CPA Firm Retirement Vesting: You EARN It
Marc Rosenberg, CPA
Over the years, I’ve helped many firms devise new partner buy-in systems. Several aspects of a standard partner agreement may initially strike new partners as onerous, unduly restrictive and unfair, simply because they have little experience with CPA firm agreements. Once a three-partner firm that wanted to bring in a manager as partner asked me to meet with him to explain key provisions of the firm’s partner agreement he was being asked to sign. When I explained the concept of a non-solicitation covenant, he shrieked with horror. “You mean if I leave the firm, I can’t take clients with? I won’t sign this. If I should leave the firm, I want to take along enough clients to set up my own firm.” He saw this standard CPA firm covenant as a Ponzi scheme which preserved the firm’s value for the older partners at the expense of the other partners. He also thought all partners should be entitled to leave the firm and take clients. Incredible story but true.
Why some new partners feel vesting in the buyout plan is unfair
Another area that perplexes new partners is the vesting provision of the firms’ partner retirement/buyout plan. Their reaction is often: (1) it’s a Ponzi scheme because the older partners get most or full vesting when they retire while younger partners take years and years to build up their accrued benefits and (2) if they are going to make me a partner, I should be immediately entitled to full partner retirement benefits and not have to wait 10-20 years to vest.
What is vesting?
A CPA firm has a substantial street value that can be converted to cash quite easily via sale or merger. The value of the firm is roughly one times revenue plus the firm’s accrual basis capital (mainly WIP and A/R). The purpose of a retirement plan is to cash out departed partners without having to liquidate the firm to do so. Instead, the firm buys out the departed partner’s interest in the firm.
The most common approach to computing partner retirement benefits is the multiple of compensation method. If compensation is $400,000 and the multiple is 3.0, that partner receives a $1.2M buyout, paid out over a number of years.
Assume a new partner leaves the firm after two years as a partner. She paid a $150,000 buy-in and was earning $200,000. Without a vesting provision, that partner would receive a buyout of $600,000, a windfall she clearly doesn’t deserve because she neither earned nor paid for it. Since she would also receive her capital back, the $600K would be a return on a zero investment! Quite spectacular…and totally undeserved.
Vested retirement benefits are not a savings account
Partners at CPA firms look at their retirement benefits as just that – benefits that are designed to be paid at retirement. Partners are extremely valuable people who drive the firm’s growth and profits and are not easily replaced. As such, CPA firms don’t want to design their retirement plans in ways that enable partners to rapidly build up a large retirement accrual somewhat like a savings account. Allowing a large retirement balance to quickly build up could induce or encourage partners to retire early. I’ve seen this happen at several firms that had an inadequate vesting provision. CPA firms want their partners to stay around for the long haul, and they design their vesting provisions to achieve this purpose.
In short, partner buyouts are earned, not gifted.
Remember the commercial starring distinguished actor John Houseman talking about his broker? He closes with: “Smith Barney earns money the old fashioned way – they earn it.” That statement is quite applicable to CPA firm retirement vesting provisions.
With thousands of CPA firm partners due to retire in the next decade, clarifying to the up-and-coming partners how the system works – and why – is essential. Let CPA Firm Partner Retirement/Buyout Plans be your guide.
5 Comments
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Marc is spot on with this one. No windfalls! Most firms use years of service as a partner and many include an age factor for their vesting schedules.
I interviewed with a firm in Las Vegas (3 partners), who said I could come in as an experienced manager, and once I built a book of business to a certain point, they’d make me a partner. The selling point was that unlike other firms, there was no non-compete so that if I decided to leave, I could take my clients with me. It’s not as outrageous as some may think.
Great point John. Its all about trust, isn’t it? The best time to get what you want from a deal (includes accepting a job offer) is to negotiate it before you do the deal. If your non-negotiable was to be able to take your clients if you leave, and you can find a firm to agree to this, that’s great for you. The counterpoint: Suppose you stay with the firm for 5 years and build up a $500,000 book of business and then, decide to leave. If you joined a firm of substance with a great reputation, and that firm invests a great deal of money and time creating and implementing a marketing plan that helps you get a substantial portion of your business, how fair is it to the firm for you to walk away with clients scott free, clients for which the firm funded your business-getting opportunities? There are two sides to the issue, as you can see. The key is for both parties to agree up front, what the rules of the game are, and then abide by them. Thanks for asking a great question!
Marc, another great article. I wonder if attitudes about this topic would change with a reposition of thinking. Calling this “deferred compensation” focuses the discussion on a provision of labor context. I prefer to think of it as ownership in a business.
“Deferred comp” paid to a “retiring” partner is a buyout of their interest in a profit making enterprise. When shareholder A buys out shareholder B in their manufacturing business, its not referred to a deferred comp.
An incoming owner to a CPA firm should be buying into a business and achieving a return on their investment. They benefit from appreciation in value of their investment if they and the other owners do the things necessary to contribute to increase the value of that business.
Marc’s comments about the noncompete is spot on. Managers doing business development and building “their” book of business are doing it on someone else’s dime.
John – thanks for your comments. Jargon and terminology in our business is often confusing. When I first started consulting, everyone called the buyout “partner retirement.” At some point, firms started calling it “deferred comp.” I had understood that the reason why so many firms use the term “deferred compensation” was to solidify their claim, before the IRS, that these payments to retired partners are fully deductible in the year they are paid (I have always pointed out to firms that I am not a tax expert). But you are absolutely correct – the buyout is all about transferring ownership in a business.