Transitioning the firm to new leaders – A case study

How operational modes are impacting the evolution
Written by Bill Reeb, CPA, CITP and Dom Cingoranelli, Jr., CPA, CMC

In my last column, we introduced “Modes” of operation we commonly find in the “Eat What You Kill” and “Building a Village” operational models. Please refer to the previous column for more of an explanation, but as a quick recap before our case study, the modes are:

• Survival. At the initial stages of being an entrepreneur, we are driven by the instinct to pay for the roof over our heads and put food on the table.
  
  
• Safety Net. Once we feel like our business will generate the resources required to cover our basic needs, we focus on building the business in a way to generate enough cash that we can build a fat savings account, pay off our business notes, and create a cushion in case times get tough.
  
  
• Success. Now that we don’t feel desperate about our financial security, we start thinking about evolving our firm in a way that makes the owners, and the people we are hiring, want to work there. Additionally, the firm becomes an entity we think about protecting. The firm’s success, reputation and strengths still are reflective and synonymous with those of the owners in this mode.
  
  
• Continuation. At this point, our focus shifts from our success (where the owners have done well financially and are secure in their own accomplishments) to creating an organization that has its own institutional identity and that can survive without them.

Read here how these modes impacting the way firms’ approach their leadership development and operational objectives.

Survival:

Cingoranelli and Reeb (CR), a small firm in Texas, opened its doors in the ‘80s. To cut costs in the beginning, they operated out of the apartment attached to Cingoranelli’s home. In the beginning, because they had just opened their doors, they looked for any work that would pay the bills and keep food on the table.

Safety Net:

As the firm thrived, the owners became much more selective regarding the work they took on. They culled the clients that were difficult to work with, and expanded the work that they enjoyed and was the most profitable. As they built up their savings accounts, paid off all of their notes and drew higher salaries, they decided it was time to make even more money. So they added employees, moved into prestigious office space, and focused on building a team of people that would take them to their next level of success.

Success:

As people in the organization excelled in their positions, CR added them as partners. While those partners were not deemed to have the entrepreneurial skills of the founding owners, the new partners were critical to getting the work done in a quality manner and on a time basis.  These new partners were important members of the team that CR did not want to lose, so enticing them with partner status and benefits seemed like a good investment and a manageable risk.

Within 10 years, CR had six partners -- two founding partners and four hard working junior partners. Cingoranelli and Reeb each owned 35 percent of the firm and the other four junior partners owned the remaining 30 percent (7.5 percent each). The two founding fathers, while being benevolent rulers, were in total control of the firm -- from management decisions to compensation to everything in between. The firm flourished. All the partners made good money, but Cingoranelli and Reeb made a lot more than the others.

The Chasm between “Success” and “Continuation”

In the case study above, we are now at the chasm between the “Success” and “Continuation” mode of operating. Unfortunately, this situation is the most common scenario found in our profession. The problem comes now when Cingoranelli and Reeb want to leave. The governance model is in the hands of the two founding owners. The management decisions and compensation allocations fall into the same system. This firm has been run to optimize around Cingoranelli and Reeb, not to optimize around the four junior partners. The junior partners have not been developed as leaders because as long and Cingoranelli or Reeb are around, these two are in control, and that’s the way they want it.

The firm did not invest in creating a marketing infrastructure because Cingoranelli knew everyone in town and could bring in business almost at will. The firm did not push or even support the junior partners developing exceptional technical ability because Reeb was the firm’s walking tax library. The junior partners were so busy over the years managing Cingoranelli’s and Reeb’s projects that they hardly had time to develop a professional network and were rarely put in key client situations to showcase their talents. Cingoranelli and Reeb have no doubt built a successful and profitable firm. And while it might be a cash cow, it is not much of an asset. The firm is not all that valuable because it is built around Cingoranelli’s and Reeb’s connections, books of business and individual instincts.

For example, it takes time to develop a gut to manage a business. This is not a switch that is turned on and off.  As a matter of fact, Cingoranelli and Reeb both paid a heavy price financially in their early years by making a number of bad mistakes to build the business instincts they have. However, they were unwilling to make those same kinds of investments in their junior partners – letting them learn through trial and error as they had.

Probably the biggest mistake Cingoranelli and Reeb have made is in the governance area. Because they were rulers, albeit benevolent ones, the other partners never really had a say in the operations (maybe a voice, but no say). While the vote was a formal process, once Cingoranelli and Reeb stated their opinions, challenging it was useless because the decision was already made. Furthermore, Cingoranelli and Reeb always came to the partner meetings in sync with one another; they’d hashed out their differences one-on-one before they included the rest of the partners. In other words, while the firm was successful and profitable, it was not positioned to move forward without the involvement of the founding fathers.

