funding a partner’s buy-in or buyoutstructuring the buyout partner buyouts for retirement can be...

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Funding a partner’s buy-in or buyout

Strategies to simplify transitionsMuch has been written about the aging of the accounting profession, particularly among the partners who own many of the smaller-to-medium-size CPA practices. The arrival of the Baby Boomer generation triggered a large growth in the number of professionals, and as the Boomers reach retirement age, many are ready to pass the torch on to younger members of their practices.

But that transition isn’t as smooth as it might appear on the surface. First, many practices are struggling with how to handle the financial side of a partner’s retirement. How does a practice provide fair compensation for the impacts of a career without placing a burden on the remaining partners? The second major issue involves the people who are expected to take the torch. As those Boomers prepare to retire, they’re discovering that their younger associates don’t always share the desire and enthusiasm they had for partnerships -- and those who are interested in ascending into an ownership role often lack the financial wherewithal.

In this document, we’ll explore both sides of that dilemma and share buyout and buy-in strategies that may make sense for your CPA practice. We’ll also touch on the human resources aspect of the partnership issue, both in terms of how careers should come to close and how younger professionals can prepare to take on their new role.

A surprising lack of planningBy their very nature, accountants are a cautious lot who constantly counsel clients to prepare for a variety of contingencies. In fact, such contingencies are central to professional standards and

practices. That’s why it’s surprising that so few practices give serious thought to retirement and the process associated with partners leaving the practice.

While most CPA practices in the top 100 require that their professionals retire at some point between age 60 and 66, smaller practices may have a less formalized approach.1 Even those with the foresight to develop formal succession plans often turn to attorneys who lack understanding about the nature of CPA practice partnerships to draft those plans. Consequently, reports Marc Rosenberg, CPA and president of The Rosenberg Associates, 9 out of every 10 agreements he reviews include major deficiencies. Even more concerning, Rosenberg says a quarter of all CPA practices fail to include retirement provisions in partnership agreements. 2

Those deficiencies are unnerving given the sheer number of partners who are rapidly approaching retirement age, at which time they are expecting their practices to buy out their equity, which typically involves either paying out capital and/or providing deferred compensation. If those practices are on the hook for such payments without a clear agreement, there is the potential for chaos and disagreement. Retirement should be a positive step, not a foundation for legal battles. 3

Just as concerning is the number of CPA practices that lack any type of formal partnership agreement. According to a 2016 AICPA survey, 37 percent of practices had no such agreement, and just over half of those reported no plans to create one. Moreover, only 35 percent of practices that were surveyed had a mandatory retirement age. 4

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Is it time to go?Another sound reason for incorporating retirement provisions into partnership agreements is that it takes much of the emotion out of the process. In some cases, younger partners might be eager to see a particular partner step away from the practice, especially if his or her performance has been slipping, or if significant health issues are involved. A well-crafted agreement can soften much of the sting. The AICPA study reported that 41 percent of practices had formal standards for acts that can trigger a forced retirement. 5

An additional common situation involves partners who aren’t particularly excited about the prospect of retirement. If their work is a critical element of their sense of self-worth, they may look for ways to make themselves appear to be indispensable, such as preventing younger members of the practice from interacting with their key clients. The result may be a gradual retirement process, in which the practice is unable to transition clients to younger partners as early as desired. That may also create a lack of opportunity for younger partners, who may become frustrated enough to seek positions elsewhere. Or, if the practice is too aggressive in urging retirement, the retiring partner may leave with resentment and complain to clients about the treatment received. Having a well-defined process and timetable minimizes the potential for these and other negative situations. 6

The partnership agreement’s retirement provisions should allow the practice enough time to prepare for the retirement. Asking for formal notice at least two years in advance is usually adequate for the other partners to create an orderly transition with clients and internal roles, and prepare financially for whatever will be paid to the retiring partner. 7

Structuring the buyoutPartner buyouts for retirement can be structured in several ways, most commonly either as a lump-sum or a series of payments over time. For most smaller practices, a lump-sum payment would require either a significant depletion of capital or debt financing. In addition, a series of payments provides a steady source of retirement income for the departing partner. Another option is an earn-out, in which the partner receives payments over time that are based on the practice’s performance, and in which the partner may need to commit to working for a set number of years.8

