Managing your partner resource
Professional practices invest a significant amount of time in professional development. Promotion to partner is a massive step for all concerned but as a practice how do you make the most of your partner resource and how do you avoid partnership disputes? In this article Howard extracts the key points applicable to PI firms from the issues raised in a Webinar that he presented to the Law Management Section of the Law society on 18 September 2013 while it has been updated for the impact of the changes announced in the Chancellor’s autumn Statement.
In some eyes promotion to partner in a professional services firm is seen as achieving the ultimate goal but in reality, that is simply the start of the next career stage. Partners have a key client service role to play in helping the further development of the practice and getting the most from a partner is not easy. Indeed for the typical PI firm the role of the partner is arguably very different from that in a more traditional full service firm. However the same issues arise in both types of firm and the potential for disagreement and disputes are just the same.
Whether you are a full service firm or a PI firm the partners are the owners of the practice and great care needs to be taken in assessing and agreeing the attributes one expects of an owner and someone with whom you will share the value that the existing partners will have largely created. In a PI firm partners are likely to be creating capital value to a greater extent than they would be in a more traditional firm where the focus is on work doing and profit generation. In essence the existing partners need to be satisfied that they are relinquishing part of their ownership (or selling a share) to an individual who will make the practice and their remaining share more valuable as a result of that individual becoming a partner. The qualities and attributes for a partner, before promotion, can be distilled in to four key areas:
- Motivation – to be self-motivated with the desire to add to the firm and to contribute to the greater good of the firm and not be working to be praised or for overall status and reward
- Intellect – individual partners need to demonstrate flexibility in their intellect, to see the broader perspective and to see the other persons point of view
- People – to be able to change approaches when dealing with different clients/partners/staff to get the best from them and not to simply like or want to be liked by the right people
- Organisation – a key attribute for a partner is to be able to prioritise, delegate and defer, be prepared to say ‘no’ and to bring in resources as and when required
When thinking about appointing someone to partner there are some underlying attributes that are a “given”. For a traditional firm these are likely to focus on technical ability and work getting, and while still valid they are less important for a PI firm where market knowledge and entrepreneurial and IT skills are likely to be “the given”.
Assessing the attributes
While whole books have been written on the subject it does seem that it is difficult to replace one to one assessment by skilled appraisers linked to theoretical and actual real life scenarios. The interviewing style should be relaxed and non-confrontational using open (non leading) questions. Very little is to be gained from aggressive or trick questioning – other than a disaffected interviewee and/or misleading results. Asking candidates to explain real life experiences – of dealing with difficult people or exceptional demands for example – gives ample opportunity to assess their true skills. This knowledge can be enhanced by using theoretical scenarios such as an in-tray test.
Developing a Corporate Framework
Once a partner is in place there are ongoing challenges with regards to partner remuneration and income. It is important first and foremost to concentrate on building the business and making profits – be it for a PI or a traditional firm. For a PI firm however profits are generated through entrepreneurial ability and careful management and control of the “process”. This contrasts with a traditional firm where work getting and doing and chargeable (and cash collected!) time is the focus.
When developing an assessment framework for a PI firm there must be a clear understanding of the difference between reward as an “employee” carrying out a function and reward as an owner and shareholder. The rewards as an owner come from the creation of capital value and from dividends. Capital value comes from the creation of a sustainable profit stream in excess of what would be a fair reward for the partner’s efforts as an “employee”. When addressing the value of a PI practice and what share ownership a partner should have, there needs to be a clearly agreed and understood valuation criteria – usually linked to a multiple of profits – which can be applied to incoming and departing partners. In addition there should be an agreed dividend policy – often a % of profits after deducting the reward as employees. Both of these criteria are best incorporated into a shareholders/members agreement – although there can be some accounting issues if the dividend policy is contractually binding. Do be aware, however, when setting the valuation criteria of the potential distortion created by the non-inclusion of contingent WIP in the accounts.
Developing an assessment Framework
Invariably, the biggest issue facing professional partnerships is the year end question that every partner wants to know the answer to – what can I draw from the firm and why is my ‘mate’ down the corridor drawing more than me?
An appraisal policy needs to be in place to ensure there is clear understanding between all the partners as to where they are in the framework and the levels of remuneration they can draw, to avoid the inevitable comparisons between individuals and the chances of disgruntled partners.
A framework needs to be drawn up that is fair and simple to understand, is adaptable for new partners joining and does not need to be revisited on an annual basis.
There are many ways to develop such a framework but one that often seems to find favour has four slices to the cake:
- Interest on capital to allow the partner to borrow from their personal banker
- A fixed share often linked to a market salary and which is paid monthly net of tax
- A slice for a performance related bonus based on meeting SMART
- Potentially a geographic or departmental performance pool
SMART stands for Simple, Measurable, Achievable, Realistic and Time specific and the objectives should be set in advance of the commencement of the assessment period. The amount of the bonus needs to be enough to motivate and deal with anomalies, but not so much as to demotivate those who do not benefit from it. Setting the amount of this “pot” causes much debate and can be a specific sum in pounds or it can be linked to a % of the total profits say 10% or 20%. The balance will then be available to shareholders either by way of dividend or retained profits as mentioned above.
However, all of this is also linked to the appraisal process which requires a blame free culture, provides mentoring and support for partners and allows for personal development.
There is a note of caution that comes with experience. Many firms (especially traditional full service firms) with say less than ten partners have found a performance related culture extremely divisive and have through bitter experience abandoned such an approach as it has created more problems than it has solved.
However creating a framework to enable partners to flourish, give guidance as to what they are likely to earn and openness and clarity to the process of assessment and reward will go a long way to getting the most from the partner resource.
Choosing the business vehicle
Getting the right structure for the firm is key and balancing the type of partner and how they are remunerated in their role is all part of this process – hence the question of whether the practice should operate as an unlimited partnership, LLP or Limited Company or a mixture. While it has always been an issue, it is even more so given the changes announced in the Chancellor’s Autumn Statement in December 2013.
All too often there is confusion between profit sharing and capital ownership, and they are not automatically linked. In a traditional partnership or LLP the capital contribution should equate to shares in a limited company where the amount of capital contributed gives an appropriate percentage stake in the firm, both in the event of a sale or any distribution of super-profits. Such a distinction is far more readily understood if the vehicle chosen is a Limited Company. While partnerships and LLPs are far more flexible vehicles, the Autumn Statement changes are increasingly leading PI practices to conclude that they should operate as limited companies now that the hybrid vehicle (corporate member of an LLP) has been substantially affected. For PI firms this is reinforced by the following:
- Bank borrowing will be repaid out of profits taxed at the lower corporate rate
- PI firms are more likely to be bought and sold and the financial world better understands limited companies
- Genuine goodwill exists in many PI firms and this can be recognised in the accounts in certain circumstances with potential tax benefits
- The disguised remuneration rules, which will result in many fixed share partners being subject to National Insurance, can be avoided by the payment of dividends from a Limited Company with no NI
This is not an absolute and there are many pros and cons which should be fully explored and debated. For example hybrid vehicles (where none of the members are shareholders in the Limited Company member of the LLP) still have a place. In the same way – and it is early days and legislation is only in draft – various structural solutions to the disguised remuneration rules have already been developed.