Succession fundamentals – Part 3

Written on Aug 06, 2015

By Bill Reeb, CPA, CITP, CGMA

Everywhere I turn, I overhear someone talking about, being asked about the status of, or referring to their need to develop, a succession plan.  

As a matter of fact, for the past 12 years through surveys with PCPS, we have been asking firms to share with us whether or not they have a succession plan in place. When you consider the responses to this question from the PCPS Succession Institute Succession Management surveys conducted in 2008 and 2012, clearly more and more firms are getting their act together, documenting their succession management strategy and thinking through the ramifications of retiring one or more senior owners. 

When you consider the fact that our 2004 Succession Survey showed that 19% of the firms had a succession plan, and 81% didn’t, great progress has been made in this area.

With all of this progress, and so many plans in place, why is succession management still such a big concern and issue in our profession? One reason is that many of the plans have never been tested inasmuch as their first senior partner is getting close to retirement. Another, more significant, reason is that the vast majority (we would say anecdotally this could run well over 90%) of the plans are extremely inadequate because:
  1. They only address a few of the critical issues 
  2. Even the plans that address most of the issues, the level of accountability tied to consequences of rewards or sanctions is grossly insufficient
Just to give you a perspective, most firms would call the following a succession plan:
  • A schedule by age of the partners
  • An estimate as to who might decide to leave when (but nothing more than that because no one has truly committed to go and virtually everyone can go)
  • A schedule outlining what the firm thinks it will owe each partner based on when the group  guesses they are leaving
  • An analysis as to whether the firm’s cash flow can afford the retirement payments
  • Some list of people coming up that might be named partners in the future
  • A list of clients that need to be transitioned to someone
If this is the basis of most succession plans today, then it should be no surprise that we feel it is grossly inadequate. As I make this statement, I realize that I am now setting myself up for the logical next question, which is “If this isn’t what we should be doing, then what is?” While we are not going to provide you with a mock-up of a succession plan in this column -- because to us a mock-up would put inappropriate emphasis on the look and presentation of the document -- we are going to go over the components that should be addressed and customized to your firm in the plan.

It is time for us to share what we believe to some critical steps and processes creating the foundation of a well-run firm. But before we cover the order in which we review and assess these component parts, I want you to understand that this infrastructure is full of moving parts. So that means that as you work through one set of issues, even though you might feel like you have reached consensus and made good decisions, each step needs to be thought of as a “current stake in the ground” rather than “decisions made in concrete.” This is because many of the decisions have overlapping implications and unintended consequences that have not been considered fully since we are trying to address the decisions one at a time, almost in a vacuum. Therefore, while we will be putting “stakes in the ground” to build a plan around, we also have to understand that as we get further into the process, we may need to adjust any or all of the earlier stakes as we learn more how previous decisions are interacting and impacting our ability to take fair and positive steps regarding the next set of decisions.

So we need to move forward one step at a time knowing full well that we may have to go back to the beginning as the entire picture of what we are building in our succession management plan becomes clearer.

Governance: The roles and responsibilities

With this in mind we start with governance because it clarifies who can make what decisions, as well as identifying the checks and balances put in place within each firm’s decision-making system. We feel it is important to make sure that the firm has a clear definition of the roles and responsibilities of key people and groups, which commonly include:
  • Board (of partners or shareholders)
  • Executive Committee (if the firm has well over 20 partners)
  • Policy Committees (like the Tax and Audit Policy Committees)
  • Managing Partner or CEO
  • Department Heads
  • Line Partners:
    • Client Service Partners
    • Technical Partners
    • Practice and Industry Niche Leaders
    • Partners Working in the Firm after Sale of Ownership (or Retired Partner Employees for shorthand)
As part of the roles and responsibilities assessment, we believe that competencies should be identified for each level within the firm. For succession management purposes, it is critical that this is addressed at the partner level, but it is even more beneficial to have a culture built around expected competencies throughout the firm.

An important next step in the process is to make sure that partners and managers understand how to manage people. Training is crucial to teach those who manage:
  1. How to manage effectively and efficiently
  2. A process to follow that will result in the rapid development of their people
  3. How to provide coaching and oversight (including evaluation) to assess performance against expected competencies 
Don’t overlook this — managing “the way it’s always been done” normally has some serious pitfalls and shortcomings that can be avoided with proper training.

The point of the three steps above is to move away from creating organizations around specific people and their unique skills, to a culture that develops people around expected skills, abilities and roles that they fill. This way, whoever becomes the audit department head is filling a role … the same role the last department head did … with expectations as to how that department will be run as well as management skills expected to be demonstrated while running it. The same is true, and even more important, when it comes to higher level positions like that of the managing partner, positions on the Executive Committee or the Board. It is critical when a person takes on one of these roles that it is not only clear what is expected, but unambiguously understood what powers have been conferred to them, together with the limitations on those powers. A fundamental to succession management is that people fill functions within the firm. Those functions are not redefined by the skills of each person who takes on a role.

