Paying New Partner Buy-Ins to the Firm, Not the Partners

making paymentWhenever a firm changes a major system that impacts the partners, maintaining fairness to those negatively impacted by the change can be a challenge.

Here’s an example. When a firm whose partners previously paid their buy-ins to other partners decides to have new partners pay buy-ins to the firm going forward, there’s bound to be some resistance.

So why do it? Why is paying new partner buy-ins to other partners inadvisable?

  • When a new partner pays the buy-in to another partner, what is really happening? The partner receiving the buy-in essentially gets an advance on goodwill benefits. But the new partner has nothing to show for it. And the receiving partner usually regards the buy-in received as “initiation dues” to join the “club” instead of the goodwill advance it really is.
  • New partners paying the buy-in to other partners is a personal transaction between the partners that excludes the firm. Therefore, it is not consistent with the one-firm concept. Also, the new partners’ capital accounts are not credited with the contribution, thus reflecting a zero balance on their first day as a partner. This being the case, when the new partners eventually retires, there is no basis for returning their capital.
  • Many firms do not prescribe the manner in which the buy-in amount is calculated. Instead, they intentionally leave it up to the buyer and the seller(s) to negotiate the price. This means that every deal is different, which is bound to make the process unfair and inconsistent.
  • If the firm wants to pay interest on capital as one of three tiers of partner income (the other two being base and bonus) new partners would not have much of a balance upon which to pay the interest.

Two Ways To Make The Change

  • The more common approach: the next new partner pays buy-in directly to the firm, not individual partners. Prior buy-ins between the partners are not re-characterized. This would mean that the younger partners who already bought in would no longer receive a share of new partner buy-ins. Though they might not be happy because they want the same deal that the older partners got, hopefully it is something they can live with.
  • An uncommon approach: the next new partner pays buy-in directly to the firm, not individual partners. Also, all buy-in payments paid by existing partners are re-characterized as capital, goodwill, or both, with corresponding reductions in the capital, goodwill or both of the partners who received the buy-in. Retiring partners might not be happy with this because they might feel as though something they were entitled to under the old system (their full goodwill benefits) and had planned on, is now being taken away from them.

The changing climate in partner buy-ins gets a lot of industry attention as many firms are now approaching their second generation of ownership. To craft a new partner buy-in that addresses the above challenges and suggests methods of dealing with them, consult our monograph How To Bring in New Partners.

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1 Comment

  1. Rob Barbacane on May 12, 2015 at 9:30 am

    We use the uncommon approach: The New partners bonus each year is paid to the partner(s) nearest to retirement.
    The New partner receives AAV’s in lieu of the bonus. The receiving partner(s) AAV’s are reduced by the same amount. The New partner makes a separate/additional capital contribution payment and the receiving partner(s) receives a capital distribution. We pay a 10% rate of return on AAV’s (intangible capital) and tangible Capital.Once a new partner has a 10% ownership interest, they stop buying-in and start receiving their fair share of Growth AAV’s each year.

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