A Q&A in Proprietorship

 

By Thea Foster, Added Value Corporation Pty Ltd

 

Firm ownership and reward is never straightforward. This article will suggest some answers to frequently asked questions, targeted at small to medium-sized firms. As every firm is different, not all comments will apply.

 

Equity

 

Question:  Are we all equal?

No of course not; we just think we are. Or perhaps we feel that our differences counter-balance each other.  “I’m better at getting the work out, you’re better at client contact.” This presupposes that each aspect of work is of equal ranking.  It isn’t.  It would seem at present there is sufficient competent staff out there to take care of production. So the person who can bring in more clients, more projects and successfully negotiate fees is more important to the practice.

By the way, quite a few firms do not have equal ownership, generally due to historical factors.

 

Question:  Do people still buy goodwill?

Absolutely, just talk to the practice brokers, or to many of the older firm proprietors.

 

Question:  Do all firms provide vendor finance for people buying in?

Not all, but many do. Maybe for the second borrowing, so if part is financed via a bank (maybe the firms’ bank) then the balance is provided via vendor finance.

 

Question:  What if we want to abolish goodwill?

This is up to the current proprietors. One method is for the firm as a company or trust to buy the goodwill from the partners, then create a loan account. Over time that can be paid out, with interest. Meanwhile, new people buying into the firm don’t pay for goodwill.

 

Question:  What else can we do to make it easier for new proprietors to come into the firm?

In addition to vendor finance and the firm securing a loan via a floating charge over its assets, in some cases firms sell and lease back their building, or sell their financial planning division. This makes it more affordable for new proprietors to buy in, while still paying a good price for goodwill.

 

Question:  So what is a good price for goodwill?

The generally accepted rule now is if fees are less than $1m, the price is around 90 cents to $1 in the $1, almost regardless of the nature or location of the fees. For fees of more than $1m, an EBIT calculation is increasingly used, generally with a multiplier of between 3 and 4, after allowance for proprietor salaries. These are general statements and are subject to the special circumstances of each firm and deal.

 

Compensation

 

Question:  What is a reasonable proprietor salary?

Somewhere between $150,000 and $250,000. Again, a very general statement. Salaries vary depending on the location of the firm and the skills and experience of the people. I consider $150,000 very low in most cases.  Likewise, for some firms $250,000 is not sufficient.

One method to determine salaries is to review senior manager salaries, then calculate the percentage difference in charge rates between senior managers and the proprietors. Apply that percentage to the managers’ salaries, and that will produce a potential proprietor salary.

Obviously salaries become a very important issue if ownership is not equal. The various salary surveys will also provide guidance. If you consider you firm a smart firm, then the salaries paid by the national firms set a benchmark.

 

Question:  How can we adjust compensation for people who work less than standard hours?

There are adjustments for hours worked, and though these mostly apply to proprietors gradually selling out, some proprietors adjust their salaries as they move to a 4-day week.  Occasionally firms permit 4-day proprietors, though often the person ends up working quite a few hours during their day at home.

One firm mentioned they found it easier to give a person going through succession extra weeks of leave. So 5 days a week were worked, but an extra 8 weeks’ leave was taken each year (obviously not all together). In some firms proprietors are limited to taking no more than 4 weeks leave at any one time.

 

Question:  If a partner is phasing out and reducing hours, at what stage must they sell equity?

I recall a firm where once a proprietor reduced hours beyond 4 per week, they were forced to sell down equity.

 

 

Performance

 

Question:  How can we adjust for underperformance?

Firstly, by determining what is adequate performance. This requires very clear guidelines of what is required from a proprietor, covering hours worked, hours charged, fees managed, assistance with firm leadership, mentoring people, clients and projects introduced, and so on. This may vary by proprietor and the firm may allow for special factors (such as a managing partner role).

Then measure performance and conduct regular performance reviews against the agreed requirements.

 

Question:  What matters when measuring performance?

Look at gross fees and gross profit. In terms of proprietor hours charged, I have seen as low as 30% and as high as 80%. There are various theories on chargeable percentages (assuming you are still using timesheets). I recall a small firm managing partner who said he was unable to get over 50% given his various leadership roles. In one of my groups, sole practitioners advised their chargeable percentages were 68%, 34%, 44% and “huge”. The averages advised for two partner firms were 35% and 50%. So the numbers are almost meaningless, unless you know more about the practice (such as whether or not they have a practice manager).

The ability to bring in clients and new projects, as well as develop new expertise is critical.  It helps to retain and develop quality staff, who might otherwise lose interest and leave.  Plus, this is generally very profitable work.  Such high performers are due a bonus.  Consider voting for an allocation from a bonus pool, or giving a managing partner permission to make an arbitrary decision.  I recall one US firm where it was possible to go to the managing partner and claim your proportion was too low.  You were then asked which other proprietors should have bonus removed from them, to underwrite your new allocation.  Difficult.

 

Question:  How is non-chargeable time measured?

Carefully. “What you do with your chargeable time determines your profit and what you do with your non chargeable time, determines your future.” – David Maister

 

 

Thea Foster (B Com FCA) is a Practice Management Consultant & Presenter and Founder of Added Value Corporation Pty Ltd. After many years of public practice, Thea now consults to firms, facilitates firm meetings, assists with succession planning and operates her successful meeting Groups, TAP Group 1, SFG 1, TAP IT, TAP SMSF and TAP AUDIT, see www.addedvalue.com.au. Thea is also a co-founder of  www.foraccountants.com.au and www.whatproduct.com.au.

 

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