Partner Retirement - Buyout Plans Presented By: Gary Adamson, CPA

Gary Adamson, CPA Recovering Managing Partner Over 20 Years as a MP of a Top 200 Firm Grew firm from 9 to over 120 people Now working with firms to reach solutions, faster Consultant, author and speaker

Adamson Advisory – Focused on CPA Partners Firm Governance Partner Compensation Partner Retirement and Agreements Partner Succession Partner Retreats Mergers and Acquisitions Partner Coaching and Goal Setting

Adamson Advisory Follow our blog at www.adamsonadvisory.com/blog Sign up for our newsletter at www.adamsonadvisory.com Contact us at gadamson@adamsonadvisory.com Call us at 765-488-0691

Partner Retirement – Buyout Plans Credits: The 2012 Rosenberg MAP Survey 2012 PCPS / Succession Institute, LLC Succession Planning Survey

Rules of the Game Talk to me Polling questions from time to time I will ask you some questions as we work through the material Pepto Bismol slides

2011 Top Issues for the Profession 1. Partner accountability / unity 1. Retaining clients 2. Bringing in new clients 2. Partner accountability / unity 3. Retaining clients 3. Succession planning 4. Fee pressure / pricing 4. Bringing in new clients 5. Succession planning 5. Staff retention 6. Staff retention 6. Fee pressure / pricing AICPA Survey of Firms with 21+ Professionals

2012 PCPS Succession Survey 62% of multi-owner firms expect succession planning to be a significant issue in the next five years. (about the same % as the 2008 survey) 54% of multi owner firms do not have a written plan in place. (improved from 65% in 2008)

The Perfect Storm 1994 to 2009, lowest number of accounting grads (150 hour requirement) Even lower number sitting for the exam The BBB

Baby Boomer Bubble 76 million of us born between 1946 and 1964 61% of all CPA firm owners are over 50 1993 – 40% of AICPA members over 40 2008 – 70% 2012 - ??

Bill Reeb’s Definition of Succession Planning Succession planning is not scrambling around to find a solution when the clock has run out. It is running your firm well now and having the people and systems in place.

Partner Retirement – Buyout Plans Inside deal – our topic today Outside deal, beyond our scope but the pricing is higher

Value of a CPA Firm Two pieces – capital and goodwill What’s different about a CPA firm compared to most of your clients? Personal relationships - transition issues Relative low buy ins and the concept of vesting Longer term payout

Value of a CPA Firm Tug of war between the “old guys” and the “young guys” What is Fair? Risk if value is too low Risk if value is too high

Two Components of Value Accrual Basis Capital Goodwill

Capital Accrual book value Payout generally cash or a relatively short term Interest is paid

Goodwill What is your firm worth to your partners in an inside deal? 110% of fees? 100%? 80%? 50%?

Polling Question What percentage of fees are you using to value your firm? 100% Less than 100% More than 100% We don’t use a percentage of fees We don’t have a buyout plan

Multiple Used To Value Internal Partner Buyouts * % of Net Fees Paid for Goodwill 2-4 Partners 149 Firms 5-7 102 Firms 8-12 65 Firms 13+ 53 Firms All Firms 2011 2010 > 100% 8% 11% 7% 9% 100% 20% 21% 17% 90 – 99% 6% 12% 75 – 89% 25% 22% 27% 23% 26% 50 – 74% < 50% 18% 15% Overall Valuation Percentages (as % of Fees) Over $20M $10-20M $2-10M Under $2M All Firms 2011 71.9% 77.8% 77.3% 88.3% 2010 71.4% 76.5% 78.7% 81.0% 78.1% 2009 82.5% 75.4% 77.6% *Rosenberg 2012 MAP Survey

So, where did 1x fees go? Inside vs outside Client transition issues (more mobility) Changing attitudes of younger partners Sweat equity

Value of a CPA Firm Typical firm with revenue of $4,000,000 Capital $1,000,000 Goodwill (80% of revenue) 3,200,000 Total Value $4,200,000

Different Approaches to Allocating the Goodwill We don’t know?! Equal Fixed amount Ownership % Book of Business AAV Multiple of Compensation

AAV (Average Annual Volume) Approach Allocates the growth in the firm’s revenue each year to the current partners Normally based on relative compensation New partner gets 0 coming in unless they buy it. When a partner retires, their AAV balance is reallocated to other partners as retirement payments are made.

