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Practice Management / Succession Planning

Have a Fallback Plan

Take a lesson from the Boy Scouts and “be prepared.”

By Rick Telberg
September 2003

EXECUTIVE SUMMARY
A PRACTICE CONTINUATION PLAN ENSURES that in the event of death or disability, a CPA’s practice will go on and its value will not evaporate.

TYPICALLY, SUCH AN AGREEMENT PROVIDES for four basic elements: The mechanism for a smooth and quick transfer of the practice, an agreed-on price or valuation method for the practice, an escape clause for both parties and an attorney’s review and discussion with the spouse or heir.

THERE ARE THREE TYPES OF practice continuation agreements: The one-to-one agreement (usually a buy/sell agreement written to cover the practitioner’s death or disability and undertaken with a firm that can absorb the firm’s work), the group agreement (several CPAs may act as successors to each other’s firm, and clients are given the choice of several surviving firms to choose from) and the state society plan (local associations or MAP committees assist the spouse or heir(s) in finding a buyer for the practice).

THE CPA MUST ASSEMBLE A COMPLETE SET of operating documents, which should list types of services offered, key employees, location of accounting records, bank account information and contracts and lease agreements; a client list, including key contacts, services provided and important deadlines; procedures used to monitor work in progress, so the standby firm can easily determine the status of uncompleted work; location of workpapers; description of filing system; and a complete guide to office procedures.

ONCE THE SOLE PRACTITIONER HAS ANALYZED the practice, he or she can begin to develop a realistic valuation for the business. No discussions with a potential alliance partner should begin without this step.

THE MOST DIFFICULT FACET OF VALUING a practice is determining what each client represents in terms of a future revenue stream. Eads says to link buyout terms to client retention. If the client decamps, the buyer reduces payments.

RICK TELBERG is editor at large and director of online content for the AICPA and his views, as expressed in this article, do not necessarily reflect the views of the Institute. Official positions are determined through certain specific committee procedures, due process and deliberation.

fter breaking away from larger regional firms, CPAs Sharyn Maggio of Shrewsbury, New Jersey, and Michelle Gallagher of Lansing, Michigan, took the plunge and started an independent practice in the past year. Brand-new to the world of sole practitioner—and with the heady tasks of getting and serving clients, opening and staffing an office and developing long-term growth strategies—neither has considered the possibility of untimely death or disability. But some veteran practitioners and practice management advisers say it’s not too early for Maggio and Gallagher each to develop a plan to keep their businesses viable if a setback prevents them from working for an extended period. This article describes the practice continuation plan, its key elements, how it helps a sole practitioner and his or her dependents and clients and how to take the first steps in implementing a plan.

ALLY AND CONQUER
Although Maggio and Gallagher have wills, estate plans and life and disability insurance, neither has a practice continuation plan for her business. “I’ve thought about doing one,” says Gallagher. “But I haven’t had a chance to.” Maggio also sees the merits, yet says she’s too busy taking care of clients. But a practice continuation plan may be the most important insurance policy a sole practitioner can have. It ensures that in the event of death or disability, a CPA’s practice will go on and that its economic value to heirs will not evaporate.

The heart of such a plan is a strategic alliance, spelled out in a contract, between the sole practitioner and another firm. Under such an agreement, the second party is ready to operate and/or buy the practice at the request of the practitioner or his or her heir or designee. Sometimes it’s as simple as the buy/sell agreements any CPA would recommend to a similarly situated client, but experts say it’s an essential part of any firm’s—or single owner’s—planning for life’s uncertainties. Considering the large numbers of CPAs approaching senior citizenship, San Francisco CPA Jerry Sample says practice succession is “one of the most serious issues facing our profession.”
Unpleasant Surprises Happen

CPAs are seven times more likely to suffer a long-term disability than death, and the value of a practice can leak away in as little as one to three months.

Source: Jerry Sample, CPA, San Francisco.

Yet “too many practitioners don’t have a practice continuation agreement,” says John Eads, the author of the seminal text Practice Continuation Agreements, published by the AICPA in 1992 and still in print (see “ Suggested Reading ”). Eads, who is now a partner at Smith Jackson Boyer & Bovard in Dallas, says such CPAs “think they’re bulletproof.”

Practice agreements are a staple—or should be—of any multipartner firm, notes Bob Gallagher, CPA, a Pittsburgh practice management consultant. “A sole practitioner can and should have the same governance and succession documents that a five-partner firm has.” Wilmette, Illinois-based practice management consultant Marc Rosenberg, CPA, says many CPAs allow “irrational fears and anxieties” to prevent them from organizing a needed alliance. In fact, he says, developing one is “not a big deal.”