Here are some of the common problems that crop up when trying to move from the “Success” to the “Continuation” mode:

• Ownership – who gets what stock once Cingoranelli and Reeb retire? 
• Would the remaining shareholders all be equal? 
• If so, who would step up as managing partner? 
• Would the new managing partner have support from the other partners to hold them accountable as Cingoranelli did, or would this current-junior-partner-turned-managing-partner mostly fill a weak, figurehead position?

If Cingoranelli and Reeb were using the “Continuation” mode of operating, a new managing partner would be in place long before either of them retires with powers to hold all partners, including the two founding fathers, accountable. Ownership would not just get proportionately allocated, but transferred based on some performance metrics to the most capable remaining shareholders. You see, Cingoranelli and Reeb brought in partners that allowed the two of them to be successful. Those junior partners have been acting as technical partners, not client service partners. In the end, a successful firm, in our opinion, can’t be run by technical partners.

So, which of the four junior partners will step up as client service partners? This is a key question. And whichever partners step up, (and that could be any number from none to four), the client service partners need to be in control of the firm. The torch has to be passed to the partners that understand running a successful CPA firm is about managing clients, training staff, and retaining happy people. If you turn the firm over to technical partners, they often:

• Just push themselves to work harder to make up for any shortcomings,
• Create a negative environment because they place a premium on people like themselves who work like mules and are less tolerant of work/life balance,
• Create compensation models that are all about charge hours and personal billings, which pushes the firm back to an “Eat What You Kill” model,
• Don’t develop anyone because they themselves do most of the work,
• Marginally care for clients. While they take good care of clients when they call … that is the key … they operate as “order takers” rather than being their clients’ most trusted advisors.

Another problem that often arises in this situation is that the junior partners have little to no chance of working together after Cingoranelli and Reeb retire. It is not uncommon to find that the four junior partners do not respect each other, they might not trust each other, and they might not want to even be partners with each other. Cingoranelli and Reeb ignored all of this when building the organization because they knew that as long as they were around to manage the situation, it was easily kept in check. But under the “Continuation” mode, it is the responsibility of Cingoranelli and Reeb to deal with this now … long before they go. They need to run off the weaker partners or incompatible partners and not saddle the firm with this kind of ownership dysfunction.

A critical phrase included in the above case study really summarizes a foundation concept of the “Continuation” mode: “…it is the responsibility of Cingoranelli and Reeb to deal with this now … long before they go.” “This” is the operative word here. It includes anything and everything that needs to be addressed. We see founding partners leave their firms in such a chaotic state of governance that it would take a miracle for the remaining partners to stay together. In such a case, the founding fathers should have broken the firm apart years earlier so that those who wanted to stay and work together could use the upcoming years before Cingoranelli and Reeb retire to build something special that can last. But CR won’t do that because the founding fathers are trying to suck every dime out of the firm they can before they go as they have little faith in what they are leaving behind.

Another classic case we find involves firms that have a talented consensus builder/peace maker as one of the founding fathers. Once that owner leaves, the rest of the partners may have little, if anything, in common with each other because the retiring partner was the glue that held everyone together. Once again, the founding fathers should have realized that if it takes Herculean strength to hold the firm together, that maybe it is time to realize that Hercules will be leaving so we better deal with this situation now.

Or how about small to midsize firms (usually between $2 million and $20 million in annual volume) that create executive committees to retain the decision-making power in a few founding fathers? When these key people leave, they often have created a system of governance that worked for them but will fail for the next generation of leaders. This is not because the next generation of leaders is incompetent; it is the classic story of the father willing a business to his three sons all with equal ownership. Rather than willing the business to the son that is most interested in the business and best suited to run the company, and  finding other ways to compensate the other two siblings, the father avoids the conflict altogether and just gives it to all of them to fight over and destroy. Generation after generation of owners avoids dealing with the problems they have created. The easiest way to deal with it is to sell off the firm to someone else and let it become their problem (the “Success” mode alternative). For those who realize that this may be a weak bet in the future and want to consider the “Continuation” mode as either their primary alternative or a strong back-up, it will require a thought process entirely different from that used in running under a “Success” mode of operation.

To summarize, it is common for retiring founding fathers to leave a cadre of partners at various stages of capability with voting rights misappropriated and in the wrong hands to assure a successful future for the organization. The failure in successful transition to the next generation of leaders isn’t nearly as much about the inability of the remaining partners, as it is about the processes, systems, and governance to which the next generation of leaders accedes, especially since that infrastructure was customized to leverage the specific individual talents and control of the departing founding fathers rather than the best way to run the firm.

Reeb is a keynote speaker, author, trainer, coach, facilitator, and management consultant with more than 20 years of business consulting experience. He has founded seven small businesses in the retail, software development and services sectors, including the CPA firm Winters & Reeb, PLLC in Austin, Texas. Reeb has also been internationally published with around 200 columns and articles to his credit.