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Succession Planning for Small CPA Firms
The Options to Consider

By Robert Fligel

The following true stories illustrate the importance of succession planning for small accounting firms.

A CPA died suddenly at the age of 39. His highest-level employee, also a CPA, then diverted all of the clients to his own account, but failed to compensate the man’s widow. Because the firm lacked a continuity agreement, the widow ended up with no money for the lucrative accounting practice that her husband had spent 15 years developing.

A 66-year-old CPA suffered a major heart attack and died instantly at his office. At the time of his death his financial affairs were in disarray, and his widow, who knew very little about his practice, was unable to prevent her husband’s clients from leaving, seeking the services of other firms.

A chronically ill 54-year-old CPA met a fellow accountant whom she trusted. The two orally agreed to purchase one another’s practice from their respective spouses in the event that they should pass away. However, the sickly CPA never told her husband about the agreement, and died after a prolonged illness. As a result, when the surviving CPA contacted the widower, it took six weeks for the two to agree to terms for the purchase of the practice. During this time clients did not receive adequate service, and nearly 80 percent of them went elsewhere. Ultimately, the surviving CPA purchased only the remaining 20 percent of the practice’s client accounts from the widower.

Stories like these are not uncommon. Most small firms do not have a succession plan. The consequences can be significant. When the senior or managing partner of a firm that lacks a succession plan becomes disabled or dies, the firm is likely to experience considerable turmoil, loss of clients and potentially the risk of going out of business entirely.

Recent PCPS/TSCPA National MAP Surveys that provide CPA practice benchmarks have highlighted this issue. In the 2003 MAP Survey of more than 1,000 CPA firms, succession planning and developing future owners was the number two professional concern. There are many reasons why CPAs fail to develop a succession plan, from lack of time to fear of the loss of control. Few people like to think about their own mortality, but these are exactly the types of issues on which CPAs counsel their clients. 

Succession Arrangements

To begin to develop a succession plan, it is advisable to consider the type of succession arrangement that would best fit the needs of the principal, the firm and the clients. The different arrangements usually include: identifying and grooming an internal successor; seeking an external successor; acquiring or merging into a smaller firm to facilitate a future buyout; merging the firm with another for a short- or a long-term buyout; and entering into a practice continuation agreement with another firm.

The internal successor option is the logical choice if there is an internal candidate who is qualified to be the successor. Only the founding or senior partner knows the attributes that have made the practice successful and whether or not the potential successor possesses those same qualities. If the potential successor does not share one or more of the partner’s key beliefs and business outlook, this type of arrangement probably will flounder. However, if the arrangement looks suitable, the potential successor should begin attending client or industry meetings, become familiar with client and practice management philosophies, and undergo training in areas such as marketing and cross-selling, technology and management.

If it is determined that pursuing an external individual successor or a firm with which to acquire or merge is the best course of action, there are many factors to examine. For starters, external successors should possess the same skills and expertise that the partner’s clients have grown to appreciate and expect. Or if acquiring or merging with a practice is the way to go, the choice of firm should not be made in haste. Rather, a list of potential firms should be created, with time spent learning about their areas of practice, client relations and methods of doing business. Some of the best mergers have taken years to develop. Networking with former employees, former employers, CPAs and other business professionals, as well as advertising in trade publications, are useful steps to ensuring that the best candidate is selected.

During this process, it is important to note that good personal chemistry usually is critical to a successful match. Capacity to handle the client load and technical competence follow close behind. Similarly, individual or firm reputation, practice specialties, fee structure, profitability, financial condition, credit worthiness, location and staff will all need to be scrutinized before any deal is finalized.

Practice continuation agreements ensure that in the event of death or disability a CPA’s practice will continue and the heirs will be able to reap the firm’s economic value. A practice continuation agreement is not the same as a transaction agreement. Rather, it is a document between two firms to cover the firm whose principal dies, becomes disabled or chooses to retire.

The types of practice continuation agreements include one-on-one agreements with another sole proprietorship, partnership or professional corporation. A one-on-one agreement usually is a buy/sell agreement written to cover death or disability. Group agreements between several CPAs enable them to act as successors to one another’s firms. Group agreements usually just concern the transfer of clients. There also are emergency assistance plans available. Through these plans, state CPA societies assist the spouse and heirs of a partner who was a member of the CPA society to perpetuate the practice in the event that previous arrangements were not made.

The major disadvantage to practice continuation agreements is lack of transition. When a precipitating event—disability or death—occurs, the successor firm may have difficulty retaining the key accounts. The reason simply is that there is a likely significant lag between the time spent creating the practice continuation agreement and its implementation. To help mitigate client loss, clients should be informed that an agreement is in development. However, unless there is an established relationship with the successor firm, retention will suffer.

Other Key Considerations

Practice Valuation and Deal Structure

There are many variables to practice valuation and deal structure, including internal versus external transactions, equity versus nonequity, fee and practice mix, profitability, industry focus, cash down, and retention periods. Practice valuation can range from 60 percent to 150 percent of annual revenues. Expert assistance always is advisable to help arrive at a fair valuation and deal structure for both sides.

Transition

Detailed attention needs to be paid here, creating a very specific plan and timetable to maximize client and staff retention and satisfaction.

Timing

If carried out diligently and thoroughly, it generally takes three months to six months, non–tax season, to agree and sign off on a merger deal. If unresolved issues or the emergence of new ones prolong the process, the merger will likely result in a bad match. Deals that are meant to happen move along accordingly.

Robert Fligel is a member of the NYSSCPA and the president and founder of RF Resources LLC, a firm that specializes in mergers and acquisitions, partner search and consulting for CPA firms.
Editor’s Note: Written by fellow practitioners, Notes from the Firm examines the decision making and steps taken by CPA firms to address professional issues and concerns commonly encountered.