Com­pen­sa­tion Con­cepts

Spe­cific pay struc­tures can help re­ward part­ners for the unique value they pro­vide to a firm.

Financial Planning - - CONTENTS - BY KELLI CRUZ

Spe­cific pay struc­tures can help re­ward part­ners for the unique value they pro­vide to a firm.

If your firm is con­sid­er­ing mak­ing any changes to your ex­ist­ing part­ner com­pen­sa­tion plan, from a mi­nor tweak to a ma­jor over­haul, there are some ba­sic con­cepts you should keep in mind. First, you should make a note that there is no magic com­pen­sa­tion sys­tem that will sat­isfy all part­ners, meet all strate­gic goals and work for­ever. Your com­pen­sa­tion plan is a liv­ing, breath­ing doc­u­ment. Thus, it will need to ad­just to meet the de­mands of our evolv­ing in­dus­try and to sat­isfy part­ner con­cerns around fair­ness, as well as com­ple­ment and re­ward com­pli­ance with ever-chang­ing firm goals.

A Ma­jor Im­pact

The ways in which own­ers are com­pen­sated can have the sin­gle big­gest im­pact on the fi­nan­cials of a firm, and it can also set the terms for fu­ture firm part­ners. There­fore, get­ting this as­pect of your com­pen­sa­tion for­mula right is es­sen­tial to the sta­bil­ity and prof­itabil­ity of the firm go­ing for­ward. In my ex­pe­ri­ence, part­ners are al­most al­ways the high­est com­pen­sated pro­fes­sion­als in the firm. Their re­spon­si­bil­i­ties in­clude the crit­i­cal roles of busi­ness de­vel­op­ment: client ser­vice and re­la­tion­ship man­age­ment func­tions. I rec­om­mend the fol­low­ing com­pen­sa­tion struc­tures. As most part­ners are ac­tively work­ing in the busi­ness, they should be com­pen­sated for the roles or func­tions they are per­form­ing for the firm. • Base com­pen­sa­tion or salary is mar­ke­trate com­pen­sa­tion for the role and cor­re­spond­ing re­spon­si­bil­i­ties. Not pay­ing own­ers a salary low­ers the per­ceived value of their con­tri­bu­tion, and makes it dif­fi­cult to man­age prof­itabil­ity on an on­go­ing ba­sis. Re­mem­ber that part­ners work in the firm, and thus their prod­uct needs to be fully val­ued and ac­counted for in the firm’s cost struc­ture. In my ex­pe­ri­ence at Cruz Consulting Group, most part­ners ac­tu­ally per­form a blended job role in ful­fill­ing the re­spon­si­bil­i­ties of sev­eral vi­tal po­si­tions for the firm. For ex­am­ple, most own­ers per­form the com­bi­na­tion of gen­er­at­ing new busi­ness, ser­vic­ing the firm’s top clients and run­ning the day-to-day busi­ness. A typ­i­cal blended job role for a firm owner might be 35% rain­maker, 40% re­la­tion­ship man­age­ment and 25% busi­ness man­age­ment. Ad­di­tion­ally, a part­ner may fill the roles of CEO, COO, CIO or chief com­pli­ance of­fi­cer. Own­ers/part­ners of ad­vi­sory firms should be com­pen­sated like any other per­son in the firm for the role they are per­form­ing as an em­ployee. I see a lot of vari­a­tion in how firms are de­ter­min­ing salary for part­ners: 1) by a com­bi­na­tion of prior year rev­enue and other con­tri­bu­tions; 2) own­ers re­ceive no salaries — their income is en­tirely in the form of in­cen­tive com­pen­sa­tion or

If men­tor­ing young tal­ent is part of the firm’s strate­gic plan, be sure to in­clude some re­ward in your com­pen­sa­tion sys­tem, or the mes­sage to your part­ners is that it’s not val­ued.

