that partner to move on.

Some fresh thinking

The issues listed above aren't new. But in an ever more Darwinian business environment it's not surprising that the Big Four, along with the likes of BCG, McKinsey & Co and Bain, have been trialling structural hacks. Here are some of the most promising ones.

Unequal partnerships

If a partner is making an above average contribution, there's no good reason they shouldn't receive above average rewards, argues David Clatworthy, Accounting Segment Head for Macquarie's Banking and Financial Services Group.

"There will always be natural leaders who want to drive the firm forward. Particularly with the mid-sized firms, things can be structured so there's a small cohort of partners with large amounts of equity. That structure allows those firms to be nimble and adaptable," he says.

If it's not possible to calibrate equity shares appropriately, extra bonuses (or some other form of payment) can be provided to partners shouldering a leadership role. "Those arrangements recognise those partners are doing more work on the business as a whole, which reduces the time they have to spend on their client base," says Clatworthy.

Specialisation and job sharing

"Your firm gets a big new client but he wants his auditing done at the cheap price his previous firm did it," says Rob Hayward, Head of Client Solutions, Macquarie Virtual Adviser Network. "Overall, the firm makes a lot of money from that client. But the audit partner is effectively penalised for doing the right thing."

The solution? "Firstly, consider the suite of services the firm is offering. Especially if it's a smaller firm, it's probably better off concentrating on doing two or three things well. It may be best to get out of auditing altogether. If that's not feasible, the auditing partner can get involved in other parts of the business. That way they're not just identified with one of the less profitable parts of the business."     

Incentivised cross selling

Time-poor clients are looking for one-stop shops. Smart operators are doing all they can to provide them, even if it does throws up a range of tricky challenges around divvying up a client's money. "Cross selling comes down to remuneration," says Hayward. "If a partner is referring 'their' client to other areas of the business there needs to be some recognition of that, which should include receiving some of the profit generated by their referral."

Cultural revolution

"You can have the best structure in the world and still have a dysfunctional firm if the partners don't get on," notes Hayward. "Which proves the importance of having a culture where people are honest and transparent about their personal and business objectives. A culture where the partners can come together as a cohesive unit to drive the business forward.

"The old school thinking was that if a partner was a big contributor they were tolerated even if they weren't a team player. The current thinking is that if a partner isn't going to collaborate with colleagues to deliver better outcomes for clients; isn't going to either step up to a leadership role or support those that have, it's time to encourage that partner to move on. Whatever the short term hit to revenue, it's just not worth keeping them around."

Implementing major change is rarely easy and there are never any guarantees it will pay off. But in a business environment increasingly roiled by disruption, those partnerships willing to experiment and adapt would seem to be the ones best placed to enjoy a long and prosperous future.

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