Marc Rosenberg’s advice on partner retirement and buyout plans

In a recent Sageworks webinar, 29 Must Haves for a CPA Firm Buyout Plan, Marc Rosenberg, CPA and President of The Rosenberg Associates, covered what it takes to develop a comprehensive, well-written, competitive partner buyout agreement.

Rosenberg began by explaining that succession planning and partner retirement are arguably the most neglected and mismanaged practices among CPA firms. He stressed that billions of dollars will be changing hands in the next 10 years as retiring Baby Boomer partners are compensated for their interests in CPA firms, and creating carefully constructed buyout and retirement plans will be absolutely essential for a firm’s successful transition.

A quick poll kicking off the webinar asked attendees if their firm actually has a succession plan in place, and a mere 19 percent responded “yes.” Rosenberg provided a few more harrowing numbers from his own clients and research as well:

• 25 percent of all firms have no retirement provisions in their partner agreements.

• 90 percent of all partner agreements his firm reviews each year are terribly out of date and missing key figures.

Rosenberg pointed out that another significant problem for CPA firms in succession planning is that the plans that many of them have in place are grossly mismanaged. Why? Many succession plans are often written by attorneys who know nothing about CPA firms and partner relationships.

Rosenberg explained that the basic components for valuing a firm are capital and goodwill. Capital is equal to about 25 percent of a firm’s revenue, and goodwill or deferred compensation is approximately 1X revenue. Rosenberg described four basic philosophies around assumptions in succession planning related to capital and goodwill (deferred compensation):

1. When a partner retires, he or she has a right to the value of their interest in the firm. Rosenberg raised an important legal issue related to the importance of having a partner buyout plan in place: When a partner leaves the firm, many courts will impute the goodwill of the partner to his/her interest in the firm. Just because there is no plan does not mean the firm is automatically exempt from deferred compensation.  The partner’s interest is more than just the capital.

2. The value of a partner’s interest should reflect his or her total interest in the firm. This includes what the partner has done in bringing in business, managing the firm, servicing and retaining clients and even developing staff. Their interest should reflect all of his or her efforts and contribution, and that’s best evaluated through a performance-based compensation system.

3. Firms don’t see this as a savings plan, or as something that can be “cashed in.” CPA firms need partners to stay around for the long haul since partners are of extreme value and contribute to the firm in ways others cannot. It hurts to lose a partner prematurely.

4. The math must work. The remaining partners should make the same amount that they made before another partner retires. It’s often the case that the retiring partner wants to continue working, receiving both his/her compensation and the buyout, but that math will not work since you will not have cash forward to pay new staff and ensure that the remaining partners make no less in salary. There will be a deficit. Ideally, the remaining partners should make more money. It’s customary to pay the retiring partner 3X compensation over a period of 10 years (see the diagram below). If the partner’s annual compensation was $300,000, you then have $900,000 to pay out over a period of 10 years. This is $90,000 a year. The remaining partners would then have $300,000 minus the $90,000 of extra income per year, so if the new staff or promoted internal hire is compensated at $100,000 a year, you now have $110,000 forward in cash.

Retirement planning requires that you determine how you will value capital and goodwill in the buyout. Whereas capital is straightforward and paid based on interest, goodwill (deferred compensation/buyout) on the other hand is not. The results of the most recent Rosenberg Survey indicate that only 8 percent of firms payout more than 100 percent of fees. Values less than that are simply because people are choosing to be more conservative. Younger firm partners, for example, may feel they have been part of building the firm, and may not favor valuations at 1X fees for those leaving. Remaining partners may not be able to take on the retiring partner’s clients, or may fear losing those clients altogether as the partner leaves. Payments would then be reduced by the partner’s clients that leave, and that would place the financial loss and burden on the firm.

How should goodwill be valued? See the chart below for the multiple used to value internal partner goodwill buyouts. According to the Rosenberg Survey, on average, goodwill is valued at 80 percent of revenue; only 24 percent of firms value goodwill at 100 percent.

For more on goodwill, structuring partner retirement systems and handling client transitions with retirees, view the webinar. For additional, more detailed information, read Marc Rosenberg’s book.

Additional Resources

Checklist/practice aid: “Retiring Well.”

eBook: Next-Level Accountants: Your guide to growing a firm of trusted advisors. Rosenberg is featured in the chapter, “Motivating Partners to Develop a Firm of Trusted Advisors.”

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