also: 28 main provisions of partner buyout plans.
by marc rosenberg
how to bring in new partners
this chart shows the different systems that firms across the country are using for partners’ goodwill payments. the data is from a recent edition of the rosenberg map survey.
more: how partner buyouts work | 11 best practices for partner compensation | why buying into a firm is such a great investment | the business side of cpa firms | it shouldn’t take so long to make partner | three types of skills you need to become a partner | seventeen basic expectations of partners
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six systems used to determine partners’ goodwill payments
| system | 2-4 partners | 5-7 partners | 8-12 partners | 13 + partners | total |
| multiple of compensation | 34% | 49% | 58% | 61% | 47% |
| book of business | 8% | 15% | 7% | 0% | 9% |
| ownership percentage | 25% | 16% | 4% | 4% | 15% |
| average annual value (aav) | 18% | 11% | 22% | 25% | 17% |
| fixed | 13% | 9% | 7% | 7% | 10% |
| equal | 2% | 0% | 2% | 4% | 2% |
the two best systems
multiple-of-compensation method. the most common method used by firms, multiple of compensation is quite simple: goodwill-based retirement benefits of each partner are equal to the person’s compensation immediately prior to retirement times a predetermined multiple. almost all multiples range from 2 to 3.
here’s an example. assume a firm chooses a multiple of 3. further assume that a partner’s income is $500,000 prior to retirement. using the multiple-of-compensation method, this partner would receive a goodwill buyout of $1.5 million. if payable over 10 years, that’s $150,000 a year. as a practical matter, most firms average the highest three of the partner’s last five years’ income, or other similar convention.
aav method. the letters stand for “average annual value,” but these words don’t adequately describe the system. a better name would be the “cumulative benefits” method.
the fundamental aspect of this system: new partners are not entitled to any portion of the goodwill value of the firm that was built up before they became partners, unless they purchase it as part of the buy-in.
here is an illustration of the aav method. assumptions:
- the firm has annual fees of $5 million.
- the firm chooses to value the goodwill at one times fees, which comes to $5 million.
- there are four partners prior to a fifth partner being admitted.
- the firm grows at 10 percent per year.
- total partner income is 1/3 of revenue, or $1,667,000.
- partner income is allocated as follows for partners a-e, respectively: 30% – 30% – 15% – 15% – 10%.
the aav method illustrated
| ptnr | balance 1/1/20 | increase in fees | balance 12/31/20 | increase in fees | balance 12/31/21 |
| a | $1,500,000 | $150,000 | $1,650,000 | $165,000 | $1,815,000 |
| b | $1,500,000 | $150,000 | $1,650,000 | $165,000 | $1,815,000 |
| c | $1,000,000 | $75,000 | $1,075,000 | $82,500 | $1,157,500 |
| d | $1,000,000 | $75,000 | $1,075,000 | $82,500 | $1,157,500 |
| new ptnr e | $0 | $50,000 | $50,000 | $55,000 | $105,000 |
| total | $5,000,000 | $500,000 | $5,500,000 | $550,000 | $6,050,000 |
the annual increase in fees is allocated to the partners in the ratio of their income allocation percentages. the aav system works only if the partner compensation system is performance-based. income is shared based on the ratio of their contributions to the firm’s profitability, which should be reflected in the ratio of the partners’ respective incomes.
new partners build up their retirement benefits year by year. when a partner retires, the retiree’s benefits are reallocated to the remaining partners. this is the fastest way for newer partners’ benefits to jump up.
partner buyout plans: 28 main provisions
| terms | what firms are doing |
| capital | |
| 1. total capital defined | mostly accrual basis capital; some cash basis |
| 2. payout period | 5-10 years |
| 3. interest on payments? | almost all firms |
| 4. individual share determined | partnership accounting is most common; some owner percentage |
| goodwill | |
| 1. the math must work. | when a partner retires, the other partner’s income either increases or, at worst, does not go down. |
| 2. goodwill valuation | 80% is average; 100% is still common |
| 3. determination of individual goodwill amount |
· most use a multiple of comp, say three times · some firms use cumulative growth (aav) · smaller numbers use ownership percent, book of business or pay-equal · comp system must be performance-based and fair if multiple of comp or aav methods used · avoid penalizing preretirement partners for transitioning clients to other partners |
| 4. role of firm ownership | virtually none |
| 5. term of payout | 10 years is very common, though there are signs of this inching up |
| 6. interest on benefits? | almost never |
| 7. vesting | · many variations
· many firms base it on age as well as years as a partner. · most common for full vesting: 10-20 yrs. · common for reductions in vesting if partner retires prior to age 60-66 · common for new partners to wait five years to vest anything |
| 8. age for 100% vesting | ranges from 60 to 66 |
| 9. when retirement allowed | most allow it any time; some firms require the partner to reach a minimum age, say 50, before being eligible for any payments |
| 10. notice required | no notice = no goodwill; more and more firms are moving to 2 years |
| 11. client transition practices | no transition = no goodwill; if the retiree fails to comply with the firm’s client transition policy, the firm, at its discretion, can reduce the buyout |
| 12. retirement mandatory? | most firms have this at 65 or 66, with a provision that if a partner wishes to continue working, annual approval is needed |
| 13. limits on the annual payout |
often 5-10% of revenue
|
| 14. when payments start if a partner withdraws | most will begin payments when a partner withdraws |
| 15. funding | very little except for life insurance |
| 16. reduce benefits if clients leave? | · 80% of firms do not reduce; 20% do
· pegging benefits below 1x fees provides a reserve for client loss |
| 17. nontraditional and/or non-annuity-type services | most firms do not pay buyouts if these services walk away when the partner retires. the key: has the partner institutionalized the services? |
| 18. retired partners work part-time | common: pay 40% of the time + new business commission, but retiree must provide value |
| 19. health coverage | varies but usually stops when a partner retires |
| 20. taxation of payments | deductible by the firm; regular income to the retiree |
| 21. death and disability | most treat it the same as regular retirement |
| 22. disability – continuation of partner’s comp | common: until disability policy kicks in or until disability is official. 100-75-50-25 is common. no pay after one year. |
| 23. withdrawing partners | must pay 100-150% of fees for clients/staff taken |
| 24. clawback | if the firm is sold for better terms during the payout period, retired partners benefit from higher terms over a 5-year phase-out period. |