Laying a Foundation for Effective Succession Planning -- Continued

Source: Public Practice

In Part 2 of an ongoing series, Bill Reeb identifies “foundational issues of a good succession plan.”

Reeb explains that ultimately, effective succession planning involves implementing best practices for running a firm. But to secure partner buy-in for any changes, the first step is to ensure that the firm “is paying at least roughly a fair market value to the near term retiring partners.” As a rule of thumb, Reeb says, remaining partners will pay a retiring partner as much as 120 percent of the fair market price, while retiring partners will accept as little as 80 percent.

A fair retirement arrangement, Reeb explains, includes two components: A return of capital and the retirement benefit. For one- to two-partner firms, this generally consists of buying a retiring partner's book. Reeb's rule of thumb is that firms will buy the book based on a retention agreement paid out over four to five years, which typically equates to 60 or 70 cents on the dollar.

For larger firms, it's about “paying a benefit for the contribution that the retiring partner has made to the firm.” Often this equates to a multiple of salary (or the retiring partner's share of equity ownership) applied to the firm's revenues.

When salary is used to compute retirement benefits, Reeb says, the most common formula is three times total compensation, based on the average of a partner's three highest years of the last five. If the benefit is based on ownership interest times net revenue, the most common discount is 15 cents on the dollar, for a net benefit of 85 cents on the dollar.

The article also discusses variations on the above benefit calculations, repayment of the capital account, and determination of the mandatory retirement age (“the ugliest discussion of all”).

For the complete article, read “Managing Succession Fundamentals – Part 2.”

From Public Practice, Texas Society of CPAs, February 2013, www.tscpa.org.