The insider: well planned and structured agreement key to successful internal succession.

• Author: Karp, Jonathan
• Position: SUCCESSIONPLANNING

When CPAs think about retiring and selling their practices, one of their first questions is "To whom can I sell my practice?" There are two primary answers: Select someone in the firm or bring a likely successor into the firm; or find a third party, such as another firm or sole practitioner.

What follows is a look at agreements addressing internal succession transactions.

Eighty percent of the firms facing succession issues in the next five years have failed to create a plan, even if they have partners in place who are capable of purchasing the retiring partner's interest and continuing to operate the firm, according to a recent AICPA survey.

In response, the AICPA has provided some tips on how to groom future firm leaders (see Page 28).

But, imagine your firm has identified the right successor, how do you negotiate the buy-sell agreement?

LET'S MAKE A DEAL

In the case of internal succession, the purchase price for an owner's interest is usually based on either a percentage or multiple of the retiring partner's compensation prior to the retirement, or of fees received from the retiring partner's clients during a certain time period after the partner's retirement.

When using the percentage of compensation basis, the purchase price often is based on the average compensation paid over a three to five-year period preceding the sale. As an alternative, some firms use the average of the three highest year's compensation during a 10-year period preceding the sale.

That average is then multiplied by a factor of between two and three, which represents the longstanding belief about a CPA firm's profit: one-third of revenues covers salaries, one-third covers overhead and one-third represents profits for the partners.

Once the purchase price is agreed upon, determining the payment period is the next step. This timeframe can range from as short as three years to as long as 15 years, with most firms falling somewhere between five and seven years.

Buyers concerned with the affordability of the payment often will require that the annual payment be capped at a percentage of the firm's annual revenue for each year of payment, usually 5 percent of gross revenue. Other firms will base this cap on a percentage of the firm's remaining partners' compensation, frequently 15 percent.

BUYER CONCERNS

Prior performance is no guarantee of future performance, as brokers say, so buyers will often be concerned that there is no guarantee that clients will transition to them, remain with the firm or continue to be profitable for the firm.

To address this...