An ownership track—partnership track—is perhaps the ultimate expression of the values of a firm. Nothing depicts as clearly and as truly what is important and valued in a firm than the criteria for the ultimate prize—becoming an owner. The decision to promote the first partner internally is perhaps the biggest achievement of a multi-professional firm —an “ensemble” firm (otherwise known as a team). There is no better way to express the value of working together as one firm than sharing the profits and value of the firm with some of the best people in the firm. Having a partnership track is perhaps the strongest motivator available for the top performers in the firm.

The partnership track we will explore in this article relies on two fundamental principles. The first is that being an owner is a privilege reserved for only the very best and most accomplished people in the firm. It is a privilege that takes a long time to earn and is a very strong commitment from both sides. The second principle is that partners are selected not just based on economic logic but that they also have to demonstrate the character and behavior expected of a partner.

These seem like very lofty statements; after all, we are not talking about someone becoming the controlling shareholder of the firm. They are most likely going to be a 1 percent to 10 percent owner. The point is that making someone a partner in a business is very difficult to undo, and it also allows them to represent the firm through their actions. Think of making someone your partner as teaching someone to perfectly mimic your signature—no one can tell the difference. That pretty much describes your partner.

Many firms look at promoting a partner as a strictly economic decision, that is, if they bring business they get to be a partner. Instead I propose a different sequence of decisions: 1) When is the firm ready for another partner, 2) What are the criteria for new partners, 3) How do we communicate the criteria, and last 4) How do candidates buy in?

When Can You Add a Partner?

Most owners would agree that unless an advisory practice grows substantially, adding more partners will only result in diluting the income and equity of existing partners. Adding more partners is fundamentally premised on the notion that owning, say, 95 percent of a bigger firm is better than having 100 percent of a smaller firm. Determining how much bigger the firm has to be before that statement is true, however, may not be so straightforward.

Mathematically, it is pretty easy to determine how much bigger the firm should be to prevent reduction of the income of existing owners. Simply calculate how much more revenue and profit you will need to make up for sharing, say, 5 percent of the profits. This mathematical approach may be oversimplifying things, but, in fact, large partnerships often set a target for partner income and derive their partnership admissions from that target.

The other approach to looking at the growth of the firm is more focused on “span of control”—how many clients and how much revenue an owner can manage and oversee. Assuming that having revenue and clients beyond the “span of control” of a partner are at risk of leaving the firm, the firm is better off promoting another qualified staffer to partner to take care of those clients.

Finally, many firms simply look at some measure of growth in the revenues of the firm in the last two to three years and then cross-reference that with the individuals who are ready to step up to the ownership level. The theory here is that as long as you have a good candidate and as long as you have the confidence that the firm is growing, you don’t want to keep that person waiting for too long.

For practical purposes, I have seen most of the firms I have worked with combine the growth criteria with the availability of candidates. During the growth spurt between 2003 and 2007, firms were quite aggressive in promoting new partners with the confidence that the growth would be there. The crisis of 2008 and 2009 put a stop on all partner promotions and put many careers on hold. As firms started growing again, in some cases, they needed to make the promotions despite not reaching the exact growth targets since the candidates had been waiting for a while.

Who Should Be a Partner?

The criteria of who should be a partner should cover the character and total performance of the candidate and not just his revenue contribution. The criteria should never be formulaic. That said, it should also be clear that the existing partners are “judge and jury” on how those criteria are applied to a candidate. I remember how I felt as a candidate for partner in my firm; I really wished the criteria were clearer—as in a formula. On the other hand, as soon as I became an owner, I immediately reversed position in favor of more broad and evaluation-based measures.

The criteria for making partner should be very individual for every firm but most firms will be focusing on the following categories:

1. Revenue contribution;

2. Management contribution;

3. Character;

4. Community and market presence (representation of the firm in public);

5. Intellectual contribution.

Revenue contribution receives the most attention, and may very well be the easiest to measure. Typically the contribution of a candidate can be expressed in the revenue he has personally added, and most firms will be tracking that number in their normal course of business. Also, some firms measure the additional business a candidate has generated from existing clients. This “internal” business development is usually considered part of the “business brought” and in most cases is treated as equally valuable. Another measure that firms can use is the revenue managed by the candidate as a lead advisor. This will be revenue from clients that see the advisor as their primary relationship with the firm, regardless of who originated the relationship.

Not every firm agrees that revenue management is as valuable as the additions of new clients. In general, firms that have a solid track record of growth and access to institutional sources of leads, such as accounting firms or banks, tend to value revenue management as high as sales. Firms that have had a harder time growing and that rely more on individual effort and marketing for growth tend to discount the revenue management as a criteria. My advice is to not go too far in either extreme.

