Partner Buyout Nuances: Queries from Firms

Partner buyout plans can be difficult to navigate. We want to be fair to our partners, and we want to be treated fairly in return. In the process, differences of interpretation inevitably arise. Here are some queries we’ve recently received you may find instructive:

Partner’s Question:  As founder and rainmaker of our firm, I have transitioned millions of dollars of clients to other partners with no payment for client value other than ongoing earnings.  Over the years, I have generously shared earnings with my younger partners.

Our reply:  What you describe is unfortunately, a common unfair practice.  When partners delegate clients to other partners for the good of the firm and the clients, this should never result in limiting the originator’s income.  In fact, there is a good case for paying even more for delegating clients than retaining them.  This does require a system for tracking the delegated clients, both on the delegator’s and receiver’s end.

If you have delegated millions of dollars of clients to others, your compensation should be significantly higher than your other partners.  As such, if you are on the multiple of comp system for buyouts, your buyout would be significantly larger than the partners who received your originated clients.  By getting a higher buyout, this is how you get your value out of the firm.

Partner’s Question:  Do you believe the value of the firm for internal buyout purposes should be consistent with outside sales prices for firms?  Our firm’s revenue is $10M.  Recently, we purchased a smaller firm, paying 120% of fees, 50% down and the balance over a three-year period.  Our internal buyout plan values the firm at 80% of fees.

Our reply:  Intuitively, I can see how you might feel that the internal and external prices should be very similar.  But they are not.  Most purchases of firms under $5M these days are going for no more than 100% of fees, sometimes less. Very large firms such as regional firms seem to be paying as little as 60% of fees.  Some go a tad higher, but never exceeding 100%.   In contrast, internal retirement plans value goodwill, on average, at 80% of fees and have done so for years.  Why the difference?

• In external sales, there are multiple buyers, so the demand-supply rule boosts the price to sellers.  But in internal retirements, there is only one buyer – your own firm – so it’s reasonable that the price would be lower.
• The client retention rate is higher for internal retirements than external sales, so, this closes the valuation gap somewhat.
• Partners like to be conservative.  Younger partners and partner potentials worry about committing to internal buyouts that are too generous and thus, too onerous, which often results in a reduced valuation.
• Younger partners and partner potentials worry about keeping the firm together and avoiding significant client loss after major partners retire.  They feel like the buyout plan is really a Ponzi scheme.
• Partners remaining after a partner retires are already busier than they want to be.  They don’t have the time to take on more clients from the retiring partner.  A lower internal valuation helps to “sweeten the deal.”

By the way, the terms of your most recent deal were way too generous compared to what firms are selling for these days.  A more normal set of terms these days are 100% of fees, no more than 10% down and payout term over five or so years.

CPA Firm Partner Retirement / Buyout Plans is a must-read for firms who need to revise and update their existing plans or need to write a new agreement.

 Partner’s Question:  In my final years, the firm has been making and will continue to make major investments which negatively impact the firm’s profits.  Examples include moving into a newer, larger office, partner retirements, the purchase of two firms, a major rebranding program and the launch of new services.   All of this is great and will have lasting benefits for the firm.  It also, unfortunately, reduces my compensation.

 Our reply:  This is a tough issue.  It sounds like you are a believer in the one-firm, team-oriented approach to running a CPA firm.  As such, a firm cannot afford to have “short-termers” vetoing investing some of the firm’s profits back into the firm.  I guess this is a fact of life as a partner in a growing, successful business. On a continuous basis, the firm is investing in the future, which often has a short-term impact on partner earnings.  It’s the “package” that partners accept as part of what being a partner is all about.  There is no question that firms who invest money today to be more successful tomorrow outgrow and outearn firms that are miserly, always trying to maximize short term profits.  It’s possible that over your career at the firm, you benefited from investments made in the past.  You can’t have it both ways:  invest in the firm because it’s the right thing to do vs. take a pass on salary reductions caused by these investments.  When you are a short-termer, it doesn’t feel quite fair.