One of the most difficult issues in managing an advisory firm is establishing a fair balance in rewarding those who own a firm and those who contribute to its growth. Even though owners and contributors are often the same people, the degrees of ownership and contribution create some extremely difficult questions: “What should a firm be doing if someone contributes 30% of the business but owns only 5%?” On the other hand, what if someone owns 30% of the firm but contributes only 5% to the business?
Both these things occur frequently, and often simultaneously—say, when founders may be slowing down while the younger professionals are emerging as business developers, experts and leaders.
The intuitive rules of fairness would suggest that somebody contributing 30% to the success of a business should receive about 30% of the rewards. But the not-so-intuitive rules of equity dictate that ownership is something different from the work and has to do with purchasing the shares and investing capital into the firm. After all, no one expects Jeff Bezos, who owns approximately 12% of Amazon, to do 12% of the work and ship 12% of the packages (even though it’s a fun thought). Then again, if Bezos were to leave Amazon, the packages would still be shipping. In many advisory firms, by contrast, when a key person leaves, a lot of the firm’s activity and value may also leave as quickly as same-day delivery for a pair of boxing shorts (yes, Amazon sells those too).
This is perhaps the quintessential issue of ownership that makes professional services firms different—the value of the firm is so strongly connected to the effort of the professionals working that it is very difficult to not seek a connection between their contribution and ownership. Still, if we were to abandon “ownership” and only focus on those actively building the firm, then how can the advisory firm have any value? And if there is no value in a firm, why would anyone be investing in it?
In my mind, there is only one answer: For a firm to have equity value, it has to look for compensation and not equity to reward those non-owners who contribute the most. At the same time, for a firm to function and attract talent over the long term, it does have to find a way to invite those who contribute the most to also be the significant investors.
In other words, in the short term, equity and the work contribution don’t have to be aligned, but in the long term they probably should be. Finding that balance, however, is very difficult.
Contribution
To even start this discussion, we need a good practical way of measuring “contribution.” I used an example of a 30% contributor who is only a 5% owner, but what does it mean to be a 30% contributor and what are the forms of contribution? An easy answer would be to look at who brings clients to the firm (business development) or who services the clients (revenue responsibility), but such a definition of contribution will ignore the entire investment and operations departments also vital to the success of a firm. In addition, what about the contributions of a CEO who grows and manages the firm through good decisions and leadership but is not involved in the service of clients or new business?
To resolve this, every firm should have a clear and explicit way of measuring people’s contribution. Without an explicit definition, the implicit understanding will likely gravitate to those involved in revenue origination (another fancy term for sales) and managing clients (though that might encourage client hoarding). There are very few firms in the industry that use balanced scorecards, but it seems to me that this is a perfect case for why and how balanced scorecards can help. If a firm has a clear understanding of who its best contributors are, it has a much easier time reconciling the friction between contributors and owners.