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How Should a Partner's Value be Determined?

This is actually the first step you should take when evaluating your firm's ability to execute an internal succession strategy or plan. Many firms begin with an assessment of their current internal talent pool. There is no question as to the importance of that step; however, if a firm's current partner or operating agreement does not allow for future partners to advance their economic positions as a partner, your talent pool will not matter. Let's face the facts, very few want to make partner within a firm so they can have an impressive business card.

Surprisingly enough, many multi-partner firms have current operating, shareholder or partner agreements that seriously restrict the financial ability of the firm to buy out the partner and provide reasonable longer term continuity or financial opportunity for the newer partners.

A financial sustainability review should be the first step but there are other key valuation factors that must be determined and these are not necessarily tied to the partner's equity or compensation. They are specific to the role and responsibility of the retiring partner.

In recent years and for the foreseeable future, more firms, especially the mid-to-large firms, are moving toward a compensation-driven retirement formula for their partners. When this particular methodology is benchmarked against the alternatives, it becomes increasingly clear why this, most often, has a significant opportunity to enable an internal succession solution, or at least the financial component of internal succession. However, this methodology also has its drawbacks as it cannot often factor key considerations such as:

  1. Rewarding founding partners or those that have contributed significantly to the growth or profitability of the firm
  2. Unusual or unique specializations a partner may possess or contribute that provides great benefit to the firm

Another popular method of determining a partner's value is the use of a unit-driven plan whereby partners accumulate units based on a multiple of factors. There is often a maximum value available to any particular partner and each unit will possess a specific dollar value. Smaller numbers of units are awarded to up and coming partners - income or non-equity - with the larger number of units awarded to the equity partners or shareholders. The popularity of this value plan is the ability to provide a sense of ownership to those being tracked for equity partner level yet the unit value at the lower end is not so large as put the plan out of balance. If this plan is executed properly it can be an effective methodology for rewarding retiring partners as well as for creating a bridge to becoming a partner for up and coming internal talent.

Regardless of the plan your firm adopts one thing is certain, it is best to value your partner's retirement package by using a "Reverse Valuation Methodology". In its simplest form the retiring partner's foregone compensation has to achieve the following, at a minimum:

  1. Cover replacement resources
  2. Pay for the buyout including working capital
  3. Leave some upside for the remaining partners

If it does not, then the continuity of the current firm is at risk. An external solution or merger for growth is a choice many firms are making but when making that choice it is best to make it because it is a strategic decision not one of desperation.

Further information on this topic can be found by reading:

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