AAV Illustration Total 1,450,000 130,000 1,580,000 1,264,000 1,100,000 Partners Net Fees Jan. 1 Yearly Increase Dec. 31 Goodwill At 80% Ptr A 1,450,000 130,000 1,580,000 1,264,000 Ptr B 1,100,000 110,000 1,210,000 968,000 Ptr C 800,000 70,000 870,000 696,000 Ptr D 650,000 60,000 710,000 568,000 New Ptr E 30,000 24,000 Total 4,000,000 400,000 4,400,000 3,520,000 3,200,000 320,000

Relative Compensation Approach Most widely used Example Firm with revenue of $6 million Netting $2 million (1/3) before partner comp At 100% of revenue, the goodwill is 3x total partner comp.

Relative Compensation Approach If goodwill is set at 3x partner comp, a retiring partner receives 3x his/her comp Generally based on the average of the highest three of the last five years, or five of last seven, etc. Why? 2012 PCPS Survey – 11% of firms using a 2.0 multiple 17% of firms using 2.5 35% of firms using 3.0

Partner Retirement Systems * 2-4 Partners 149 firms 5-7 102 firms 8-12 65 firms 13+ 53 firms 2011 All 2010 Multiple of comp 36% 48% 55% 44% 45% 41% Book of business 13% 7% 2% 10% 15% Owner Pct. 20% 12% 9% 14% AAV 17% 19% 30% 18% Fixed 11% Equal 3% 0% 4% 1% No provision 28% 41 firms 13 firms 5% 3 firms 8% 4 firms 61 firms 23% 88 firms *Rosenberg 2012 MAP Survey

Polling Question What method are you using to allocate firm goodwill to individual owners? Multiple of compensation Book of business Ownership percentage AAV Other or we don’t have a buyout plan

Goodwill Payout Terms Deferred compensation structure Beware of code section 409A Ten year payout common – sometimes shorter No interest or CPI

Vesting Concept of earning the buyout / retirement / deferred comp over time The firm wants partners to stick around for the long haul Generally two scales in use – age and years of service

PCPS Survey Results -Vesting Minimum years of partner service to vest: 6 or fewer years, 30% 10 years, 28% 15 years, 13% 20 years, 16% Minimum age to receive full benefits: Age 55, 26% Age 60, 23% Age 65, 23%

Two Hybrid Vesting Examples Plan A 20 years as a partner Full vesting at age 65 50% limit until age 56 Plan B 25 years with the firm, vesting does not begin until year 11 Full vesting at age 65 with a 2.5% per year reduction for a departure before 65

Death and Disability Payout is generally the same as a normal retirement Perhaps some “bonus” if insurance Define both ST and LT disability And, salary continuation, if any

Non Compete Provisions Rule #1. Consult an attorney in your state. True non-competes rare today Payments for clients taken is the new norm. 100% common, up to 150 to 200% Term? Payments for taking staff

Maximum Payouts Protect the golden goose 5-10% of fees (10% is high) One firm, 12% of profits before partners How it works

Guarantees or Collateral Forget it

Mandatory Retirement / Buyout Increasing trend to set the date 2012 PCPS Survey: 54% age 65 15% age 66 to 69 14% age 70 Why does the firm need to control it?

Polling Question Our mandatory retirement age is: Age 65 Under age 65 Over age 65 We don’t have a mandatory retirement age

Post Retirement Employment? This is no longer a partner position At firm’s discretion (most do) Pay for specific duties / tasks. Normally billable time, new business, other projects. Charge time – typically 40% of billed time New business – 10 to 15% for three or less years. DO NOT – allow a “retired” partner to continue to do what they always did and receive retirement benefits.

Notice / Transition Most firms don’t penalize the retired partner for lost clients. However There is a movement to notice and transition requirements/expectations, with penalties Notice – minimum of one year (two is better) Transition process that must be completed

Client Transition Policy Starts with a new client sales pitch: “If you go on a sales pitch alone, you get shot.” Continues with team orientation to servicing clients; creating “multiple touch points.” The firm maintains the partner’s comp during transition. The firm drives the transition process. Written plan (dates, post-retirement plans) Name the successors to the retiree—by client, target dates. Agree on announcements, internal & external. Quarterly monitoring of progress.

Funding? Rare, but sometimes 401k or other retirement plan offsets

Health Insurance An important story

How Does the Math Work? Assumptions Cash Flow Current Comp is 300k Add a staff for 100K Retirement payments are 3x over ten years Cash Flow +300,000 -100,000 -90000 +110,000

Buying In The days of the big $ buy-ins including value for goodwill are over $100,000 to $150,000 Accrual balance sheet Financing?

Other Stuff Look back provisions upon a subsequent sale What is the split upon a sale? When do payments start upon an early withdrawal? Does a “for cause” termination affect the payout? What is the firm’s process for transition of clients?

Questions?

Thank You Follow our blog at www.adamsonadvisory.com/blog Sign up for our newsletter at www.adamsonadvisory.com Contact us at gadamson@adamsonadvisory.com Call us at 765-488-0691