Here Comes the Baby Boomer Bubble – Valuing Your Practice for Partner Retirements
by Terri Eyden on
The news here is that the goodwill values used for partner retirements, what I call inside deals, have trended downward over the last decade or so. These are almost always expressed as a multiple of revenue, and the generally accepted value used to be one times revenue.
The value discussion here is for traditional accounting firm revenues. If you have significant revenue in your firm from nontraditional services, such as financial services, insurance products, pension administration, etc., then these should be valued separately.
The surprise for many of us BBB members is that the new average out there is a little less than 80 percent of revenue. The latest 2012 Rosenberg MAP survey of 369 firms puts the average at about 78 percent. For the thirty-three largest firms in the survey, those with over $20 million in revenue, their goodwill value is only 72 percent of revenue. Clearly, one times revenue is gone.
So, once we get our heads around the new lower value for our firms, how do we split it up or allocate it among the owners of the firm? More specifically, how do we determine how much to pay to a retiring partner? To quote Marc Rosenberg, "The Multiple of Compensation Method is the gold standard in the profession at all sizes and particularly at firms with eight or more partners and, 45 percent of all firms use this method." There are four or five other methods out there, but discussion of them is beyond the scope of this article.
The Multiple of Compensation Method uses relative partner compensation to allocate the goodwill value of the firm. Typically, a firm will use an average of three to five years of the retiring partner's total compensation (not including fringes) as the starting point. The average comp is then multiplied by a factor to arrive at the partner's share of the firm's goodwill number.
In a fairly typical example, if a firm is netting 33.3 percent profit before any partner compensation and they are using a goodwill value for the firm of 80 percent of revenue, then the goodwill value is 2.4 times total partner comp. If our retiring partner's average compensation was $300,000, then the retirement benefit using the 2.4 multiplier is $720,000. Note that the multiplier and the methodology is normally the same for all partners in the firm.
In most firms, the goodwill gets paid out in the form of deferred compensation (ordinary deduction to the firm and ordinary income to the partner). Terms range from five to ten years, with no interest. Seven- to-ten-year terms are more common than five. The CPAs reading this are thinking "but with no interest, the value used for the firm is really less than 80 percent!" Yes, that is correct.
There are many other partner retirement considerations, including vesting schedules for age and years of service, death and disability provisions, mandatory retirement ages, post-retirement employment, client transition expectations, and caps to protect the firm. If you are updating your partner agreements to address the new goodwill values, make sure you are bringing the entire agreement up to date.
It is probably time to pull those agreements out of the drawer, dust them off, and take a look!
Read more articles by Gary Adamson.
About the author:
Gary Adamson is the President of Adamson Advisory, specializing in practice management consulting for CPA firms. He is an Indiana University graduate and has extensive hands-on experience as the recent managing partner of a top 200 CPA firm. He can be reached at (765) 488-0691 or email@example.com. For more about Adamson Advisory, visit www.adamsonadvisory.com or follow the company at www.adamsonadvisory.com/blog and www.twitter.com/adamsonadvisory.