The Essence of a Well-Crafted Partner Buyout Agreement
Marc Rosenberg, CPA / Sep 23, 2019
CPA firm partner retirement/buyout plans have always created angst among partners. Prospective and young partners often question the plans because they see themselves paying into some sort of Ponzi scheme, wondering if their payday will ever come. The departure of impactful retiring partners seems to jeopardize the future viability and hence, value of the firm. On the other hand, veteran partners fear that younger partners don’t have the right stuff to keep the firm together and write their retirement checks. They wonder if the firm would be better off merging than staying independent, to secure their exit strategy.
Buyout plans have been around for decades, with trillions of dollars paid to retirees during that time, thus proving that buyout plans “work.” This controversy surprises a lot of people.
Following is the essence of a fair and properly conceived retirement/buyout plan.
The whole basis for the existence of buyout plans is that CPA firms build a highly liquid, significant value that is recognized on the street. The owners of these firms naturally want their interest in this asset redeemed upon retirement. Experience has shown that the asset behind this value – the annuity income stream from clients – is successfully retained by successors, be they younger partners or larger firms in a merger.
Buyouts are not an entitlement. There are critical requirements that pre-retirement partners should fulfill to be “eligible” to receive their buyouts. Two of these are (a) giving the required notice (typically 18-24 months these days) and (b) to proactive transition clients – ideally, in accordance with a written client transition policy – to other firm members. Retiring partners “earn” their buyout by safely delivering their clients to the firm.
Buyout plans are not savings plans that the partners can cash out at full value when they choose to leave the firm. Instead, largely through vesting rules, buyout plans should be designed to create incentives for partners to stay around for the long haul.
CPA Firm Partner Retirement / Buyout Plans is a must-read for firms revising their existing plans or writing a new agreement. The book addresses ►what CPA firms are worth, ►what partners must do to get their buyout ►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 ►how to prevent your plan from becoming a Ponzi scheme
Deferred compensation should be performance-based. Few partners question the wisdom of allocating income to partners largely based on performance. Partner retirement payments should be viewed the same way because they are a second form of compensation – one that is deferred. Systems used to calculate a departing partner’s buyout should be based at least partially, on what each partner did to build the value of the firm. Hint: this does not mean that the buyout should be based solely on business origination because there are many other performance attributes – managing the firm and developing good staff, to name two – that build a firm’s value.
The math must work. Very simple. An acid test of a well-conceived buyout plan is that after a partner retires, the remaining partners should make more money than they did before the retirement. Or at least, the partners should earn the same. How does this work? For the most part, the firm uses the compensation they no longer have to pay the retiree, to pay the buyout payments. Also, because the math works, funding of the buyout plan is unnecessary – in fact, virtually all CPA firms do not fund their buyout plans.
CPA firm buyout plans are very conservative because (a) the future is uncertain in an industry experiencing disruptive change, (b) new and young partners worry about the firm’s survival after the retirement of rainmakers and (c) inevitably, some clients might leave after a partner’s retirement.
Succession planning is not just something that begins shortly before a partner retires. Instead, succession planning is a daily partner duty. Clients should have a back-up provider in case the lead partner suddenly leaves the firm. Partners should be delegating as much work as possible to staff and they should be mentoring and training the staff to take on higher levels of responsibility. Partners should be building teams underneath themselves. Clients should be delegated from older to younger partners when it’s best for the client and the firm.
With all the above in place, signing on to a partner retirement agreement may be the best investment a new partner ever makes!