Is Your Partner Agreement Deficient? 16 Must-Have Provisions
Marc Rosenberg, CPA / Jun 11, 2018
Properly written partner agreements contain more than 200 provisions, all important.
We have reviewed hundreds of partner agreements and helped firms create or revise several dozen, and based on this experience, I’ve identified what I consider the 16 most critical provisions in CPA firm partner agreements. The items are not listed in order of importance. Interestingly, it’s common for these 16 items to be improperly addressed or omitted altogether.
- Partner retirement/buyout. Either provide for this provision or specifically state that there will be no buyout. Agreements that are silent on this may result in a court deciding this amount for you and may rule that a departed partner is due a substantial factor for goodwill. This section alone has 25 major provisions with well over 100 choices for handling. One the worst omissions I see repeatedly is the lack of a requirement for a retiring partner to comply with written client transition practices that have teeth to them.
- Ownership percentage. Many firms make the mistake of placing too much importance on ownership percentage, which results in unfair compensation, buyout, buy-in and voting. Make sure your agreement does not over-rely on the meaning and use of ownership percentage.
- Partner capital. Don’t allow partners to manipulate their capital accounts with unrestrained and excessive withdrawals.
- New partner buy-in. The firm should require buy-ins because all partners should have a meaningful amount of money invested in the firm that is at risk. Make sure the buy-in is paid to the firm, not individual partners.
- Voting. Don’t allow a small number of power partners to disenfranchise low ownership and/or new partners. Conversely, don’t let a group of minority owners stage a coup.
- Death and disability. Benefits should be calculated the same as a normal retirement. In the case of a disability, clear guidelines are needed for compensating the partner while disabled and determining when the person should be declared retired. The firm should show empathy to disabled partners but they shouldn’t become a major financial burden on the firm either.
- Overall firm management. The primary responsibility for managing the firm should rest with a management team headed by the MP aided by PICs, department heads and non-client service professionals in admin, HR, marketing and IT, as needed. Management by committee or the full partner group is a recipe for disaster.
- Managing partner. Give strong decision-making authority to the MP. The MP can’t manage the firm if a vote must be taken every time a decision is needed. The MP is the same as a CEO (though depending on the firm’s size, the MP need not be a full-time position) who should be allowed to serve indefinitely vs. a position that is rotated by mandate.
We wrote CPA Firm Partner Agreement ESSENTIALS because 75% of firms’ agreements are either outdated or missing critical provisions: even more disconcerting, 20-30% of firms don’t even have a written partner agreement. This book incorporates hundreds of best practices including ► voting, ► ownership percentage and capital ►non-solicitation covenants ►partner duties and prohibitions ►mandatory retirement ►non-equity partners ►death and disability ►managing partner authorities ► executive committees ►clawback ► new partner buy-in ►ownership percentage
- Executive committee. Functions as a Board, not a committee that manages the firm. Should be the same as the compensation committee if this is the method used by the firm to allocate partner income.
- Non-solicitation covenant. The firm must protect its intellectual property and assets. The firm developed them over many years at considerable expense; departing partners shouldn’t be allowed to simply take these assets for free. If partners leave the firm, they should be prohibited from taking clients, prospects and staff, even if they offer to pay for them. If these prohibitions are violated, the offenders should be required to pay a significant but not unreasonable amount of liquidated damages, regardless if the clients, prospects and staff were solicited or not by the departed partners.
- Partner compensation. Be short – one or two sentences at most, using very general terminology. Firms change their comp systems frequently; you don’t want to change your agreement every time a change is made.
- Partner duties. Partners must devote 100% of their time to the firm; no side businesses or service to boards or governments without the firm’s approval. No side income. Performing effectively as partners is a tough, demanding job requiring long hours and extraordinary focus; don’t let your partners get distracted.
- Prohibitions and expulsion. If you don’t provide for these, the firm has very little recourse to penalize partners who commit bad acts or perform poorly. As long as the firm communicates duties and performance expectations for partners in writing, there should be provision for expelling partners who fail to comply with these requirements and/or perform as a partner. Be specific about the retirement benefits that may or may not be payable to an expelled partner.
- Mandatory retirement. Yes, mandatory retirement is still legal for equity partners at 99.9% of firms. Even if the firm wishes to allow partners past retirement age to continue working, firms should still have a mandatory retirement provision. This way, the firm decides if an aging partner should be allowed to continue working, not the older partner. This provision is a great way to get the retirement issue for a specific partner addressed.
- Non-equity partners. For decades, CPA firms have erred in promoting managers directly to equity partner as a retention device and other reasons, regardless of their ability to function as an equity partner. Today, 60% of firms provide for this important intermediary title. The trend is even fewer equity and more non-equity partners.
- Sale of the firm. Firms have been known to abandon their partner buyout methodology when the firm is sold and an allocation method is needed to distribute the sale proceeds. Instead they revert to ownership percentage, an unfair and illogical practice. The proceeds should be allocated based on each partner’s relative retirement benefits.
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