By Marc Rosenberg
Buying a family home is one of the the biggest investment most people make in their lives. And because most of us are not real estate experts, we protect ourselves by engaging an attorney to ensure that the purchase is handled correctly. We don’t hesitate for a moment to invest a few thousand dollars of attorney fees to hire an expert.
MORE ON PARTNERSHIP: How Business Entity Type Affects Partner Income | What Partnership Gets You (and Doesn’t) | 5 Cautionary Tales in Partner Compensation | Partner Pay in Retirement Transition Period | 23 Key Provisions in a Partner Buyout | Management Stipends: Who, How and Why | When a Firm Tanks While a Partner Soars | Research Results: How Firms Pay New Partners | What Does Buy-In Buy? | How Profitability Affects Income Allocation | Keys to Bringing in New Partners
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Being a partner in a CPA firm should be no different.
Think about it. Based on data from the 2016 Rosenberg MAP Survey, here is a rough idea of the value of a partner’s ownership in a $10 million firm:
30-year income stream at $400,000 per year $12,000,000
Goodwill retirement buyout @ 3 times comp $1,200,000
Capital retirement buyout @ 25% of goodwill $300,000
TOTAL CASH FLOW $13,500,000
If ever there were a no-brainer, it would be to spend a few dollars to protect your $13.5 million investment by seeking the expert advice of an attorney and a consultant to create a partner agreement for your firm.
Yet, according to the 2016 AICPA PCPS Survey, 37 percent – more than one-third! – of multipartner firms do not have partnership agreements. (We will use the generic term “partner agreement” to describe the agreement among a CPA firm’s owners for governing the firm, regardless of whether the legal entity is a partnership, LLC, LLP, corporation, etc.) Based on our experience consulting with CPA firms, I’m certain this 37 percent figure declines as firm size increases, but it’s still in the 20-25 percent range for all substantial firms – still inexcusable.
Many of you reading this are sitting smug and satisfied because your firm has a partner agreement. But merely having an agreement should not make you feel content.
The key question is this: Is the agreement properly written and consistent with CPA industry best practices?
I have read hundreds of agreements in my career, and I must tell you that 50-75 percent are so poorly written they fail to address a dozen or more critically important issues.
Why Some Firms Don’t Have a Partner Agreement
I see these excuses all the time. Many are interrelated:
- Topping the list is “We just haven’t had the time.” In my experience, these are code words for “We know we will never agree on key, sensitive terms and we want to avoid fighting over them for fear it will break up the firm.” Common issues of potential dispute include partner retirement benefits, managing partner duties and non-compete covenants. So, they reason, “Why bother creating an agreement if we know we will never agree on the terms?”
- Unwarranted confidence by dominating partners (usually founders) that they don’t need a partner agreement to control and manage the firm. In these situations, there is a huge gap between these power partners and the other partners in terms of rainmaking, reputation, age, technical knowledge, leadership, compensation and other traits. They feel they can operate the firm as if it’s their firm despite having several partners and can do whatever they want because there is zero chance of an uprising.
- True procrastination. Many people are truly disorganized or have difficulty focusing on doing first things first (borrowed from Stephen Covey’s "Seven Habits" literature). They know that putting together a partner agreement will be a long, arduous, boring and expensive task and they simply can’t find the time to get it done, even if they may be able to agree on the terms.
- Ignorance is bliss. Some owners may be brilliant at accounting and tax but are blissfully unaware of the dire consequences of not having a partner agreement.
- Penny wise and pound foolish. The partners know that they should have a partner agreement, but they aren’t willing to pay the money to hire a lawyer and/or a consultant to get it done.
- Merger plans. Some firms question why they should make the effort to create a partner agreement when their exit strategy is to sell the firm instead of bringing in new partners. OK, that addresses the partner retirement part of the agreement. But there are dozens of other critical issues the partner agreement needs to address, such as voting, duties of the managing partner, partner duties and prohibitions.
One final note. It’s incredible how many agreements I have read that are older than dirt, written 10 or even 20 years ago. Few things in life remain the same. There have been many changes in partner governance methods and agreements at CPA firms over the years. Here are a few examples:
- Many agreements require retiring partners to transition clients as a condition of receiving their full benefits.
- Notice of intent to retire is a lot further out than it used to be.
- New partner buy-ins are much smaller than in the past.
- The role and impact of a partner’s ownership percentage have greatly diminished.
- Non-compete and non-solicitation covenants have changed.
- Decision-making authority has shifted from the partners as a whole to the managing partner and the executive committee to parallel a shift at firms from a partnership governance philosophy to a corporate structure.
If your firm has a well written agreement, make sure you have a consultant and/or attorney look it over every two or three years to make sure it is current.