What Does Someone Have To Do To Qualify?
Of course what someone has to do to qualify as an owner is going to depend on how you have defined what it means to be an owner in your firm. If "owner" is only an investment status, then to qualify requires simply being a qualified investor. If "owner" is a job role, then qualification will have more complex criteria. It is interesting to observe that the difference in what it takes to qualify to be an owner differs between silo firms-where a candidate usually has to simply contribute to the economics-and ensemble firms-where a candidate has to make a meaningful contribution to the firm.
The answer to the question of owner qualifications is actually surprisingly different among firms. In some firms, everyone is an owner, or everyone who develops a certain level of business is an owner, or all "key people" are owners, which may include the founders and the receptionist. My personal bias is that ownership should be reserved for those individuals who are driving value in an organization, and that ownership should be a privilege and an investment.
Criteria for ownership might include:
Contribution to the firm
Revenue
Retention and growth of existing clients
Intellectual
Management
Unique skills that drive the value of the business
Maturity
Decision-making
Employee management
Community presence and representation
Ability to bear risk
Financial
Professional liability
Character and Values
Internal candidates for ownership and those you might consider admitting from the outside should be held to the same admission criteria. If you are considering an external candidate, even a high-level one, but are not certain they yet qualify to be an owner, bring them in as an employee and make them an owner when you have had an opportunity to evaluate them in all the criteria for ownership, as you would an internal candidate.
Are The Current Owners Ready?
The preparedness of the candidates is one consideration, but just because you have individuals who are ready to be owners does not necessarily mean the firm is ready to add new owners. Sometimes firms are pressured to make people owners-sometimes really great, qualified people-but it ends up messy because the existing owners were not yet ready to have partners.
Evaluating the preparedness of the current owners is part psychology, of course, and requires some introspection by the current owners. It also requires a clear answer to the question of what it means to be an owner. Does being an owner give someone input or some element of control? If so, how do the current owners feel about getting input or sharing control? Does it give someone access to financial information? (Yes, it does.) How do the current owners feel about opening the books? Does it tag this person as a future successor or eventual majority owner? If so, do the current owners envision this person in that role? Does it have implications on the current owners' incomes? If so, are the current owners prepared for that?
Her are some signs to look out for to know if you might be ready to share ownership (or not):
When you have more responsibilities in running and leading the firm than you can handle personally.
When you are prepared to share those responsibilities.
When you are looking for partnership and collaboration in decision-making and setting the direction of the firm.
When you are prepared to share the financial information and financial rewards.
When you are ready to take some chips off the table.
When you need more skills/capacity/capital to continue to grow.
Is The Firm Ready?
Although the question of owner preparedness is mostly psychological, the question of firm preparedness is mostly financial. The key question here is, "When is the firm growing enough so that new partners will not dilute income or value of existing partners?" If a new partner receives a share of the firm that is proportionately greater than the financial reality of what they bring to the deal, it will result in immediate dilution of the other owners. In some firms this is acceptable and in some it is not, but in any firm it's important that you understand the financial impact of admitting a new owner.
Considering the dilution effect is a relatively simple financial modeling process:
1. Estimate compensation changes when a candidate becomes a partner (salary increase, additional benefits, perks and other).
2. Calculate how much profit needs to increase to afford the increased compensation AND an additional person receiving profit distributions.
3. Translate the target profit to target revenue ($X) based on your current or projected profit margins.
4. Every time you grow by this amount of revenue ($X), you can afford a new partner without dilution of the income of existing owners.
These are some of the considerations in planning for the admission of new owners into your business. From here it gets much more tactical:
determining a "fair" price;
financing the transaction;
structuring ownership.
We will drill into each of these areas in my April column: "Adding New Owners: Executing On Internal Succession." In the meantime if you are thinking about admitting new owners into your firm, spend some time thinking about your objectives and what the owner role means in your firm, especially once it expands to include new owners. With planning and foresight, the development of employees into peers can be a very gratifying experience. Make sure you have the plan in place to make the ownership transition gratifying as well.
Rebecca Pomering is a principal of Moss Adams LLP and practice leader for Moss Adams Business Consulting. She consults with financial advisory practices on matters related to strategy, compensation, organizational design and financial management.