Succession-Planning Dos and Donts

EXECUTIVE SUMMARY

DON’T FAIL TO PLAN. CPAs have to get moving, experts say. Succession isn’t a process that can be done well under pressure or in a hurry. Firms need to address the issues of finding a new firm owner, nurturing future leaders, transitioning clients, codifying operating processes and drafting necessary agreements. NURTURE NEXT-GENERATION LEADERS . The best new owner isn’t just someone with the purchase price; it’s a leader who can run the firm successfully so retirees’ payouts continue. Senior partners have to help younger colleagues understand owner responsibilities and the art of managing a large number of clients and complex engagements. BOW OUT GRACEFULLY . “Retired” partners who retain control may cause turmoil. A partner who retires should relinquish equity ownership and key decision making. If a retiring partner plans to continue to come to work, the firm and the partner should define what that work will be and what both should expect. CODIFY THE CORPORATE STRUCTURE . When owners agree in advance on a corporate structure that one managing partner will implement, then staff and partners have a model to follow, making the transition to new leadership easier. DON’T PUT ALL THE EGGS IN ONE BASKET . Partners should use varied funding vehicles and not count on a buyout to cover retirement needs. The succession-planning survey found 77% of firms had not funded their retirement programs fully, and 61% had no retirement funding at all. Funded retirement plans give partners the security to make practice continuation decisions that emphasize the needs of clients and staff. REMEMBER THE BIG PICTURE . When firms consider succession planning to be one aspect of running a better business—one that can weather a successful switch to a new generation of leaders—they will be able to achieve the best results.

ANITA DENNIS is a JofA contributing editor and freelance business writer.

or many CPAs the practice they have spent years building is both their most valuable asset and their retirement vehicle. However, surprisingly few have a solid exit plan for selling their firms or turning them over to the next generation. Indeed, most baby-boomer partners, born between 1946 and 1964, have considered funding a retirement program unnecessary in the belief they can readily find willing buyers for their practices when they’re ready to sell. That’s not necessarily so, says consultant William Reeb, CPA, of Winters & Reeb PLLC in Austin, Texas: “Basic laws of supply-and-demand may make that scenario a problem, given the number of small firms with partners between 45 and 70.”

Reeb, who conducted the 2004 PCPS survey on succession planning, says 70% of surveyed firms recognized succession would be an issue in the next 10 years, and 41% thought the solution should be a merger or sale (vs. an internal transition). But “the handwriting is on the wall: A buyers’ market will result from oversupply when CPAs start to retire in force,” he says. Partners who don’t invest in developing the leadership, operating efficiencies, procedures and a culture that can ensure firms’ continuation after they go “will be shocked at the rapidly declining value of their biggest personal asset.” To help CPA firm partners prepare a successful exit, this article offers tips derived from the survey and conversations with practitioners.

DON’T FAIL TO PLAN
While 62% of firms surveyed said succession planning would be an important issue for their firms in the near future, only 19% had a written succession plan. Half hoped to formulate one soon, while 22% believed they didn’t need one at all. Although 28% said they already had successfully managed succession issues, 30% hadn’t dealt with the topic at all and 8% acknowledged they had managed it poorly in the past.

It’s time to get moving, experts say. “Succession isn’t a process that can be done well under pressure or in a hurry,” Reeb says. “While it’s possible to address the issues of finding a new firm owner, nurturing your future leaders, transitioning clients, establishing operating processes that will continue, drafting necessary agreements (practice continuation, buy-sell and other agreements) and more, those steps are best supported by evolution.”

NURTURE NEXT-GENERATION LEADERS
The best new owner isn’t just someone with the purchase price; it’s a leader who can run the firm successfully so retirees’ payouts continue. When partners fail to treat junior partners and managers like future owners, young principals don’t learn essential leadership skills. “Senior partners have to help younger colleagues understand owner responsibilities and the art of managing a large number of clients and complex engagements,” Reeb says.

Practitioners who launch a firm tend to be good at bringing in business and building client relationships, notes Richard Caturano, CPA, managing partner of 240-person Vitale, Caturano & Co. in Boston and chairman of the PCPS executive committee. When firms rely on founders to do that indefinitely, the next generation doesn’t develop those skills. Mature partners should take junior colleagues along on client visits and meetings as much as possible so they can learn by example, he says.

“It takes at least five years of lead time to develop a successor,” says Christine Lauber, CPA, a South Bend, Indiana, sole practitioner. Part of that process involves selecting the right people to groom. A partner candidate with the necessary entrepreneurial instincts takes responsibility for both errors and achievements, she says, and

Puts the client first. Focuses on quality (even if a clear financial reward isn’t always obvious). Looks for opportunities and initiates action. Is observant about his or her environment. Is a long-term thinker. Focuses on results. Is comfortable with performance compensation.

Note: Younger colleagues likely will make some errors when given new responsibilities, so senior partners should keep that aspect of the learning curve in perspective. “A $1,000 mistake during the learning phase may prevent a $100,000 mistake once the new partner is in charge,” Reeb says.

