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Buying Out Retiring Partners

What You Need to Make Sure the

Plan SucceedsPlan SucceedsJune 9, 2016

Presented by

Terrence E. Putney, CPA

CEO, Transition Advisors, LLC

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Transition Advisors, LLC

National consulting firm working exclusively with accounting firms on issues related to ownership transition

What’s on your mind?

I don’t think we can pay for

partner retirements-too

expensive

Will there be anybody

there to buy me out when

it’s my turn?

What’s on your mind?

I don’t think I’ll get paid what my

equity interest is worth at retirement

We don’t have an agreement and we

have partners leaving soon

What’s on your mind?

I don’t trust the

younger people in

our firm to keep

the firm going and

buy me out

What’s on your mind?

And then one day your partner walks in

like Jerry Maguire

Today’s Agenda

• Can you replace retiring partners?

• Proper transition of duties

• Methods used to structure buyouts• Methods used to structure buyouts

• The right value for your firm

• The financial arrangement

• Other aspects of your owner agreement

External Data

2012 PCPS Succession Survey

2015 Rosenberg Survey

2015 Inside Public Accounting National 2015 Inside Public Accounting National

Benchmarking Report

Polling Question

Does your firm have adequate talent on the

bench to replace retiring partners?

• No, we don’t

• I think so, but we don’t have a good way to admit • I think so, but we don’t have a good way to admit

them as owners

• Yes, I am confident we do

• We don’t plan to replace our partners internally

Transition Plan

Allow at least two years to

transition a retiring

partner’s duties

You must have that partner’s

replacement(s) in place by

that time to properly execute this plan

Assessing Your Firm’s Succession Readiness

Partner Succession Projection

Partner 1-3 yrs 4-7 yrs >8 yrs

A RR

B RS

RR=Role Reallocation RS=Role Succession

B RS

C RS

D RR

E RS

Transition Plan

• Internal succession team with capacity

• Understanding of how to replace the retiring

partner’s duties

• Enough time and active involvement • Enough time and active involvement

Make the day a retired partner walks out the

door a non-event

Tying Transition to Buyout

• At 2 year notice period

• Written transition plan-very specific

• Failure to provide notice OR failure to execute

plan-either set discount or variable dealplan-either set discount or variable deal

Polling Question

Please email a copy of the Generic Transition

Plan

YesYes

No

Methodology

Multiple of comp

Book of business

Equity

AAV

8+ Partners1

51%

6%

7%

25%

<8 Partners1

34%

13%

24%

16%AAV

Fixed

Equal

None (not incl)

25%

11%

4%

12%

16%

10%

2%

18%

1Rosenberg

AAV Article

How to admit new partners: A fresh approach

The AAV method can help accounting firms find the

right formula for bringing in new owners on terms

everyone can live with. everyone can live with.

December, 2015

http://www.transitionadvisors.com/succession-planning.php

AAV/Unit Method

• Determination and use of AAV units

• Example

• Redistribution-retirements and terminations

AAV/Unit Method

Use for new partner admission

• Admission date

– Ptnr A: 1,200,000 units

– 5 other ptnrs: 1,000,000 units each– 5 other ptnrs: 1,000,000 units each

– New ptnr: 0 units

AAV/Unit Method

Use for new partner admission

• 5 years later

– Ptnr A: 1,400,000 units

– 5 other ptnrs: 1,200,000 units each– 5 other ptnrs: 1,200,000 units each

– New ptnr: 200,000 units

• Ptnr A retires-10 year payout

– 140,000 units redistributed annually to remaining

partners

AAV/Unit Method

Benefits

• Doesn’t require new partners to buy intangible value

• Flexible allocation

• Rewards sweat equity• Rewards sweat equity

• Built in vesting

• Flexibility of comp based combined with ownership

of equity based

Polling Question

I believe our approach to valuing our owners’

interest in our firm is:

• Fair and affordable

• Fair, but I’m not sure we can afford the buyouts• Fair, but I’m not sure we can afford the buyouts

• Not fair, too low

• Not fair, too high

• N/A, we don’t have an agreement

Principles of Value

Tangible value-accrual basis

book value

Intangible value-clients, Intangible value-clients,

employees, name, goodwill

Intangible value is often 3 to 6 times

tangible value

Principles of Value

Common Theory is to assume inherent value of one

times revenue or three times compensation

Reality is intangible value in a CPA firm

is based on a buyer’s expectationis based on a buyer’s expectation

of future results following a transition

of the relationships and other assets

that make up the intangibles

Principles of Value

Without a proper transition of roles for a retiring

partner, the intangible value of the firm is

dramatically diminished

Too much emphasis on the financial terms

Not enough on the transition plan

Valuation Multiple

>100%

100%

90% +

8+ Partners

8%

20%

8%

<8 Partners

8%

25%

9%

% of Net Fees-Goodwill-Rosenberg

90% +

75% +

50% +

<50%

8%

24%

20%

20%

9%

24%

23%

11%

Internal v External Valuations

Why do external sales appear to sell at a higher

multiple than internal buyouts?

