CPA partner buyouts: two main methods

Should a firm allow a retiring partner to be bought out personally by another partner?

CPA firms use two main methods to buy out retiring partners:

1. The firm buys out the retiring partner and his/her retirement payments are paid directly by the firm.  The remaining partners “pay” for the buyout payments by treating these payments as an expense of the firm.  So, if a partner’s income allocation percentage is 20%, he/she will essentially be paying for 20% of the retiree’s retirement payments.
2. Retiring partners are bought out directly by other partners.  This is usually linked strongly to client transition.  If a younger partner gets 50% of a retiring partner’s clients, he pays 50% of the retiree’s retirement payments.  It is common for retiring partners to arrange their own deals with “buyer” partners, though some firms “steer” this process in a manner that is good for the firm.

Which method is “right”?  Which is the best?  Which is most common?

 
Advantages of one partner buying out another directly

• One partner takes on the financial obligation of making retirement payments instead of the firm as a whole.  This means more cash flow to the other partners.
• If the firm has a formula comp system that places a high value on book of business, the buying partner will benefit substantially from his new and higher book of business.  It’s only fair that he bear the brunt of the cost to acquire that business.

Why the firm should buy out the retiring partner

• Acquiring a book of business for something close to one times fees is a very lucrative investment if the clients are retained.  The buying partner essentially “buys” significant, future compensation increases.  This isn’t fair to the other partners.
• When partners start making deals with other partners to buy and sell firm ownership and clients, all sorts of dubious and inconsistent “agreements” get made.
• The partner willing to buy the business may not be the best partner in the firm to service the retiree’s clients.  When ownership is transferred between two partners, it shuts the firm out of the client transition process.

Conclusions

As you can probably tell, I favor the approach where the firm buys out retiring partners.  Which is most common?  For firms under $5M, both methods are used a lot.  But for firms over $5M, the method I prefer is easily the most common.