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of firm from their industry research teams. Other benchmarking information
66 Managing and Governing the Professional Services Firm

can be found in the Annual Statements Study, published periodically by
banking industry trade group Robert Morris Associates.3

Compensation is not only about money. In a professional services firm, where
the most valued assets of the business walk out the door every day, it™s also
about recognition and stability. The elements of compensation create a bal-
ance that affords the professional and his or her support staff the peace of
mind to focus on the creative work of the firm, thereby enhancing perfor-
mance (see Exhibit 3.2).
Because there are typically few hard assets, sufficient cash f low is critical
in maintaining organizational dynamics. In firms where cash f low is a prob-
lem, productivity is adversely impacted almost immediately.

Targeted lifestyle income
$ ___________

Incentive Commission

+ +
Base pay

Bonus Options

+ +

Standard firm benefits package

Professional group perks

Leadership perks

Options (stock, shadow equity)

Exhibit 3.2 Typical Compensation Options for Professional Services Firms
Partnership and Governance Structures

Firms should focus on a targeted lifestyle income range for all employees.
This comprehensive look at compensation permits great f lexibility in the al-
location of benefits (typical cafeteria plans) and in the development of risk
management initiatives, such as self-insurance, that the firm may wish to
Firms should also be aware that ongoing, uncritical offers of benefits
could turn those benefits from a competitive tool into a potential liability.
The subject of compensation, benefits, and staff retention are covered in de-
tail in Chapters 9 and 10.

When a Benefit Becomes an Obligation
All compensation issues should be reviewed on a regular basis and mod-
ified periodically to prevent the potential risk of a benefit turning into
a “condition of employment.” Conditions of employment have been the
grist of many court cases and can be construed to occur when com-
panies award the same benefits consistently, and without review or al-
teration, for many years. When, in hard times, a company suddenly
begins to cut back on such benefits, and employees have sued, the
courts have often supported the employees™ claim that the “benefit” had
become “a condition of employment.”

Compensation, or pay for performance, is typically composed of:

1. Base salary
2. Bonus
3. Incentive plan and gain sharing programs (Items that can be subjected
to leverage)
4. Options
5. Commissions
6. Employee benefits
a. Health, wellness, and lifestyle benefits
b. Long-term benefits
7. Professional group perks
8. Leadership perks

Regardless of what elements are included in the compensation package, it
is important to identify a targeted income level for each principal and em-
ployee. Base pay, depending on the nature of the professional™s work (e.g.,
business development versus staff auditing) and the amount of, and leverage
potential for, incentive pay usually ranges from 40 percent to 80 percent of
total compensation and should be based on comparative wages within the
firm™s geographic region or industry. Numerous sources for comparative
68 Managing and Governing the Professional Services Firm

salaries exist, including the U.S. Department of Labor ™s Bureau of Labor
Statistics,4 various online sources,5 and local development agencies6 that
track wages as part of their services in attracting companies to a locality.
These sources can also provide extensive lifestyle cost information, including
prevailing information concerning employee benefits programs.
Bonuses for senior level and other professionals and staff may be estab-
lished by employment contract, by firm history, or by industry practice.
Bonuses are usually discretionary and should be used only to reward extraor-
dinary performance that has been identified and documented. Bonuses are
typically paid from profits and represent a share of excess profits before
taxes (if a C-Corp), shareholder dividends, reinvestment objectives, and any
extraordinary reserves have been paid.
Incentive plans and gain-sharing programs are targeted programs de-
signed to promote a limited objective or to spur short-term objectives. These
programs will lose some of their potency if they become de facto awards.
These plans are often funded as a percentage of gross income for specific
lines of business, accounts, or overall revenue gains. Risk /reward calcula-
tions (or leverage) are key to developing and administering effective incen-
tive and gain-sharing programs.
Options represent rewards given to promising professionals within the
firm whom firm principals view as next generation leaders. Options usually
offer equity participation at a fixed price to eligible participants. Partici-
pants can exercise their options with their own monies or, in some instances,
can be underwritten by the firm as a form of sweat equity. The value of op-
tions f loats with the fortunes of the firm, and participants should receive
continuing updates on the value of the firm and their options. Shares associ-
ated with options programs are usually restricted and may have additional
antidumping provisions.
Commissions are normally available only to firm members involved in cor-
porate development and /or sales, although many firms have a finder ™s fee
program that extends to all employees who refer new business to the firm.
Commission plans proliferate, and plan terms vary by industry and by local-
ity. Principals should consider a few things in establishing any commission
program: Commissions should almost never be paid on gross billings (struc-
ture them on net income numbers), and commissions should be keyed to net
collected revenues. While employees, including principals, want to be paid
commissions in a timely manner, either reserving a portion of the commis-
sion or delaying the commission until funds are received is recommended.
Charge-backs should never be handled as lump sum transactions. If it is nec-
essary to charge back a commission, do it over a period of time.
Employee benefits programs usually have two parts: short-term benefits
characterized as health, wellness, and lifestyle benefits; and long-term bene-
fits characterized as sustenance benefits. The short-term benefits include
health insurance; vacation, sick, and personal days; short-term disability;
Partnership and Governance Structures

