Howard’s Inner Circle, No. 13: Two Diverging CPA Firm Business Models

Being a detached, independently paid and unpaid observer of CPA firms for over two decades allows me to freely comment.

The early successful business model was a firm with a number of rainmakers, often as little as two or three. They were great at business development especially via one-to-one contacts, and also adept at maintaining and working a tight referral network where referrals were expected to go both ways.

Over time, this well-established model has morphed itself into two new distinct business models. One is where those rainmakers have become the executive committee of a CPA firm that runs in a corporate style. Where previously, firm policies and strategies were hashed out in open discussion at partner meetings, decisions are now made at closed executive committee meetings. And no matter how it is sugar-coated, it is understood who are the powers-that-be, and how getting into the inner sanctum, the management committee, is only done by invitation or by a successful power play.

Contrast that with the second business model that also developed from the earlier rainmaker model. These are firms that strive to operate as a team with management building consensus and having a real understanding of the importance of the various individual’s contributions in the firm’s successes.

If I were to predict which of these two models will prove better, I would select the later. This modified team approach:
• Grooms successors;
• Encourages collaboration;
• Has greater multi-disciplinary capacities;
• Rewards innovation
• Promotes a firm-wide project management instead of a capture-what-you- kill mentality;
• Is more susceptible at building real working alliances;
• Taps well into intergenerational resources;
• Promotes widespread mentoring in both directions;
• Supports technology at all levels; and
• Is structured for everyone to be focused on their roles in business development.

In both models relationships remain the key, and referrals are still the main source of new business. The real difference is the lack of community in the corporate model. Although lip service might be given; it exists only in name and spin. The second model, the modified team approach, with a real manager rather than a CEO, truly promotes community. This approach will turn out better in the long run as all indications are technology, globalization, outsourcing and many other factors are permanently changing the rules of the game. Businesses and professional firms will be seeking to become members of various communities and will do so only by building trust and cultivating loyalty as the basis for relationships. Only one of these diverging CPA firm business models lives that.
© 2010
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The above is from the newsletter, Howard’s Inner Circle, which periodically appears on the blog, “Instigator” at http://howardwolosky.blogspot.com/. It may be reproduced in full if that fact is stated and Howard Wolosky is credited as the author.

Howard’s Inner Circle, No. 12: The Current Decrepit State of “Journalism”

One article entitled, “Ditching a $500,000 Salary to Teach Lit,” says it all. I found the article on Yahoo! Finance at http://finance.yahoo.com/career-work/article/109420/ditching-a-500000-salary-to-teach-lit?mod=career-worklife_balance. It was provided by CCNMoney.Com and written by a contributor.

What I expected as I read the title was a story about a difficult decision and how the transition went. The hope was to learn from this individual’s experience. I would have never read the article if the title, although a bit longer more accurately read “Ditching a $500,000 Salary and Selling Your Business at Age 50 for $6 Million to Teach Lit.” We can work at shortening my title if you want, but you get the idea. By the way, there were three bold faced tips in this short article on how he did it. They are 1. By Taking the First Good Offer; 2. By Investing Conservatively, and 3. By Drawing Down Cautiously.

This is the current state of “journalism.”

© 2010
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The above is from the newsletter, Howard’s Inner Circle, which periodically appears on the blog, “Instigator” at http://howardwolosky.blogspot.com/. It may be reproduced in full if that fact is stated and Howard Wolosky is credited as the author.

Howard’s Inner Circle, No. 11: What Is the Best Book You Ever Read? Why?

I read a lot of self-help and business books and always get a few kernels of brilliance from them. However, the self-help books often bother me as many are constructed as workbooks filled with exercises and warnings if you don’t do the exercises you won’t get anything from the book. The business books are also heavy-handed, as authors after making one keen observation apply it in every context he or she can think of to prove its worth.

The most recent book I read was Paper Airplane by Michael McMillan mentioned by Tim Storey in Utmost Living. It was very good, but not my favorite. It tried to be too many things: a self-help book, a business book, and camouflaged with brilliant design work, also as a children’s book. In the end, it reminded me of my favorite book.

Tom and Pippo Make a Mess by Helen Oxenbury is hard to find as I believe it is out-of-print. I discovered this so-called child’s book at well over age 50, when it was brought to my attention by Alex’s father. He had been reading the book to Alex for many years (my guess at least eight). Alex, a remarkable young man, who has fought with tenacity since he was born at a birth weight of 21 ounces, loves the book, and often, after his father finishes reading it, rips up the book and makes a mess.

Every adult and child can benefit from its message whether as a gentle reminder or as a wake-up call. Unlike the many self-help and business books, Tom and Pippo Make a Mess has an ever so-light touch, and encourages the reader to think and reach his or her own conclusions. Equally important, the book’s message with Alex’s comment resonates louder the more times you read it or have it read to you.