Rather, the person taking on the role will be required to redefine themselves and their skills in order to effectively fulfill the expectations of the role. Another fundamental included in these three ideas is that the firm needs to move away from the more common “I will let you know when I believe you are competent and ready when I see it” type of developmental approach to one of “we will develop each of you to meet and exceed a minimum set of competencies across numerous areas important to our firm’s culture and values, based on the role you are filling.”

Once governance has been determined and/or fine-tuned, we are now in a position to know who can hold whom accountable with what powers and limitations. It is at this point that we move on to the next step in the succession process: the financial package for the retiring owner.

The financial package for the retiring owner

Because many firms have some part of their compensation, and often retirement or ownership as well, tied to client book, it is important to lock in a fair retirement based on how the firm is operating today. The reason is that when creating a strong succession plan, you are likely to ask all partners to agree to some changes. If you want to create an open dialogue with a senior partner about giving up some of his or her book for the betterment of the firm, which is also typically synonymous with asking that partner to give up some of their security regarding annual compensation and even more important their internal power, it is critical to give them confidence that their past efforts are being considered when creating the reward structure going forward.

At this point, we need to pin down the process for determining the retirement benefit and equity/capital amounts due the retiring senior partner. We addressed this in part two and three of this series so if you want to review this topic in more detail, just refer back to those columns. This process should include identification of issues such as:
  • Vesting requirements 
  • Penalties for withdrawing without adequate notice 
  • Transitioning procedures for client relationships
  • Penalties for inadequate the client transition
  • Transition period compensation framework
Next, we address the process of distributing the ownership of the retiring partner(s) as well as awarding additional ownership to our top leaders. This often is done very haphazardly. Then, after a few partners retire, because the voting control was sloppily managed, it is not uncommon for either 1) the weakest people in the firm to have a stranglehold on the firm’s decision-making processes, or 2) the ownership to be so diffused or out of balance that the decision-making process is less about maintaining and evolving a well-run firm and more about power groups, voting blocks, politics and protectionism. By the way, notice that we used the word “top leaders” in our opening sentence to this paragraph. It was intentional. A firm needs to have a compensation system that rewards its top performers and pays them well. But the top performers are not always, to the surprise of many, a firm’s top leaders. The equity, that is, the ability to influence the direction, values and culture of our firm, should be allocated to your top leaders, not your top performers. In many instances, they are one and the same, which is great. But all too often, they are not, and this distinction is critical when managing the future survival, continuity, profitability and success of your firm.

After we have addressed equity, which often requires a redistribution of existing equity, it is important for the firm to adopt a decision-making philosophy. The new philosophy is simple.

We all have opinions.  We should openly share our opinions. Once we have done so, we should vote. It is okay … actually it is healthy … to have differences of opinion and strong beliefs about choices the firm should make and solutions it should implement. However, once we vote, regardless of whether your vote aligns with the final decision or not, everyone is bound to support and implement the decision made.

While most firms are better served to make all of the voting public (meaning everyone knows how each partner voted), anyone should be able to call for a private vote on any issue if a partner feels that the group is being bullied or pressured into a position, or feels like a more honest vote will occur if a ballot is taken.  

The firm should be encouraging key behaviors of healthy organizations which include 
  1. Open communication
  2. Creating a culture where it is okay, even good, to disagree
  3. An understanding that when a majority, or whatever voting threshold identified for a specific issue is attained, the firm will have made that decision and begin to move forward
  4. An understanding that once a decision is made, whether you supported it or not during the vote, that you support it after the vote
The purpose of this process is to make sure that the “no” vote in an organization doesn’t become more important than whatever the majority “yes” vote is. So many times, what starts out as benevolent leadership’s attempt to be inclusive by building a firm around the idea of consensus eventually morphs into its dysfunctional twin where the firm is constantly catering to its weakest link – usually the partner who wants everything to remain the same and wants never be held accountable.

The Ohio Society of CPAs has established a collaborative effort with the Succession Institute to provide small firms with the tools they need to manage their practices and seamlessly transition to new leadership. The Succession Institute is lead by its owners Bill Reeb, CPA, CITP, CGMA and Dom Cingoranelli, CPA, CGMA, CMC®, who have each been working with CPA firms and family businesses to help them improve their performance for over 30 years. Visit their page now to learn how you can save on the solutions right for you.

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