I don’t believe a firm can have a sustainable future without every partner having contributed at least some significant amount of new revenue to the firm. If some of the partners have never brought a client to the practice, the firm will be very vulnerable to the loss of its business developers. This often happens to firms where the first generation is the true business developer, where the second generation of partners usually received clients from the firm. What happens frequently in such cases is that the first generation realizes that if they retire, the future of the firm is very uncertain despite the fact that they supposedly have many partners. The result is that they often sell externally to reduce the risk.

On the other hand, if a firm does not value revenue management, it is really undermining the most crucial aspect of firm success—client retention. Most referrals come from existing clients and, therefore, client retention and satisfaction is the key to successful business development. Undervaluing client retention in favor of sales can create the atmosphere of a brokerage boiler room, and most wealth management firms would rather avoid that.

Each of the partnership criteria and how to measure and apply it is discussed extensively in the book. In this article, I just want to add a couple of sentences on the importance of character. Evaluating character is a very subjective task but that should not stop firms from expressing their expectations for new partners and actually evaluating how the candidates compare to those expectations. It may sound a little corny to have the partners meet and consider whether someone exhibits integrity, sound judgment, high ethical standards, and so forth, but, at the end of the day, character is the difference between a partner who could get the entire firm in trouble and someone who will elevate it to new heights.

How to Manage Expectations?

I am very skeptical of broad ownership plans that essentially make every employee an owner. My experience has been that such plans dilute the sense of ownership. Rather than a privilege, being an owner becomes an entitlement and a default state. The criteria for partnership should be clear, and there is also very little reason I can see for not publishing the criteria to all employees. After all, if you want the partner promotion to motivate, you have to establish what the rules are for earning it.

Partnership opportunities should not be restricted only to advisors. A successful firm is impossible without strong leadership and performance from the operations functions of the firm. All of the qualities and criteria we have described so far apply to operations managers as well. The only factor that is not so directly applicable is the revenue contribution. The requirement to grow the firm to a certain level of revenue for each partner may make it more difficult for operations staff to be considered. Still, every firm should look at its operations leaders and determine if it is able to offer them ownership.

How Do Candidates for Partnership Buy In?

First of all, it should be understood that new partners will buy their shares rather than have them “granted.”  Granting shares completely undermines the value of the firm and also creates a dangerous precedent. It is natural for the senior partners to feel sympathy and loyalty to their associates and try to give them favorable terms on the buy-in. The right place for expressing that sympathy is by providing financing rather than severely discounting the valuation of the firm or even giving part of it for free. The term “sweat equity” typically applies to situations where somebody was severely underpaid for years while the firm was being built—that is very rarely the case with advisory firms. Employees who have worked at market level compensation in my mind would not have “sweat equity” or have the right to some “grant” or “discount.”

Valuations for buy-ins are usually done through a valuation expert or using an internal formula cross-referenced with external transactions. Even if using internal formulas, expert valuations can validate the formula and avoid some tragic disconnects between economic reality and internal buy-ins.

In nine out of 10 cases that I have observed of firms promoting partners internally, the firm has financed the purchase. Almost by definition the new partners are full of energy, ambition, and drive but have very little money to allocate for purchasing shares from their firm.

There are many alternatives to the sale of shares or units to a new partner; all of those alternatives have their purpose and merit. However, all alternatives are not nearly as powerful as motivators as the full ownership. The idea of “making partner” is a badge of honor, a sign of achievement and a status symbol that goes well beyond the monetary effect of the dividend or equity accumulation.

Why Share Your Firm?

Whichever method of partner promotion you choose to use and however you value your firm and finance the transaction, you have to remember why you are doing this. The reasons are many—to reward and retain your best people, motivate your key employees to exercise the care and caution of an owner, drive your advisors to grow the firm with you, reduce dependence on the owner(s), create multiple options for exit and succession, allow yourself more time off since others will cover for you, strengthen the management team by adding more owners with unique skills and experience. Hopefully your motivation comes from one of these reasons. 

Check out the following Advisor Teams:

  1. CIC Wealth Management (Commonwealth Financial Network)

  2. Dowling & Yahnke Wealth Management

  3. Ellison Kibler & Associates, Merrill Lynch

  4. Private Ocean

 

This article is an abbreviated version of the chapter under the same name from the book, The Ensemble Practice, now available from all major book retailers.

About the author and the book:

Philip Palaveev is an industry expert and highly sought-after consultant focused on creating a team-based financial advisory businesses aimed for sustained growth, profitability and value. Philip is the owner and CEO of The Ensemble Practice LLC, (www.ensemblepractice.com) a business management consulting firm defining the evolution of advisory practice. He specializes in helping independent financial advisors grow their business from a solo practice into a thriving ensemble firm.

The book, The Ensemble Practice, is a detailed roadmap to creating a successful, team-based advisory firm. The book is available in all major bookstores.