What’s your favorite book? Why?
© 2010
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The above is from the newsletter, Howard’s Inner Circle, which periodically appears on the blog, “Instigator” at http://howardwolosky.blogspot.com/. It may be reproduced in full if that fact is stated and Howard Wolosky is credited as the author.

Howard’s Inner Circle, No. 10: 2011 Accounting Cover Stories

For many years each month as editor-in-chief of Practical Accountant I decided on what would be the cover story. It wasn’t hard do but for one fact; we had to decide on the subject matter as much as a year and a half before the issue came out. The reason was the editorial calendar had to be in place in July of the preceding year and there was no guarantee that each month there would be a development affecting the accounting profession worthy of cover story coverage.

Because habits are hard to break I decided why not have some fun and pick out 12 possible 2011 cover story candidates now for a magazine for the accounting profession.

Tentative and Very Hypothetical 2011 Editorial Calendar
January--Plethora of Estate Tax Engagements
February--How CCH, RIA, Intuit, LexisNexis, and Others Are Utilizing CPA Firms as Business Partners
March--Reverse Mentoring: Overcoming a Firm Management’s Deep-Grained Aversion
April--Success Stories and Best Practices from Early Social Media Adopters
May--Increasing Revenue and Correctly Positioning a Firm During an Economic Downturn
June--CRM: What Firms and Clients Are Doing Wrong
July--Regionals Replacing Nationals as Auditors of Public Companies
August--Outsourcing Manufacturing and Distribution Functions
September--Walking the Cost-Cutting Walk: Fee Reductions on Modified Engagements Complement Advice
October--Tax Prep--Protecting Against Fee Erosion and Client Flight
November--The Practice Development Joint Ventures Art Form
December--Hidden Benefits of Firm Associations, State Societies, and Trade Groups
© 2010
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The above is from the tenth issue of the newsletter, Howard’s Inner Circle, which periodically appears on the blog, “Instigator” at http://howardwolosky.blogspot.com/. It may be reproduced in full if that fact is stated and Howard Wolosky is credited as the author.

Howard’s Inner Circle, No. 9: Not So Fast with a Roth Conversion

If it sounds too good to be true, l have learned to pause and reflect. That is just how I feel about conversions of traditional IRAs to Roth IRAs. For some time there has been extensive positive press coverage regarding the fact that in 2010 the income restrictions have been lifted for a conversion and the resulting taxes can be paid over two years. Many of the articles are written as if it is a forgone conclusion that the election makes sense. I think the dangers and reasons why it might not pay to make a conversion must be more fully explored.

The fact that the participant should have adequate additional assets (other than using retirement plan distributions) to pay the tax and how the conversion affects the current tax rate is often mentioned in passing. What specifically isn’t being adequately explored is the immediate impact on an individual’s current and future net worth.

People who are eager to convert as much as possible must understand the taxes due on the conversion and on liquating assets to pay the tax on conversion can be very substantial. It would take a good deal of time to recoup that expenditure and achieve again the same compounding. That nest egg will take a very substantial hit.

Equally important, I see very few detailed projections using the comparisons of the tax impact of making or not making the conversion. Also missing are state tax implications which might include penalties for early distribution if the state doesn’t follow the federal rules on conversion, and the difference if the individual moves to another state. Assumptions also must be made as too whether there will be significant future changes to the income tax rules including the possibility of an excise tax being imposed on Roths of certain values.

Other major considerations are when the money might be needed, avoiding required minimum distributions, the ability to make controlled withdrawals at lower tax rates, as well as what happens if money is withdrawn within five years. The uncertain estate tax ramifications and estate planning implications especially as to possible distributions to heirs and charities also come into play. One article I read raised an interesting point as to whether a conversion to a Roth would more greatly expose the underlying assets if there is a subsequent divorce.

Also not sufficiently addressed is the mindset of the individual considering whether to make a conversion or not. Will they remain comfortable with the conversion if after they pay the taxes, the investment in the Roth goes down substantially or if economic adversity requires tapping into a Roth? How will that participant view the advisor who helped the participant make the Roth conversion? Although a conversion can be undone, the option is available for a very limited amount of time.

Assuming the decision is made that a Roth conversion pays particular care must be taken. For example, if institutions will be changed, make sure there is no tax withholding from the account when the transfer is done. Also it should be reviewed whether nondeductible IRA contributions were made.

Finally, an advisor should ensure that the participant fully understands and acknowledges all the possible ramifications of a conversion as the impact is substantial, immediate, and long lasting. Although the possible future benefits could greatly exceed the costs, the decision is a gamble, and as such, it should be a fully educated one.
© 2010
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The above is from the ninth issue of the newsletter, Howard’s Inner Circle, which periodically appears on the blog, “Instigator” at http://howardwolosky.blogspot.com/. It may be reproduced in full if that fact is stated and Howard Wolosky is credited as the author.

