When Founders Don’t Want to Buy Each Other Out

Over the years, we have worked with a number of small firms that had the following dilemma: What to do when the partners are all in their 60s and none wishes to buy out the other? This problem is particularly acute with two-partner firms, though can be troublesome for other firms with multiple partners wanting to retire on a similar timeframe.

We have distilled this dilemma into a case study to guide firms to a solution. This case is based on real facts.

The facts

• Very profitable, $3M compliance firm located in a major city.
• 2 founders in their early 60s; they have been together for 30 years.
• One wants to retire in 3 years and the other in 10 years; both want to work part-time after retirement.
• They have one manager in his early 30s who has been with the firm for 10 years. The manager is not a business-getter. No other staff has partner potential. The partners are ready to promote this manager to equity partner.
• The founders do not want to buy each other out.
• Neither the founders nor the manager wants to merge into a larger firm.
• They have always used a production formula to allocate income and wish to continue doing so.
• They had no buyout plan in place.

 CPA Firm Partner Retirement / Buyout Plans is a must-read for firms that need to update their existing plans or write a new agreement. The book addresses ►what CPA firms are worth ►what partners must do to get their buyout money ►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

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Why this case is so unique and taxing

1. Partner comp and partner buyout at a 2–3-person firm are always the hardest because no system or plan can be executed until they can look each other in the eye and agree. When firms are larger, they are more institutionalized and usually have little difficulty complying with whatever the present system is.
2. The founders don’t know what they want to do and haven’t thought about things until, in the blink of an eye, they are in a succession planning mode. They agree that merging up makes the most sense but want to give a shot to developing new partners, something they have only done once in 30 years (the current manager).
3. The founders feel that a significant part of their practices cannot be transferred to others. “Client X will never switch to a different partner.”
4. There is a limit to how much business they can transfer to the manager. The manager is critical to the founders as a doer on their client work.
5. After being an eat what you kill firm for 30 years, they want to move to a one-firm concept. Yet, because neither wants to buy each other out, each needs to sell an undetermined amount of clients to the manager and new partners; this is not consistent with the one-firm concept.

Solutions

1. The best scenario for them is to move post-haste to merge into a bigger firm. At a minimum, they should explore options by convening no-obligation meetings with 2-3 vetted merger partners.
2. It’s not feasible for one junior, non-business-getting partner to run the entire firm. He has two urgent, other areas of focus: (a) absorb the founder’s clients and (b) develop 1-2 new partners. How will he lead, set strategy, assume responsibilities for hiring new associates, overseeing IT and all other business functions (let alone new business development)?
3. Since the founders don’t want to buy each other out and one wants to retire many years before the other, the only option is for the founders to sell their clients to the manager and other new partners in tranches.
4. As the founders transfer/sell clients to the manager, their Finding and Minding will decrease with the manager’s numbers increasing correspondingly, thus enabling the manager to afford the buyouts.
5. There really are 3 plans needed:
   • Buyout plans for the two founders.
   • Buyout and new partner buy-in plan for the manager.
   • Buyout and new partner buy-in plan for future partners.Voting:
6. Voting
   • One person-one vote, but…
   • When the equity partner group consists of the two partners plus the manager, a 2/3 vote should be required to pass all matters, with the following caveat: Each founder has veto power to overturn a 2-1 vote for mergers of all types, making someone a partner, changes to the partner agreement and expelling a partner.

Retiring founders or dominant partners is a difficult task no matter the firm. Small firms stand to be challenged at every turn, especially if the quantity of replacement partner candidates is less than the quantity of retiring partners. Taking care to address succession planning well ahead of near-retirement years is key and improves the value of your firm whether you plan to transfer ownership internally or sell to another firm.

Has your firm been successful in transitioning out founding partners? How did you do it?