child care; educational reimbursement; skills training; and so on. Many of
these can be bundled into so-called cafeteria programs where, up to a certain
dollar amount, employees can choose their own benefit “cocktail.” Unemploy-
ment insurance and workers™ compensation are also considered benefits and
need to be considered. Long-term benefits include long-term disability insur-
ance, 401(k) plans, Simplified Employment Pensions (SEPs), profit-sharing
plans, and so on and often pick up when short-term benefits expire. Most ben-
efit plans are offered to all employees, typically after a short waiting period.
Principals and professionals in most professional services firms are also
accorded perks, which may include reimbursement for certain entertainment
and business development expenses and participation in community activi-
ties and networking costs. For some, there are company cars or car al-
lowances. For others, there are club dues. The list goes on. Who participates
and to what extent is a decision for firm leaders. Perks represent out-of-
pocket money. Each expenditure should be periodically reviewed and its
value reassessed.
Leadership team members typically have additional perks associated with
their roles in guiding the firm. Often these perks are associated with privi-
lege, but if the funds are well spent, it is in the interest of the business to ac-
cord them.
All costs associated with compensation need to be viewed both compara-
tively to ensure marketplace competitiveness and discretely because they are
a major component of the firm™s pricing structure. How much to bill and
how to support pricing decisions are covered in detail in Chapters 7, 9, and
10. The higher the labor content (total costs measured against individual
performance) in any firm™s capital structure, the more difficult it may be to
compete. Costs should be justified by a value proposition that provides an at-
tractive profit margin. In all, a professional services firm is trading hours for
dollars. With a finite number of hours in the year and a variety of overhead
and necessary investment commitments that eat into those hours, the firm
(and individual professionals) must be cautious how billable hours are spent
(Exhibit 3.3).
How the professional services firm makes its collective business and policy
decisions is extremely varied from firm to firm. Because of the nature of pro-
fessional services, rigid hierarchical models seldom work for long”profes-
sionals tend to want a collaborative environment. Some firms gravitate to a
model featuring a moderate leader working collegially with a larger group of
inf luential peers who, in turn, represent critical practice areas or profit cen-
ters. Others are attracted to a strong leader moderating the discourse among
a larger leadership group. In some instances, professional services firms have
reached out and hired professional managers for all, or most, operational
functions while reserving practice issue decisions to internal peer groups.
The term decision management is appropriate because many professional
services firms engage in a less formalized process of decision making. This
70 Managing and Governing the Professional Services Firm

365 days

Weekend Holidays Vacation days

104 10 20

days @ 11

220 days

Sales Administration

15%“25% 55%“75%
of time
of time of time

Nets 121“165
days to sell

Short gigs and lots of
travel eat days

Overhead, budget,
and your cut

Your daily/performance rate

Exhibit 3.3 The Time Professionals Have to Sell
Partnership and Governance Structures

informality allows for a broad discussion of ideas and issues before decisions
are made. Often a general consensus is reached through the attrition of op-
tions rather than in response to a targeted call to action. In this peer envi-
ronment, such an approach helps promote a sense of participation, although
it can tend to slow problem resolution. Those firms that have documented
their processes and follow consistent procedures further enhance their deci-
sion f low while at the same time allowing concerned professionals to focus
only on problems as they arise.
Many professional services firms that have attempted to adopt corporate,
top-down models for decision making in a quest for efficiency have found
that this approach is met by great uneasiness within the ranks and may, in
fact, be vigorously resisted.

Home Office/Branch Office Model
In the first application of this two-part model, the firm™s main office sets
broad policy guidelines, including profitability and burden targets, then typi-


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