BOW OUT GRACEFULLY
Only 36% of firms set a mandatory retirement age—though not having one can complicate succession. “Retired” partners who retain control may hinder growth, alienate promising future leaders and cause turmoil. “Know when to bow out,” Caturano says. “A partner who retires should relinquish equity ownership and key decision making. If he or she wants to continue as a consultant, fine—but send a press release to make sure everyone knows his or her role has changed.”

At Horovitz, Rudoy & Roteman, a 45-person Pittsburgh practice, Gordon Scherer, CPA, says his firm made a plan to pass the baton at a partner retreat two years ago when, at 60, he decided to exit his managing partner job by the end of 2004. Since then, his firm has taken advantage of leadership training available from his CPA firm association to help in the succession process. Scherer says, “This past year I’ve included the incoming managing partner in every major decision” and encouraged next-generation leaders to represent the firm in public so they could become perceived as its face. He also says: “If a retiring partner plans to continue to come to work, define what that work will be, how compensation will work and what the firm and the partner expect.”

CODIFY THE CORPORATE STRUCTURE
Chief executives at large organizations manage according to rules created by a board of directors and make day-to-day decisions without obtaining buy-in from every owner. Seven out of ten surveyed firms said they, too, followed documented operating procedures. Smaller firms may find it helpful to emulate the corporate model and create standard procedures and a management structure that includes an outside board of directors.

When a strong managing partner who’s made most of the decisions retires, younger partners—in hopes of creating a more collegial atmosphere—often try to run the firm by consensus. That’s a poor way to manage an organization. “If every owner is involved in every decision, chaos ensues,” Reeb says. When owners agree in advance on a corporate structure that one managing partner will implement, then staff and partners have a model to follow, making the transition to new leadership easier.

DON’T PUT ALL THE EGGS IN ONE BASKET
The succession-planning survey found 77% of firms had not funded their retirement programs fully, and 61% had no retirement funding at all. Among firms with funded plans, the average plan was just 13% funded. “Funding our retirement along the way provides us the security to make practice continuation decisions that emphasize the needs of our clients and staff,” says Peggy Ullmann, CPA, of Ullmann & Co. in Phoenix. “A retirement plan might be funded by the firm—mine is—using a profit-sharing plan, simplified employee pension plan or simple contributions. The employee also may fund the plan via contributions to a 401(k) or to a Roth or traditional IRA. Individual savings and investments for one’s senior years also are part of a typical retirement scenario.”

Some firms designate income from niche services to fund partner retirement. For example, Horovitz, Rudoy & Roteman offers a proprietary in-house payroll service that represents about 3.5% of the firm’s income, and “our principals have designated that money for funding the cost of partner retirement,” says Scherer.

REMEMBER THE BIG PICTURE
“If you approach succession planning as a single-focus task, you will fail,” Reeb says. Instead, firms must consider the range of issues that need to be addressed in different ways, including basic strategies such as creating a single corporate structure that will carry the firm from one set of leaders to another and nurturing new firm executives who can lead the organization into the future.

As baby boomers retire en masse and acquiring firms become more discriminating about the types of practices they buy, practitioners with unfunded retirement plans may face tough realities when they’re ready to leave the work force. Insiders note that trend already is taking shape. “While a firm once might have been happy to take on new clients of any type, buyers now want clients that fit their specific practice,” Reeb says. Future firms will be more likely to focus on buying CPA practices because of certain niche strengths, access to a particular community or other strategic issues. “Buyers will be unwilling to pay for marginal clients or for clients supported by services that will be discontinued because they don’t fit those of the buying firm,” he says.

Ultimately, those who approach succession planning as a way to get the best financial deal likely will face disappointment, because this method is too simplistic for such a complicated task. Says Reeb: “When firms consider succession planning to be one aspect of running a better business—one that can weather a successful switch to a new generation of leaders—they will be able to achieve the best results.”

Ideas for Sole Practitioners

P ractice continuation agreements that establish who will operate or buy a firm in the event of a sole practitioner’s death or disability are critical, but the PCPS survey found just 8% of the surveyed sole practitioners had them—and those that did sometimes neglected to think through some important aspects.

Groups of firms often form a reciprocal agreement that if one owner dies, another will buy his or her firm. However, the agreements don’t always stipulate which firm will buy the practice or how to value the firm or structure the transaction. Participating owners may not have investigated each other’s financial situation, staffing or client base to see whether they would be able to retain the old firm’s clients. As a result, when an owner dies and it’s time to enforce the agreement, the remaining firms may have no interest in buying.

“The best practice continuation agreements specify all the details of the purchase: who will buy, what they will buy, what they will pay and how the transition will work,” says Reeb. Agreements also should detail how to handle billing rates and profits in case of an owner’s disability, or when a disabled partner returns to work. While this often is more detail than anyone really wants to work through, the issues need to get resolved before a disability or tragedy occurs, he says.

Despite these considerations, agreements don’t have to be complicated in practice. Adele Brady Bolson, who runs a three-person firm in Bellevue, Washington, has a relatively simple arrangement with another practitioner. If Bolson should die, the other CPA has first right of refusal to buy the practice. If she chooses not to buy, she will handle the sale of Bolson’s firm either to current employees or to an outside buyer for Bolson’s estate. For her efforts, she will receive 10% of the purchase value.