{"id":54358,"date":"2018-04-21t16:04:26","date_gmt":"2018-04-21t20:04:26","guid":{"rendered":"https:\/\/48e130086c.nxcli.net\/?p=54358"},"modified":"2020-08-31t21:22:42","modified_gmt":"2020-09-01t01:22:42","slug":"ownership-percentage-capital-accounts","status":"publish","type":"post","link":"\/\/www.g005e.com\/2018\/04\/21\/ownership-percentage-capital-accounts\/","title":{"rendered":"ownership percentage and capital accounts"},"content":{"rendered":"

\"cut3 ownership percentage problems and 4 provisions for the capital section.<\/strong><\/p>\n

by marc rosenberg<\/i><\/p>\n

the term \u201cownership percentage\u201d has wrought havoc in cpa firm operations for decades. how so?<\/p>\n

more:<\/strong> what\u2019s in a (firm) name?<\/a> | a crash course in partner retirement\/buyout plans<\/a> | 5 key reasons to have a partner agreement<\/a> | protect your business with a solid partner agreement<\/a>
\n\"goprocpa.com\"exclusively for pro members. <\/span><\/strong>log in here<\/a> or 2022世界杯足球排名 today<\/a>.<\/span><\/p><\/blockquote>\n

first, let\u2019s take a step back. there are five primary ways that ownership percentage may impact a firm and its partners:<\/p>\n

    \n
  1. determining new partner buy-in<\/li>\n
  2. allocating partner income<\/li>\n
  3. determining partner retirement\/buyout benefits<\/li>\n
  4. allocating the proceeds of the firm’s sale to the partners<\/li>\n
  5. voting<\/li>\n<\/ol>\n

    the old-school model of cpa firms dictated that ownership percentage determined all<\/strong> or nearly all of these five factors. we still see many smaller firms (say, under $5 million) use this approach. here is how it worked:<\/p>\n

      \n
    1. buy-in<\/strong> is computed by multiplying the new partner\u2019s ownership percentage (however this is mystically determined) times the value of the firm, such value equaling the sum of its capital plus goodwill (for purposes of this example, assume goodwill equals one times revenues). if the new partner\u2019s ownership is 10 percent and the value of the firm is $5 million, the buy-in is $500,000.<\/li>\n
    2. partner compensation.<\/strong> if a partner is a 20 percent owner and total partner income is $2 million, this partner\u2019s compensation is $400,000.<\/li>\n
    3. partner buyout.<\/strong> if a partner is a 20 percent owner and the value of the firm, including goodwill, is $5 million when the partner retires, then his or her retirement benefit is $1 million.<\/li>\n
    4. allocation of the proceeds of a firm sale.<\/strong> same as above.<\/li>\n
    5. voting.<\/strong> if a someone is a 60 percent partner, and all the other partners\u2019 ownership totals 40 percent, and the minority partners always vote no, the 60 percent partner wins every vote, 60-40.<\/li>\n<\/ol>\n

      these practices create enormous problems:<\/p>\n

      1. in the annals of practice management, what ingenious method exists to determine what the ownership percentage should be for a new partner? or the existing partners, for that matter? hint: there is none.<\/p>\n

      in hundreds of partner interviews over the years, i frequently ask them how their present ownership percentage got to where it is. almost all say, \u201ci have no idea.\u201d<\/p>\n

      2. basing compensation, retirement benefits and distribution of firm sale proceeds on ownership percentage completely takes out the performance factor in determining how these vitally important areas are valued. only through a quirk of fate would the partners\u2019 ownership percentages bear any relationship to their comparative performance.<\/p>\n

      3. basing partner votes on ownership percentage effectively disenfranchises the low-ownership partners because their votes don\u2019t matter.<\/p>\n

      every time a vote is taken, the majority partner(s)’ votes exceed the sum of all<\/strong> the low-ownership partners\u2019 votes.\u00a0\u00a0 this is no way to encourage people to act like partners.<\/p>\n

      the folly of using ownership percentages to govern firm decisions<\/h3>\n

      four people from a larger firm decided to quit and form their own firm. any new business needs startup capital, so the partners forked over the cash. one partner was much wealthier than the other three, so his capital contribution represented 40 percent of the total. the firm elected to use ownership percentage to allocate compensation and determine retirement benefits.<\/p>\n

      after two or three years of operations, it became apparent that the 40 percent partner needed a new role in the firm. he came into the firm, just as the others did, as a normal client service partner. two problems soon surfaced: the 40 percent guy had a much smaller client base than the others.to make matters worse, he had difficulty retaining the clients he had and wasn\u2019t able to bring in new business. some of the other partners delegated some of their clients to the 40 percent guy, and he lost them, too!<\/p>\n

      to resolve the problem, the firm made the 40 percent guy the firm administrator. well, he screwed that<\/strong> up too!<\/p>\n

      imagine the quagmire the firm found itself in: it had a 40 percent partner who had the highest compensation and accumulated retirement benefits, but he needed to be terminated.<\/p>\n

      after a great many awkward discussions, the 40 percent guy was bought out and left the firm.<\/p>\n

      what role should ownership percentage play?<\/h3>\n

      not much. the relationship between the five main areas of impact and ownership percentage should be kept to a minimum or totally eliminated. here is a chart that you can use as a guide:<\/p>\n

      the role of ownership percentage<\/strong><\/p>\n

      \"chart<\/a><\/p>\n

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      capital<\/strong><\/p>\n

      in the days when almost all firms were simple partnerships, each partner\u2019s capital account was increased by capital contributions and income allocations and decreased by cash distributions. this remains the method used by most firms, even though other legal entities have surfaced.<\/p>\n

      some firms don\u2019t use the partnership accounting approach and use these methods for determining each partner\u2019s capital accounts:<\/p>\n

        \n
      1. maintain separate capital accounts for each partner off the books<\/li>\n
      2. ownership percentage times total capital<\/li>\n
      3. some firms define ownership percentage as each partner\u2019s capital plus goodwill divided by that number for the firm.<\/li>\n
      4. each partner\u2019s share of the capital is in the ratio of his or her partner compensation.<\/li>\n<\/ol>\n

        it is quite common at many large firms (usually those over $20-$30 million) to redetermine each partner\u2019s capital account requirement every 1-3 years based on relative compensation. the result is that partners whose income rises faster than others’ will have an additional capital contribution to make. conversely, partners whose income grows slower than others’ will be refunded part of their capital balances.<\/p>\n

        other provisions for the capital section of the partner agreement:<\/p>\n

        1. active partners should not<\/strong> be permitted to withdraw their capital from the firm.<\/p>\n

        2. partners should not<\/strong> be permitted to overwithdraw their income allocation. common excuses to violate this rule:<\/p>\n