a per­cent­age of prof­its; 3) salaries are de­ter­mined yearly based on prior year rev­enue con­tri­bu­tion (draw); 4) salaries for all ac­tive own­ers are equal and not based on mar­ket rates. • In­cen­tive pay is vari­able com­pen­sa­tion for meet­ing or ex­ceed­ing goals that are tied to the key strate­gic ini­tia­tives of the firm. It’s im­por­tant to in­clude part­ners in the in­cen­tive or bonus pools to en­sure their full con­tri­bu­tion is be­ing re­flected in their com­pen­sa­tion. I speak with many firms that ex­plain they don’t need to pay part­ners a per­for­mance in­cen­tive be­cause these part­ners are al­ready shar­ing in the firm’s prof­its. They feel this is the per­fect way to align each owner with the re­sults of the firm. I can’t ar­gue with that logic. What’s left out of that equa­tion, how­ever, is that profit dis­tri­bu­tion does not ac­count for the in­di­vid­ual per­for­mance of each part­ner. Ad­di­tion­ally, you may have some part­ners who earn a smaller per­cent­age of the profit pool and may not be mo­ti­vated to con­trib­ute at a higher level if they are not re­warded eq­ui­tably for their ef­forts. Keep in mind that in­cen­tive pay should be tied to an­nual goals and re­sults paid out quar­terly, semi-an­nu­ally or an­nu­ally. Typ­i­cal in­di­vid­ual driv­ers of in­cen­tive com­pen­sa­tion in­clude new clients; new rev­enue gen­er­ated; to­tal rev­enue man­aged and/or num­ber of clients man­aged; client re­ten­tion and sat­is­fac­tion; de­vel­op­ing and men­tor­ing staff; events or mile­stones and spe­cial projects. • Own­er­ship dis­tri­bu­tion is the re­turn on the owner’s in­vest­ment in the busi­ness — it’s not com­pen­sa­tion for work­ing in the busi­ness, or even on the busi­ness. Some firms try to man­age a bot­tom line to a cer­tain value by shift­ing most or all owner com­pen­sa­tion into this dis­tri­bu­tion cat­e­gory. The les­son here is that own­ers need to be fairly com­pen­sated for their roles first, and then over­all busi­ness ex­penses and prof­itabil­ity must be man­aged from that base­line. Owner com­pen­sa­tion plans should de­fine the role of the own­ers and the value of the jobs, hold each owner ac­count­able to a cer­tain level of per­for­mance, and dif­fer­en­ti­ate be­tween re­wards for their la­bor and of own­er­ship. Rec­og­niz­ing own­ers and part­ners as em­ploy­ees first al­lows the own­er­ship group to dif­fer­en­ti­ate con­tri­bu­tions made by dif­fer­ent part­ners at var­i­ous phases in their ca­reers.

A Big Chal­lenge

One of the big­gest chal­lenges firms face is not dis­tin­guish­ing be­tween those part­ners whose roles are di­min­ish­ing as they sun­set out of the firm and those who are still fully en­gaged in run­ning and grow­ing the busi­ness. Part­ners’ com­pen­sa­tion should change over time as their job role, per­for­mance and con­tri­bu­tions shift. This is the only struc­ture that can ac­com­mo­date for the changes in part­ner role and value to the firm that oc­cur over time. Here are some fi­nal con­sid­er­a­tions to keep in mind when you’re mak­ing mean­ing­ful changes to your part­ner dis­tri­bu­tion plan. Be­fore mak­ing these shifts, find out what your part­ners do and do not want in a new com­pen­sa­tion sys­tem. You can do this by fa­cil­i­tat­ing a brain­storm­ing ses­sion. As a start­ing point, you might ask the part­ners to an­swer the ques­tion, “What do you value the most?” Be­fore you can de­velop a suc­cess­ful, com­pre­hen­sive com­pen­sa­tion sys­tem, you must have a very clear and agreed-upon credo as to what makes your firm tick. You may be sur­prised at how agree­able your part­ners are once they’ve made their points of view known and have the op­por­tu­nity to con­sider the opin­ions of their fel­low part­ners. The com­pen­sa­tion sys­tem you cre­ate should be re­lated to your firm’s strate­gic goals. For ex­am­ple, if men­tor­ing the next gen­er­a­tion of tal­ent is part of the firm’s strate­gic plan, you should in­clude some form of re­ward for it in your com­pen­sa­tion sys­tem. If you do not do this, the mes­sage to your part­ners is that men­tor­ing is val­ue­less. Ev­ery type of com­pen­sa­tion sys­tem has com­pelling rea­sons for adop­tion, and just as com­pelling rea­sons for why it should not be adopted. It’s up to you to de­cide what sys­tem works best for your firm and your part­ners. At the end of the day, your part­ners want to be com­pen­sated fairly and eq­ui­tably, just as ev­ery other em­ployee in your firm does. Whether you choose to com­pen­sate them with a base salary, in­cen­tive or a com­bi­na­tion of both is up to you and your busi­ness strate­gies. How­ever, you should al­ways keep in mind that mak­ing your part­ners happy will also help to keep your clients happy. And isn’t that the end goal for ev­ery firm?

One of the big­gest pit­falls firms face is not dis­tin­guish­ing be­tween part­ners whose roles are di­min­ish­ing and those who are fully en­gaged in run­ning and grow­ing the busi­ness.

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