Compensation

The single largest cause of partnership (or small company) breakups in profitable businesses is disagreement or discontent from one or more partners regarding compensation.

Frequently, because the partners own equal shares, they take equal salaries. However, the value of their contributions is usually not equal. This ‘inequity’ caused by inflexible compensation will pull at the fringes of the partners’ relationship, and may someday tear it apart.

This is a very common problem in service businesses, such as medical practices, engineering, architectural, consulting, and CPA firms. Law, financial planning, and mortgage brokerage firms are frequently organized to allow the partners to ‘eat what you kill,’ where each partner’s revenue less their share of expenses (direct and indirect) are subtracted to arrive at their compensation. This alleviates most of the discontent, but also results in liquidating all of the firm’s profit, leaving no incentive to own stock or value in the partnership itself. Further, it leaves no incentive for referring work to each other, or growing the firm by sharing clients with a new practitioner. Each individual’s earnings are limited to their own productivity. This method leaves little value in the firm itself beyond expense sharing.

An effective compensation plan will result in a firm that has value due to its profitability and growth. Effective compensation systems stimulate growth because the partners are appropriately incentivized to be productive and grow the firm. Having a well-defined and equitable compensation system will also make attracting talented professionals easier. The best professionals always want to be compensated based on the value of their contribution to the organization, which is the underlying principle of our solution. Partners and staff must be compensated based on the value of their contribution to the organization.

CASE STUDY: OUR FIRM

Using our CPA firm as an example, shareholders and staff contribute to the business in many important ways. Sue brings treats. Donna picks our college basketball brackets. Neal is our clutch shooter in golf scrambles. Tanya is ‘the ref,’ and I push the concept of ‘business casual’ to soaring new lows. In spite of all of these competing valuable contributions, we’ve managed to boil them down to an essential three: production (billing), administration, and business development. Each manner of contribution is compensated differently.

For production, we compensate shareholders and staff 40% of collected billing up to $200,000 per year, and 50% above $200,000. Non-officer staff receive an hourly wage for administrative duties performed. Officers receive a small salary for each of the administrative responsibilities they assume, such as general manager, IT, human resources, etc. We also offer a bonus of up to 40% of the annual billing of a new client, if they are retained three years or more. Finally, we have a discretionary profit sharing bonus payable to non-shareholding staff.

This compensation system not only incentivizes owners and staff to produce, but also to share work. If a shareholder wants to work less, they can do so without fear of other shareholders feeling cheated. Nor are they cheating themselves by giving work to other shareholders or staff, because they will participate in the profit earned. This model is more effective if the firm’s profit is 20% of revenue or more. Finally, with significant profit distributions to shareholders and an appreciating stock price, there is a strong incentive to become a shareholder. Having key employees become shareholders is a powerful retention tool.

Call MRO today for help identifying the activities that drive value and profit in your firm, and designing appropriate methods of compensation to incentivize those activities.

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The Power of Effective Compensation

Brian Murray

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