Buyout Schmyout: A Partner-Candidate Asks If It’s Worth It
We occasionally receive lengthy replies to our blogs and like to share our readers’ perspectives. A senior manager of a three-partner firm in the Midwest wrote to us on the topic of succession and buyouts, following my April Fool’s blog on raising the minimum retirement age to 85. This is Part 1 of a 2-part series.
Reader: I wanted to leave a note and say that I read your email blasts pretty regularly. I enjoy the content you have and think it raises questions in the profession that should be considered. I think you understand better than many a big problem CPA firms are having.
The profession faces a heavyweight fight against a formidable opponent…human nature. As a species, we are not wired to embrace change and new thinking. It is comical in this profession. When we consider a difficult project, the first avenue we consider is “How did I do this last year?” SALY.
Whether it’s the prior-year workpaper for a routine client or a discussion on strategy, SALY (“Same as last year”) shows up everywhere, doesn’t she? While SALY causes our industry plenty of setbacks, I don’t think it’s always a bad place to start for difficult projects. However, as you note, getting stuck in SALY and not considering new information, technology, and perspectives, is where we fail to put forth our best efforts.
Reluctance to Change
Reader: We place excess value in the routine, even when it is arduous, less efficient, and even potentially harmful to our physical and mental health. As CPAs in professional practice, we set these expectations upon ourselves and the traditional model is slowly killing the profession.
Amen! This occurs with every generation — new ideas have to be pushed through many of the “senior” professionals who are comfortable with where they are.
One reason for complacency or reluctance to change is the relatively well-paid nature of seasoned accounting professionals. If partners can earn $300k–$500k (which is still below industry average), there’s little incentive to try something new. So what if they earn an extra $25k per year — even $100k — on new efficiencies? Many will gladly pass if it’s “hard” because it involves change and their lifestyle is already more than meeting their needs.
But the industry will change. Younger founders of new firms build them from the ground up with modern approaches. Larger firms have the resources and strength of leadership to identify and invest in these opportunities before it’s too late. It’s the small- to mid-sized firms with “leaders” who are primarily client-service professionals who leave something on the table if they lack the interest in keeping up.
Is this a problem? Not necessarily for them. But if they want to build a firm with a legacy that outlasts their tenure, CPA firm partners need to think about best approaches for the organization, their community, clients, and successors. Not all do, though. Turning out the lights or selling can be the easy-out.
CPA Firm Partner Retirement / Buyout Plans is a must-read for firms that need to update their existing plans or write a new agreement. The book addresses ►what CPA firms are worth ►what partners must do to get their buyout money ►how to value a firm’s goodwill ►the acid test of a well-conceived retirement plan ►6 methods of determining an individual partner’s buyout ►vesting ►notice and client transition requirements ►mandatory retirement ►non-compete and non-solicitation covenants
Buyouts at Risk?
Reader: It is so interesting to me that senior partners don’t reflect more on “why” this is. Young professionals don’t want to “buy” a practice from a retiring partner. High-achieving young professionals already have a book of business that is pretty full and prosperous.
Yes. And, someone else may want to buy it. If the firm has done such a great job that retiring partners have full books of business, and incoming partners do too (we see this problem a lot today), there’s room to grow and add more leaders!
The obvious challenge then is “who” because there just aren’t enough professionals. The second challenge is “what.” A book of business that is stale and low-profit will not appeal to anyone.
Many client bases contain both great clients and crappy clients. If the mix favors the latter, there may be a professional out there who’s ready to step up, manage more, delegate more, build a team themselves, take over that business (and pay for it). Maybe it’s not you, but there is likely some value to most retiring partners’ business activities.
I would also consider where the high-achieving young professionals’ book of business came from? Likely much of the work was given to them by the firm — when overworked senior partners delegated clients to their younger, talented professionals. This is how the profession works, and unless you want to leave and try to take your clients with you, there’s likely some price to be paid for groundwork laid by senior firm leaders.
The Ponzi Scheme Analogy
Reader: The buy-in, buy-out model creates a Ponzi scheme, and young professionals have done the math and considered the trade-offs of the current system. Many young people find it inequitable to compensate retiring co-workers for work they are no longer doing. Physical and mental health already suffers from sitting at a desk and enduring a work/life equation that is out of balance for 1/3 of the year. The costs are too high under the current model. That is one reason why there is a shortage of young people staying in this profession.
The Ponzi scheme comparison deserves attention. If the last person holding the bag gets nothing, this is obviously a problem.
Buyout plans work only if there’s a profitable, growing, healthy business in place when partners retire. Next generation business leaders need to assess this, and at many firms there is a strong upside to buying into such a practice with the intent to continue to invest, grow, and sell to the next generation.
If instead we’re talking about the transferring of a dilapidated book of business no sane professional would want (e.g. low-fee, high-volume 1040s of a bunch of Baby Boomers and out-of-date systems and processes), there may not be much to “buy out” that’s of interest to the next generation.
That said, there is often value in some portion of a retiring partner’s business or book of business. As we often say, “the math must work.” This requires:
+ Savings by not having to pay the partner’s annual income
– Less the annual buyout
– Less the cost of one or two additional new hires to continue the growth
= Net increase in remaining partners’ income.
The net result should be a positive number that’s incentive enough for the successor partner to want the work. If not, a new deal needs to be struck.
I should add that the vast majority of CPA firms do have active buyout plans, as evidenced by the fact that 80% of all CPA firms over $5M in revenue (per the latest Rosenberg Survey) are making buyout payments to retired partners.
Part 2 of this series can be found here.
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CPA Firm Partner Retirement / Buyout Plans
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Regarding Buyout Schmyout – We just spent about 2 years offand on working out the details of our operating agreement which includes the buyin and buyout formulas. We are very aware of the fact that if the folks left behind aren’t making money, really good money, then the model falls apart. So we added in a number of features which will help them with the jitters on the agreement. The big concern is that the IRS will do automatic filing and we’ll lose a large percentage of our 1040 practice. We have a provision in our agreement that if the Adjusted Gross Receipts drops by more than 15 % the note payments are forgiven by that same %. So if collections go from 2,000,000 to 1,600,000 (20% Drop) then the note payments for the following year will drop by that same percentage. (Note there is no reduction until collections drop by <= 15%). If the following year the collections rise to only being down 18% then the following year's payments go up by the recovered 2%. Once the collections rise to less than 15% below the inception year, then the note payments are raised back up to the original amounts. Any "forgiven" payments are permanently forgiven, and as illustrated above, while the payments can return to the original amount, they can't rise above that initial level. It's a ridiculously complicated agreement, but heck, what good is being a CPA if you can't handle a complicated calculation? My point is that there is a way to assuage the fears of both the sellers and the buyers, but it all starts with trust and with the desire to potentially sacrifice a little extra payout so that those behind you prosper as well.
Rob – this is one of the most brilliant ideas I’ve come across in recent years. I’ve worked with firms to adopt a similar provision, but none stated so eloquently and sensible as your approach. Thanks for taking the time to respond!