The Equity Promise Most Firms Cannot Keep

Ten years ago the complaint I heard most often was that no young accountant wanted to buy into a practice. That has changed. Across the valuations we are doing now, a meaningful share are equity transactions — senior people buying in, older partners rolling out over a period of years. The demand is back. What has not come back is the ability of most firms to answer a simple question: when, and on what terms.

For Australian accounting practices, succession has quietly split into two different problems. One is finding a buyer for the whole firm. The other, more common and more urgent, is holding on to the person who would have bought into it.

The second problem is the one firms create for themselves.

For a long stretch, principals told me they could not find anyone interested in partnership. The younger people did not want the debt, the risk, or the hours. That was a real phenomenon and it drove a great many practice sales, because there was nobody internal to sell to.

Over the last three to five years the picture has shifted. We are seeing more equity transactions, and we are valuing more practices for the purpose of an internal buy-in rather than an external sale. A common structure at the moment is two senior practitioners gradually retiring while two people in their thirties buy in on a rolling basis. That is a healthy arrangement and it is becoming less unusual.

But it only works where the practice is one somebody would actually want to buy into. That is not a given, and it is worth being blunt about it. Equity in a practice with flat performance, an ageing client base and no culture to speak of is not an opportunity. It is a liability with a price tag.

It is worth setting them out plainly, because a firm that cannot manage either one has nothing to offer, no matter how the promise is phrased.

The first is a new seat. The partnership goes from three to four, and nobody currently in it takes home less. That is an addition, and additions have to be funded.

The second is an existing seat. Somebody steps back, sells down, and the incoming partner buys what they are giving up. Nothing has to be created, because the income already exists. What has to happen is that a person actually goes.

That is the whole set. Find another million dollars of fees, or free up a share of the fees you already have. And the uncomfortable part is that a great many of the firms making the promise are in no position to do either. The growth is not there, and the person who would have to step back has no intention of doing so. It is not usually dishonesty. It is a commitment made without checking whether the practice could deliver on it.

That is why three years turns into another three years.

This is the part almost nobody works through before making the promise.

I regularly sit in valuations where a principal mentions, almost in passing, that a senior person has been promised equity in a few years. When I ask what has to happen financially for that equity to become available, there is very often no answer.

If the promise is a new seat, and you do not want to reduce what the existing equity holders take home, the money has to come from somewhere. In the practices we value, the arithmetic usually lands in the order of $1 million to $1.5 million of additional revenue at the top of the practice to support one more partner-level income without diluting the existing ones.

That is not a small ask, and it is a particularly large ask in a market where organic growth is hard to come by. Firms are not adding a million dollars of fees by accident at the moment.

Which leaves two honest ways to fund it. Grow the practice by enough to carry the new position. Or accept a reduction in existing partners' drawings for a defined period, on the understanding that the incoming partner will earn it back.

If neither of those is going to happen, then what is on offer is not a new seat at all. It is the other kind of promise, and it depends entirely on somebody being willing to step back.

The second kind of promise does not need a dollar of new revenue. The income is already being earned. Somebody simply has to stop taking it.

Financially that is the easier of the two. In practice it is the one I see stall most often.

I still meet principals in their sixties and seventies who have been two years away from retirement for the better part of a decade. Every year the date moves out. I have had more than one tell me, without any apparent discomfort, that they intend to die at the desk. There are not many of them, but there are enough, and each one is sitting on somebody else's future.

It is not usually greed. Where identity and practice have grown into the same thing, stepping away raises a question about who you are that most people would rather not answer. That is understandable as a human matter. It is still a governance failure, because a promise was made on the assumption of a departure that is not going to happen.

Two practical things stall the sell-down even where the intention is genuine. The first is valuation. If there is no agreed basis for pricing the equity, the argument arrives at the worst possible moment — when one side wants to leave and the other has to pay. The second is funding on the buyer's side. An incoming partner in their thirties is usually borrowing against the purchase, and a price that ignores what the equity will actually earn them is a price nobody can take up.

The person on the receiving end works all of this out eventually. They always do.

There is a group behaving quite differently from the principals I have just described, and if you are planning succession you need to understand them, because they are increasingly the ones selling.

I am seeing a noticeable difference in the conversations I have with practitioners in their early fifties. They are much more willing to ask what life after the practice might look like, and to ask it early. Some are planning succession properly. Some intend to sell and do something else entirely. I am currently talking with a practitioner turning fifty-two who has begun his succession planning deliberately and well ahead of time, which is exactly right.

The economics go some way to explaining it. The average practice partner takes home around $400,000 a year, and in a strong practice it might be five, six or seven hundred thousand. Twenty to twenty-five years of that leaves someone comfortably placed. They do not need the practice, and in my experience they are far less likely to feel that the practice is who they are.

One of my favourite examples is a forty-one-year-old in Orange who wants to sell his business clients and keep the individual returns. He can service the individual work in about six months, which leaves him the other six months of the year to do whatever he likes with. His view is that there is only so much money a person needs.

I do not read that as a lack of ambition. It is a deliberate decision about what the practice is for, and it is not a decision you would have heard anyone articulate twenty years ago.

At the extremes, I can be talking to an eighty-year-old who cannot imagine leaving and a fifty-two-year-old who is already planning what comes next. Those are entirely different conversations, and a firm planning succession around the first while its best people are becoming the second will get the timing badly wrong.

The practical response is not complicated, though it does require some honesty.

Ask the equity question at the point of recruitment, not five years in. If someone tells you at interview that they want to own something one day, that is valuable information and you should treat it that way. It tells you whether you are hiring an employee or a future partner, and those are different hires.

Then, when a capable person raises it later, do not stall. Stalling is what costs firms their best people, and it costs them at exactly the point when that person has become expensive to replace. If the answer is "not yet, and here is why, and here is what would have to change", that is a respectable answer. Most people will accept it. What they will not accept is a rolling three years.

An attractive practice is made of ordinary things. The right culture. A place people enjoy working. Performance that holds up. A location and a way of working that suits how people live now. None of it is exotic, and all of it takes years, which is the argument for starting before you need to.