Howard’s Inner Circle, No. 8: Big Four Shouldn’t Be “Too Big to Fail”

Early during the financial crisis, the phrase “too big to fail” received a lot of media play especially with regard to AIG. Similarly, a number of years ago following the demise of Andersen I got the distinct impression that the powers that be viewed the Big Four accounting firms also as “too big too fail,” probably a comfort to those Big Four firms. Rather than blaming the firm, the focus then became one of blaming individuals at the Big Four firms when certain undetected frauds and accounting irregularities came to light.

It will be very interesting to watch what happens regarding Ernst & Young, as the 2,200-page Lehman bankruptcy report by a court-appointed examiner puts E&Y in a very unfavorable light. Lawsuits can be expected but of more interest is what, if any, actions the PCAOB will take. Just as important is whether the PCAOB will publicly address the role that auditors played with regard to the financial crisis and what, if any, regulatory changes need to be made.

My belief is there has to be serious debate on whether the current way that auditors of public companies are employed should be changed. With the bulk of the audits being conducted by the Big Four and employment as an auditor subject to the decision of the executives of the company being audited, it should come as no surprise, auditors at the Big Four are very careful not to ruffle feathers.

In May of last year I urged the AICPA and CPAs to take the lead in closely reviewing and critically evaluating the way in which auditing of public companies is currently performed, beginning with the illusion of independence. See “Auditors: Doing the Right Thing?” at http://howardwolosky.blogspot.com/2009/05/auditors-doing-right-thing.html.

As long as the Big Four perform the overwhelming bulk of the audits of public companies, the marketplace and those firms are positioning those firms as too big to fail. That is great for those firms and their revenue especially if the government regulators are in agreement.

Unfortunately, as we saw with the financial crisis, those who were too big to fail actually profited greatly until the balloon burst and then they were bailed out with public dollars. Andersen wasn’t that lucky and I don’t believe that the any of the remaining Big Four should be.

As with those Wall Street firms, the Big Four has a special revenue-generating mindset. The problem is that this mindset has become quietly synonymous with the auditing of public companies and colors the auditing. The only way that this can be changed is if auditing public companies can be restructured so auditors are truly independent.

© 2010
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The above is from the eighth issue of the newsletter, Howard’s Inner Circle, which periodically appears on the blog, “Instigator” at http://howardwolosky.blogspot.com/. It may be reproduced in full if that fact is stated and Howard Wolosky is credited as the author.

Howard’s Inner Circle, No. 7: Reducing the Divorce Rate of Accounting Firm Nuptials

I have always been intrigued by mergers and acquisitions of accounting firms. The initial exploratory discussions are usually described as “dating,” and if the parties are serious, a due diligence is conducted to see if a “marriage” will follow.” As with most courtships, the parties are on their best behavior and there seems to be a sort of tentative dancing so the parties get to know each other better and see if they’re truly compatible. You might even see some passion as one, or both firms, see their coming together as meeting a deep need that couldn’t be met otherwise. If there is a perceived dealbreaker, the parties go their separate ways and begin dating again with another firm, or swear off dating for a time.

I dislike the dating analogy--but if we’re going to use it, be forewarned that half of marriages end in divorce, and unlike what we read about messy divorces, we see very little about the messy firm demergers that occur or the exodus of incoming partners a few years after the two firms join. My guess is both are more prevalent than we expect and, of course, kept very quiet.

If I was giving advice to a firm that was “dating” another firm, in addition to discussing typical issues such as compensation, buyouts, equity, firm management, etc., I would advise the due diligence to focus significantly on compatibility, and the possible obstacles to, as well as, the details of integration.

I believe the most successful firms with regard to mergers and acquisitions are those that have the most experience with them, and therefore know quickly in discussion with firms if the deal should go forward. They are also very adept at, and understand, the importance of quickly integrating the two firms so the all the firm members have a common firm identity. Firms with less experience with mergers and acquisitions are usually successful because they really know the other firm well, and once they wanted to date, knew whom they wanted to ask.

The firms that don’t do well probably need to be a little more analytical and observant before jumping into marriage. I am not urging a longer courtship only searching for a deeper understanding of what their marriage is likely to be, and how a foundation for a solid marriage can be laid. It requires going beyond agreeing on terms and concentrating on the M&A process and the associated dynamics.

© 2010
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The above is from the seventh issue of the newsletter, Howard’s Inner Circle, which periodically appears on the blog, “Instigator” at http://howardwolosky.blogspot.com/. It may be reproduced in full if that fact is stated and Howard Wolosky is credited as the author.