Ron Stewart, CPA, from Monroe, Louisiana, has long been an “evangelist” for practice continuation agreements. Stewart had one in place with a nearby CPA firm, Heard McElroy and Vestal, for 10 years, partly to provide for untimely death or disability but also because it broadened the range of services he could offer clients. “As time passed, we talked more and more about a formal affiliation,” he says. Finally, facing what he called “upheavals in technology and client needs,” he decided to trigger the plan a couple of years ago, in effect merging to share the workload. “It just seemed like the right thing to do,” he says. Now, at age 59, he is a partner at Heard McElroy and Vestal. “It’s the greatest thing that ever happened,” he says.

HOW AND WHAT
A well-thought-out practice continuation plan can provide a sole practitioner with a mechanism to expediently transfer his or her practice; the framework to eventually merge or sell the practice (offering a turnkey retirement plan); additional expertise and specialty services not otherwise available in a single-owner firm; in the event of death, the smooth sale of the practice and full value to the practitioner’s heirs; in the event of temporary or long-term disability, uninterrupted service to clients at a predetermined fee; assurance to clients that a trusted provider will continue to handle their affairs; and, not least of all, peace of mind to the sole practitioner, who, though he or she may own the firm alone, doesn’t need to feel alone.

The typical practice continuation agreement provides for four basic elements:

The smooth and quick transfer of the practice.
An agreed-on price or valuation method for buying/selling the practice.
An escape clause for both parties.
An attorney’s review and discussion with the spouse or heir(s).

There are three fundamental types of practice continuation agreements:
The one-to-one agreement.
The group agreement.
The state society plan.

T he one-to-one agreement usually takes the form of a buy/sell agreement written to cover the CPA’s death or disability. A sole practitioner generally undertakes this with a firm that is large enough to absorb the smaller one’s work without being overwhelmed. A variation involving two practices of equal size is a cross-purchase agreement, in which two practitioners agree to purchase each other’s practice if an untimely event occurs. Under group agreements, several CPAs may act as successors to each other’s firms, and clients are given the choice of several surviving firms to choose from. Under the state society plan, local associations or MAP committees assist the spouse or heir(s) in finding a buyer for the practice.

ASSEMBLE DOCUMENTS FOR REVIEW
The overall practice continuation plan begins with the sole practitioner’s compiling a complete set of practice operating documents. He or she needs to create a comprehensive client-list profile, too. The CPA must be able to express a thorough understanding of the business of the practice. His or her objective is to use this understanding to induce a suitable allied practice to act as successor. According to the Guide to Managing an Accounting Practice (see “ Suggested Reading ”), a complete set of operating documents may include

A profile of the proprietorship, including types of services offered, names of key employees, location of accounting records, bank account information and location of contracts and lease agreements.

A client list, including key contacts, services provided and important deadlines.

Procedures used to monitor work in progress, so the standby firm can easily determine the status of uncompleted work.

Guide to using the firm’s computers.

Location of workpapers.

Description of filing system.

Office procedures for handling the receipt and return of client information.

Billing schedules and collection policies.

Procedures for identifying and paying accounts payable.

Location of personnel files.

ANALYZE THE PRACTICE
The sole practitioner should begin his or her business analysis with an evaluation of several criteria, according to Eads’ Practice Continuation Agreements, including

Reputation. How good is your reputation for client service and technical expertise? How visible is it in the community? What are your distinguishing characteristics?

Specialties. What are they? Will the successor need the same specialties?

Rates and write-downs. How do they compare in the market? How do they compare with those of the potential successor firm?

Profitability. What has been the practice’s gross, net and salary for the past five years?

Location. Is the local economy sound? Is the market highly competitive? What are lease terms of the office space? How do the terms compare with the market average?

Staff. How’s morale? How well do staff members relate to clients? Are employees likely to remain with the practice through a transition? Are noncompete agreements in place?

Once the CPA has analyzed the strategic business components of the practice, it is time to compile the nitty-gritty details of the client list.