• External deals are bid

• Internal deals are a put option• Internal deals are a put option

• Different package of terms

• Internal deals are designed to keep the firm viable

• External deals are designed to maximize liquidation

value

Right Financial Arrangement

Tie the payout to the transition-

appropriately

• Trusting the transition plan

will be executedwill be executed

• Trusting the transition plan

will work

• When you can’t take that chance

Right Financial Arrangement

Backwards Valuation Reward your retiring

partners fairly for their

years of sweat equity

BUTBUT

Don’t expect your

remaining partners to

borrow or take a step back

in compensation to do it

Right Financial Arrangement

Available capital is the retired partner’s foregone

compensation

Three uses for that capital

• Pay the retiring partner off• Pay the retiring partner off

• Cost of replacing that partner

• Some upside for the remaining partners for

assuming the obligation and the extra work

Right Financial Arrangement

The basic assumption is:

• An owner is earning compensation as an owner,

even with lowered time commitment, and NOT at

the same time, being bought out ORthe same time, being bought out OR

• The owner is being paid for their equity and if still

working is being paid as a non-owner

It’s hard financially to do both at the same time

Right Financial Arrangement

Example

Retiring partner comp and benefits $300k

Replacement resources $120k

Remaining capital $180kRemaining capital $180k

Need to decide how much can be used for

buyout and how much should be left behind

Example

• Firm volume $1.9 million

• Retiring partner equity 45%

• Retiring partner comp & ben $275,000

• Capital account $175,000• Capital account $175,000

• Payout retirement over 5 years

(works out to $171,000 per year)

• Cost of replacement resources $125,000

Example

• Year 1 net cash flow

$275,000 less $125,000 equals $150,000

of available capital

$150,000 less $175,000 (cap acct) less$150,000 less $175,000 (cap acct) less

$171,000 (retirement) equals

$146,000 of negative cash flow

• Years 2 thru 5 net cash flow

$150,000 less $171,000 equals $21,000 of negative cash flow

Example

Alternative plan

• Pay capital over 5 years

• Pay retirement over 10 years

Example

• Years 1 thru 5 net cash flow

$275,000 less $125,000 equals $150,000

of available capital

$150,000 less $35,000 (cap acct) less$150,000 less $35,000 (cap acct) less

$85,500 (retirement) equals

29,500 of positive cash flow

• Years 6 thru 10 net cash flow

$150,000 less $85,500 equals $64,500 of positive cash flow

Polling Question

How many equity partners/shareholders do you

have in your firm?

• 1

• 2-4• 2-4

• 5-9

• 10-19

• 20+

Mandatory Retirement Age

• 88% of $20M+ and 78% of $10M to $20M1

• 77% of $20M+ and 74% of $10M to $20M2

• 58% of $2M to $10M; 24% of <$2M1

• 51% of <$10M2• 51% of <$10M2

• 47% of all respondents3

1Rosenberg 2IPA 3PCPS

Mandatory Retirement Age

• Average age is 661

• 54% use 65, 29% are 66 to 702

• Trends

1Rosenberg 2PCPS

Tax Treatment

• Increasing use of cap gain treatment under

736 (b)

• Match up with appropriate payout period

• 736 (a) avoidance of self-employment taxes• 736 (a) avoidance of self-employment taxes– Lifetime payments, no ongoing service, cap acct paid

• 409 A issues

Personal Goodwill

• Requirements of Martin Ice Cream case

• One time opportunity to lock in cap gain

treatment

• Interface with existing or new deferred comp • Interface with existing or new deferred comp

plans in mergers

Vesting

Tenure

• 28% 10 years1

• 33% less than 10 years1

• 23% 20 years or more1

Age-partial

• 41% <551

• 30% = 551

Age-full23% 20 years or more Age-full

• 26% 551

• 23% 601

• 23% 651

1PCPS

Options If Internal Succession Fails

• Cull out saleThink about down-sizing to a level your remaining partners

can handle

• Upstream mergerGive your firm at least 2 to 3 years to find a suitable

merger partner before you have to find a replacement Give your firm at least 2 to 3 years to find a suitable

merger partner before you have to find a replacement for retiring partners

Articles

CPA Firm Succession Series

July, 2013 thru June, 2014

www.transitionadvisors.com/succession-planning.php

CPA Firm Valuation Series

October, 2014 thru December, 2014

www.transitionadvisors.com/valuing-accounting-firm.php

How To Admit New Partners-A Fresh Approach

December, 2015

www.transitionadvisors.com/succession-planning.php

For More InformationVisit the AICPA Succession Planning Resource Center

http://www.aicpa.org/InterestAreas/PrivateCompaniesPracticeSection/StrategyPlanning/center/Pages/default.aspx

• Gary Adamson, Adamson Advisory• Mary Bennett, MLBennett Consulting• Bonnie Buol Ruszczyk, bbr marketing• Sarah Dobek, Inovautus Consulting• Angie Grissom, The Rainmaker

Companies

• Tamera Loerzel, ConvergenceCoaching

• Terry Putney, Transition Advisors• Rick Solomon, Thriving Firm• Carrie Steffen, The Whetstone Group• Sandra Wiley, Boomer Consulting

#SuperConf15

• Dustin Hostetler, Boomer Consulting• Rita Keller, Keller Advisors• Roman Kepczyk, Xcentric

• Jennifer Wilson, ConvergenceCoaching

www.cpaconsultantsalliance.com

Bridging the Gap: Strengthening the Connection Between Current and Emerging Leaders in the

CPA Profession

Amazon.com

$49.97

Free White Papers on Industry Trends

• CPA Firm Leadership: Communication Drives New

Possibilities

• Measuring Happiness at Work: How Firms Can Win • Measuring Happiness at Work: How Firms Can Win

With a Happy Culture

• Top CPA Firms Succession Challenges

Download at: www.cpaconsultantsalliance.com

For More Information

Please visit our website for resources including free reports, whitepapers and case studies,

www.TransitionAdvisors.com

You may obtain a hard copy of this presentation by making a request by e-mail to Nicki Johnston, Marketing Director, a request by e-mail to Nicki Johnston, Marketing Director,

Transition Advisors, LLC. Please send your name and mailing address to

njohnston@transitionadvisors.com