Essentially, the buyout is compensating the partner for his or her historical earnings that contributed to the practice’s capital, covering the replacement of the partner’s time through the hire of new professionals, and rewarding the remaining partners for assuming the buyout’s obligations. 9

What’s it worth? The starting point in the buyout process involves determining what the practice as a whole is worth. After all, a partner in a four-partner practice may hold 25 percent of ownership, but the value of that 25 percent depends entirely upon the total value of the practice. While that may seem to be an obvious concept for professional accountants, the reality is just 53 percent of practices in the AICPA study had formalized a valuation methodology for partner ownership interest upon retirement. 10

As with most businesses, the assets held by CPA practices fall into tangible and intangible categories. The tangible assets are cash and investments, receivables, and fixed assets in excess

Whitepaper: Funding a partner’s buy-in or buyout

“ The partnership agreement’s retirement provisions should allow the practice enough time to prepare for the retirement.”


of the liabilities on the balance sheet. The intangibles include goodwill, the value of the workforce, and other items such as brand names. While intangibles are often valued at two to five times their tangible counterparts, they are usually based on a practice’s future earnings potential, which depends heavily upon client and staff retention. 11

The buyout plan must prescribe the valuation of the practice’s capital and its goodwill. It’s easy to value capital based on straightforward factors (generally, it’s equal to about 25 percent of a practice’s revenue), but goodwill tends to be more hazy. Marc Rosenberg reports that most practices value goodwill at 80 percent of revenue, with just under a quarter of practices choosing to value goodwill at 100 percent of revenue for buyouts. The lower number reflects a more conservative approach and the attitude of younger partners who feel they deserve a larger share of goodwill for their work in building the practice’s earnings and reputation. They may also worry that a retirement will lead to the loss of some of that partner’s clients, impacting earnings. 12

Rosenberg identifies four central philosophical components to capital and goodwill when planning for buyouts:

• A retiring partner is entitled to the value of their interest in the practice, including a portion of the goodwill.

• The partner’s interest should reflect all contributions, including efforts to add clients, manage operations, and develop staff.

• Losing a partner prematurely generally hurts a CPA practice, because partners contribute in ways non-partners cannot.

• Any remaining partners’ compensation should increase or at least remain the same following a buyout.13

Acquisitions are different. Some practices attempt to value partner interests by looking at the total price the practice would command if it were to be acquired by another practice. That approach is fundamentally flawed for several reasons. For one, acquisitions often involve bidding or negotiation processes that may drive the market value artificially higher. For another, a buyout is a guaranteed sale, in which the other partners are contractually obligated to purchase their partner’s share. The practice also remains the same during the buyout, increasing the likelihood that current clients will remain with the practice, which is less likely to be the case in an acquisition. 14

Common approaches. Typical self-funding buyouts are structured to pay out any cash basis capital during the first year of retirement, with any accrual basis capital above the cash basis amount spread out over five to ten years. Payments of deferred compensation are paid over ten or more years. 15

One approach involves paying the retiring partner a total of three times his or her normal annual compensation, but spread it across ten years. Sinkin and Putney offer an example in which a retiring partner had earned $300,000 annually. The remaining partners therefore agree to pay her $90,000 per year for ten years, or a total of $900,000. Assuming the practice’s revenue at least remains level, and the staff member hired or promoted to replace the departing



partner earns $100,000 annually, the remaining partners have gained $110,000 in net cash each year ($300,000 less the $90,000 payment and the $100,000 employee compensation). 16

Tax treatment. While payments to retired partners are generally treated as compensation, and are thereby deductible for the practice and taxable to the payee as ordinary income, many practices are electing to designate a portion of those payments as acquisitions of goodwill. While that allows a retiring partner to treat that part of the payments as a capital gain, it forces the practice to amortize the payments over 15 years instead of immediately deducting them, making them less attractive. 17

Limiting retirements. A well-constructed plan should also limit the amount of buyout payments that can be made at any one time, particularly if partners are close in age. If the practice faces several simultaneous retirements, or a series timed so that payments are being made to several retirees at once, the payments can quickly drain the available capital and create more debt than the remaining partners may be willing to assume. One practical approach is to limit total payments to a percentage of annual revenues, with 6 to 8 percent as a common standard. 18

Preparing for new partnersAs longtime partners retire, CPA practices also need to think about the best ways to bring younger replacements into the organization. That’s important not only because of the many leadership roles partners provide within a practice, but because increasing the number of owners should enhance the practice’s ability to the fund the current partners’ retirements when that time comes.