INVENTORY THE CLIENTS
A complete inventory of client profiles is essential for properly negotiating a fair value for a practice. Eads recommends that the CPA compile, in columnar schedule form, the following data on each client:

Name, affiliates and subsidiaries.
Description of business.
Client location.
Names and ages of principals and their equity percentages.
Corporate structure and vulnerability to loss of key executive.
Period of time as client.
How client was obtained.
Type and frequency of services rendered.
Function and number of employees needed to adequately handle the account.
Description of client’s accounting and management systems.
Average fees paid in the past three to five years for regular and special services.
Number of company and personal tax returns prepared for principals and others.
Potential for a fee increase.
Direct costs of servicing the client.
Adequacy of client workpapers and records.
Method of setting fees.
Unusual service problems.
Staff problems with client, if there are any.

VALUE THE PRACTICE
Once the sole practitioner has properly analyzed the practice, he or she can begin to develop a realistic valuation for the business. No discussions with a potential alliance partner should begin without this step. Of course, the value encompassed by the information in the firm’s complete balance sheets and income statements always is essential. But the most difficult facet of the valuation is determining what each client represents in terms of a future income stream. In addition, valuation methods are varied and sometimes subjective. An impartial, qualified valuator can be helpful.

A bout valuing the sole practitioner’s intangible book of business—that is, the control and retention of the client list—Eads recommends basing the buyer’s payments on the collection of future revenues from clients. “Structure a payment method on each client that makes both parties a winner,” Eads says. For example, “If I buy your practice and retain all of the clients under my control, then over the agreed-payment period, I will have paid you 100% of the value assigned. But if a client goes away in the first year, I owe you no more payments” for that client. Each payment is client-specific, and no other client is allocated any part of the payment. “This is what I call a win-win situation for both parties and it is extremely fair,” Eads says. “No party pays more or no party receives more than the retained clients’ value.”

But assigning value to a client list has always been a difficult problem for CPA practices. “In the more than 100 deaths of CPAs that I have handled,” Eads says, my guideline has been that “the practice is worth no less than normalized cash collected on clients for the 12 months previous to death.” Eads defines normalized as continuing, or ongoing, and subtracts nonrecurring business such as filing a form 706 for an estate.

Tips to Organize a Continuation Plan

Review the different kinds of practice continuation agreements:
One-to-one.
Group.
If available, the state society’s emergency assistance program.

Make basic preparations:
Determine what effect your business and personal objectives will have on your choice of successor.
Assess your firm’s market position.
Get your firm in shape.

Assess the value of your practice:
Choose appropriate valuation methods.
Perform the needed valuation calculations.

Search for a successor:
Consider your colleagues, peers, staff, previous employers or a larger firm.
Draw up a list of the best candidates.
Approach the candidates.
Hold preliminary talks.
Don’t rush any decisions.

Begin formal negotiations:
Determine the subjects of negotiation.
Set limits on how much you are willing to compromise.

Once negotiations are completed, implement the plan:
Contact your attorney to draft an agreement.
Discuss plan with spouse and attorney.
Finalize contingency letters of instruction to spouse, clients, attorney and staff.
Communicate in writing to all parties what their role in the transfer will be.
Set up a meeting with your successor.
Set up a date for the first annual review of the agreement.

Source: Practice Continuation Agreements by John A. Eads, CPA. Issued by the Management of an Accounting Practice Committee, AICPA, 1992.

PEACE OF MIND
The ultimate goal of the practice continuation plan is to identify, approach and partner with a suitable firm. But where should a sole practitioner search? CPAs active in their profession and their communities come in contact with potential partners on a regular basis. Bankers and attorneys can be a source of referrals, and CPA societies and professional associations can be a good source for partners.

Eads advises sole practitioners to begin developing strategic relationships with like-minded colleagues through their community groups, professional associations and state CPA societies. For example, the California state society has been considering a proposal to create a pool of firms willing to participate in practice continuation agreements, as sellers or buyers. Most practitioners look for a colleague they have known and trusted for years. They also may consider their own staff and former employees or employers. Sometimes an ideal candidate is right under their nose.

T he process of considering a practice continuation plan, developing it and, finally, executing it is marked at every phase with hard questions for the sole practitioner. They are, to be sure, questions of life and death. But properly handled, the practice-continuation-planning process can sharpen the CPA’s business, help him or her grapple with difficult estate issues and prepare for the best instead of the worst.

Suggested Reading e-MAP: Management of an Accounting Practice Handbook, AICPA. www.cpa2biz.com .

Management of an Accounting Practice Handbook, vols. 1, 2 and 3, AICPA, 2003. www.cpa2biz.com .

Practice Continuation Agreements: A Practice Survival Kit by John A. Eads, AICPA, 1992. www.cpa2biz.com .

Guide to Managing an Accounting Practice, Practitioners Publishing Co., April 2002. www.ppcnet.com .

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