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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
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$49.97
Free White Papers on Industry Trends
• CPA Firm Leadership: Communication Drives New
Possibilities
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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