However, adding partners isn’t quite as easy at sounds. While most of today’s CPA practice partners began their career in an era when earning the right to become a partner was the eventual goal of every newly minted CPA, today’s crop of new professionals doesn’t always see things that way. Some are unwilling to pay “dues” today for a chance at benefits or more status down the road. Others are less likely to make the long-term commitment that working for a partnership demands, or are unsure about the prospects for the profession. For those who do have an interest in a partnership, the reluctance to take on additional debt to do so may be a deal-breaker. And, in some cases, current partners may not be eager to provide financial incentives that may temporarily reduce the value of their own shares. 19

At the same time, the owners of many local and regional CPA practices bemoan the lack of younger employees who display the attributes conducive to partnership, including leadership skills, an entrepreneurial attitude, the ability to generate new business, and the basic ambition to take an ownership role. 20 Some practices are using partner-in-training programs as a way to both interest potential candidates in the opportunity and determine whether they would be a good fit. Programs of this type are typically a year or two in length, giving prospective partners a chance to sit in on some partner meetings, gain access to behind-the-scenes information such as profitability data, and take on projects designed to sharpen their skills as needed. 21


“A well-constructed plan should also limit the amount of buyout payments that can be made at any one time, particularly if partners are close in age. ”


Another approach that helps to prepare prospective equity partners for that role is the development of “non-equity partner” positions that offer many of the perks and public status associated with full partnership, without the extra compensation or commitment. Clients may not be aware of the difference between the two types of partners, helping fulfill the non-equity partner’s psychological need to hold a prominent role in the practice. The full partners can subsequently decide whether to extend an equity partnership offer or simply allow the individual to stay in the partially elevated role. 22

Creating the buy-in programThe first step in developing a buy-in program for new owner-partners is ensuring that an appropriate buyout plan is in place for retirement, because the two are interconnected. Part of the cost of becoming a partner is agreeing to take on a commitment to financially support retiring partners, along with the expectation that the extra responsibility associated with partnership comes with a long-term benefit.

A buy-in plan is an effort to find a middle ground between competing interests. The current partners have probably invested substantial sweat equity in the development of the practice and want to ensure that they will be properly compensated for that. The new partners want to maximize the value they’ll receive for their investment, whether that investment is an upfront payment or a deduction from future earnings. The plan needs to address what new partners stand to gain, how much of a share the new partner will receive, how the price of admission is determined, and whether that price goes to the practice’s coffers or directly to the other partners.

The plan needs to be formalized in writing, detailing specific costs, any financing options, and the expectations for new partners. New partners must know exactly what role they’ll play, what type of professional development is expected, and how their progress toward goals will be measured. Anything that’s vague or left open to interpretation will only lead to misunderstandings, arguments, and future legal challenges. 23

The structure of the buy-inThere is no single buy-in structure that’s right for every practice. Some practices expect new partners to make an immediate payment in cash or by assuming a large loan. Other may expect payments quarterly or annually, perhaps by taking a portion of whatever share of profits or bonuses partners are entitled to. 24

In the past, CPA practices typically expected new partners to buy in with valuations that added a significant goodwill factor to a capital account number, but that often led to buy-ins in the $400,000 to $700,000 range, which were out of the reach of many professionals. That led most practices to abandon this approach, and the recent Rosenberg Survey found that the average buy-in investment among the 400 practices it surveyed was $144,000, with only 18 of the practices reporting that they required more than $400,000. 25

Today, it’s more common for buy-in values to be based on the new partner buying a portion of the practice’s accrual basis balance sheet, and earning a share of goodwill value through a vesting process that rewards years of service.



