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The Trouble With Big Partnerships

When I worked for Arthur Andersen in the 1980s, there were some partners - not most, but some - who used to count the ceiling tiles in their offices, comparing the total with other partners to verify their place in the firm’s pecking order.

That was one of the first signals I picked up that something was wrong with the way the firm was organized.

As time passed, I became convinced that there are some flaws inherent in running a big business (and, as the biggest accounting firm in the world, Arthur Andersen was a very big business) as a partnership. When a professional firm has offices all over the world and hundreds or thousands of partners, those partners represent middle management. They don’t set policy or get involved in the firm’s finances or strategies; they just go about their business, which mostly means selling and rendering services to clients.

But unlike middle management in corporations, partners have the power to elect the firm’s senior managers, usually consisting of an executive board that in turn selects the firm’s top executives. The company’s entire power structure becomes an exercise in politics. It is an environment in which tile-counting can flourish.

Internal politics certainly still exist in corporations, but in most corporations there is a separation between the privileges of ownership and the obligations of management. A corporate CEO is chosen by a board of directors that is elected by shareholders. The majority of shareholder votes are usually held outside the firm. In theory, at least, ownership sits at the top of the pyramid, and authority flows downward through the board and CEO to the rest of the company’s management. The CEO and the board are empowered - even obliged - to make tough decisions that may be unpopular with the people they manage. Business lines can be closed or sold. Redundant employees, including middle managers, can be let go. Such moves are much harder to accomplish in a partnership.

Another problem with professional partnerships is that the skills that earn accountants or lawyers partnership in the first place - technical excellence or rainmaking ability - are not the same skills that are most useful in running a global business. It’s a tough job, made tougher by the power of rank-and-file partners, and made tougher still because the pool of potential CEOs is limited mostly to people who have grown up within the organization. Fresh perspectives are rare.

The law firm of Dewey & LeBoeuf LLP seems set to become the latest professional firm to fall victim to its own poor management. The firm warned employees last week that it may soon have to close, the result of a wave of partner defections and an unsustainable burden of debt.

It makes no sense for a law firm to rack up huge debts. Law firms don’t need much capital equipment beyond offices, desks and computers. They can slow their hiring or lay off associates if work dries up. And, since partners share the firm’s profits, cash flow should automatically be cushioned when business is slow, since partners’ earnings will be reduced.

But Dewey apparently went on a hiring binge that included huge multi-year income guarantees to new partners, with no requirement that those partners bring in enough business to justify those guarantees. Because new partners got big guarantees, incumbent partners at the firm also wanted their share - and they had the political clout to get it.

Interestingly, the firm’s former chairman, Steven Davis, is reportedly under investigation in connection with the firm’s finances. Bad management, however, is not a crime in itself, and nothing that sounds criminal has surfaced thus far in press reports about the firm.

I left Arthur Andersen in 1992 to start my own business. Andersen imploded a decade later because it did not have anyone with enough foresight and authority to quit working for Enron Corp., a $50 million a year client. The partners in the Houston office could not give up their biggest client without ending their careers. The firm’s managers at its Chicago headquarters had reason to worry about Enron, but they had bigger reason to worry about the reaction of partners around the globe if they walked away from so much business. So they gambled with the future of the entire organization and lost.

I don’t have partners at my firm, and I don’t intend to have any. I am open about our finances with our employees. They share in our profitability and success, but I still have the authority to do whatever I think is in the best interests of the firm. We have succession plans to pass on this responsibility if something happens to me.

You can’t run a very large company this way, but (except for the fact that many state laws essentially force partnerships upon some professions) you don’t have to run it as a partnership, either. Ownership and management are separate functions. Employees and managers should be paid based on the value of their work, which can include a share of profits. Owners keep whatever profits are left. But although owners get paid last, managers still should be working for them. There is a big risk that decisions will be skewed to satisfy managers’ demands, rather than owners’ needs, when partnership agreements combine the two.

Middle managers should be tending to business, not counting ceiling tiles.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s recently updated book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us,” and Chapter 4, “The Family Business.” Larry was also among the authors of the firm’s book The High Achiever’s Guide To Wealth.

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