Even a price of $144,000 may be out of reach for an up-and-coming professional, so practices have to determine equitable ways to help with financing as a way to encourage the new partners. While some withhold repayments from future payroll and profit distributions, a sensible approach relies on outside financing. The practice agrees to guarantee a loan made by an outside lender, and in so doing, helps the new partner obtain a better rate and terms. The new partner pays the borrowed amount directly through his/her monthly income to the lender. 26

Adding to ownershipWhen partnership plans allow for different levels of ownership among the partners, such as new partners receiving a much smaller share, eventually those newer partners are likely to ask how they can increase their percentage of ownership or even become equal partners.

A CPA practice is likely to change over time as both partners and clients come and go. A partner whose role is critical today may be less important in 20 years because of changes in the industries served or a desire to be less active in the business. A carefully drafted partnership agreement should also address how shares of ownership may change over time, and how larger partners will be compensated for any reduction of their ownership percentage. The complexity inherent in such an approach justifies any investment in bringing an outside specialist in to draft or review a practice’s agreement. 27

Financing buy-ins and buyoutsIf your buy-in or buyout program calls for financing of transactions, it may be difficult to work with traditional lending sources. For example, local banks are accustomed to financing tangible asset transactions, and may not be comfortable with the complex nature of professional partnerships like CPA practices.

That’s why a growing number of CPA practices turns to specialty lenders that are accustomed to working with the accounting profession. Such lenders understand how a practice like yours operates, and are familiar with the nature of your structure and revenues, so they can approach the underwriting with realistic expectations and an appreciation for inherent risks.

Working with Oak Street Funding®

With a loan from Oak Street Funding, you can borrow against the future cash flows from your clients. It’s a solution other CPA practice owners have used to finance strategies for partner buy-ins and buyouts.

Oak Street can customize a loan for your needs and situation, from $100,000 to $30 million, with a term of one to ten years. The goal is to help you finance growth with minimal out-of-pocket cost by leveraging the power of your practice’s cash flow. Learn more or request a free quote at www.oakstreetfunding.com or 1-866-OAK FUND.

The strategic opportunities available to CPA practices are limitless. Access to affordable capital is the key to taking advantage of those opportunities, and Oak Street Funding has money to lend.


“A CPA practice is likely to change over time as both partners and clients come and go. ”


About Oak Street Funding

The materials in this paper are for informational purposes only. They are not offered as and do not constitute an offer for a loan, professional or legal advice or legal opinion and should not be used as a substitute for obtaining professional or legal advice. The use of this paper, including sending an email, voice mail or any other communication to Oak Street, does not create a relationship of any kind between you and Oak Street.

Loans and lines of credit subject to approval. Rate may vary at any time. CA residents: Loans made pursuant to a California Department of Business Oversight Finance Lenders License (#6039829). Potential borrowers are responsible for their own due diligence on acquisitions.

1 Stanger, Richard and Carlson, Carolyn, “Planning Partner Retirements,” accountingtoday.com, undated.

2 “Marc Rosenberg’s Advice on Partner Retirement and Buyout Plans,” sageworks.com, December 16, 2016.

3 Putney, Terry, CPA, “Buying Out Retiring Partners,” cpapracticeadvisor.com, January 16, 2018.

4 American Institute of CPAs, “CPA Practice Succession Management Multi-Owner Survey Report,” 2016.

5 ibid.

6 Stanger and Carlson, op. cit.

7 Sinkin, Joel and Putney, Terry, CPA, “Planning and Paying for Partner Retirements,” Journal of Accountancy, April 2012.

8 Murphy, James, “How To Structure And Finance Your Partnership Buyout,” forbes.com, July 3, 2017.

9 Sinkin and Putney, op. cit.

10 AICPA, op. cit.


12 sageworks.com, op. cit.

13 ibid.


15 Putney, op. cit.


17 ibid.

18 ibid.

19 Weinstein, Stephen, CPA, “Adding a New Owner to Your practice,” Journal of Accountancy, August 2003.

20 ibid.

21 Adamson, Gary, CPA, “Here Are Some Best Practices for Admitting New Partners to Your Accounting Practice,” accountingweb.com, undated.

22 Weinstein, op. cit.

23 ibid.

24 Meyer, Cheryl, “What to Know Before You Become Partner,” aicpa.org, undated.

25 Rosenberg, Marc, CPA, “How Practices Disguise Their New Partner Buy-In,” rosenbergassoc.com, January 4, 2016.

26 Adamson, op. cit.

27 Weinstein, op. cit.


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