How Does Your Buyout Compare?

Buyout and retirement are hot topics that are being actively discussed by executive committees and senior partners at firms across the nation. Shareholders are logically asking questions like: "How much is my buyout realistically going to be, and when am I actually going to receive it?" and, "Does my buyout compare to what's being offered at other firms?"

To help answer these and other questions, we conducted a survey to assess the current situation and thinking at the top CPA firms across the country. The survey's goal was to collect meaningful but non-intrusive information about each firm's retirement practices, as well as to gather sufficient demographic information to identify common factors among and across practice size ranges.

Indeed, it was enlightening to uncover how firms differ in their buyout structure and retirement philosophy as we examined the range of practices from the top multi-state firms to the smaller regional partnerships.

SURVEY STRUCTURE

We grouped firms into four size categories (see charts). Total partner/shareholder annual compensation was also collected, along with a variety of data on retirement and buyout issues, methods and concerns.

We used SurveyMonkey to conduct this study. Because distribution was directed to busy managing partners, we limited the number of questions. Although similar buyout/retirement issues facing the upper tier also affect much smaller partnerships, we restricted this study to a manageable size and focused on the top 200 firms in the U.S. We excluded the four largest firms, in the belief that their far larger size and different partnership dynamic would skew our results. The survey was e-mailed to a private list consisting of 257 firmwide and office/regional managing partners at leading American CPA firms, representing 177 unique firms. Of the 177 firms, 55 completed the survey (31 percent). We're grateful for their participation.

SURVEY RESPONSES

Question 1: How many partners (or shareholders) are currently at your firm? Across all respondents, the average number of equity partners was 33, but the mean was skewed high by several comparatively large firms, and therefore the median number may be more relevant. Ordering responses from smallest (seven partners) to largest (176 partners) reveals that the middle firm in the list (the median) had 22 equity partners.

Question 2: Equity partner/shareholder age distribution. (See charts.) Here we see the very obvious "Baby Boomer bulge" where over half (59 percent) of the partnership is age 50 or older. Equally obvious is that the younger equity partners (Generation Xers) are in the minority, yet they will be the ones responsible to fund the buyouts of their senior colleagues. This disequilibrium is causing many to question the sustainability of conventional buyout structures into the future.

Question 3: Annual firm revenue. (See charts.) The "middle market" of firms with revenue from $20-$49 million was in the majority, and at 55 percent, constituted a larger segment than all other ranges combined.

Question 4: Total equity partner annual compensation. For the 47 firms responding to this question, on average, their total partner/shareholder compensation was $18.2 million per year, with a low of $2.8 million and a high of $123 million. On a per-equity-partner basis, the median compensation was $460,000 per year, with a low of $265,000 and a high of $2 million per partner.

Question 5: Does your firm have a mandatory retirement age? The vast majority of respondents (89 percent) reported that their firm has one. For the 48 firms that supplied the specific retirement age, it was exactly 65 years on average, with a low of 55 and a high of 71 years.

Question 6: Does your firm have a partner/shareholder buyout obligation? As in Question 5, the vast majority of firms (95 percent) reported having a buyout obligation. Of the 55 responding firms, 52 have a formal partner buyout in addition to return of capital at retirement. Only three firms are structured such that their partners receive no exit compensation other than a return of capital.

Question 7: Estimated total buyout obligation (for current equity partners). This was a two-part question, breaking out non-qualified and return of capital separately. For the 48 firms responding to the nonqualified part, the average buyout obligation was $32.1 million, with a minimum of $1 million and a maximum of $310 million. Of the 48 respondents, 41 firms had an additional return of capital amount that averaged $8.6 million, with a minimum of $300,000 and a maximum of $60 million. On a per-partner basis, the nonqualified median was $886,000, with a low of $80,000 and a high of $2.86 million buyout. The corresponding return of capital amounts were $195,000 median, a low of $16,000, and a high of $1.67 million per partner.

Question 8: Funding status of buyout. Almost all (96 percent) of the responding firms reported that their partner buyout obligation was either partially (27 percent) or entirely (69 percent) unfunded. Only 4 percent reported a fully funded status for their nonqualified buyout plans.

Question 9: Buyout calculation method. Two thirds of the 52 firms (65 percent) responding to this question base their buyout on a multiple of individual partner's compensation. About a quarter of the respondents (23 percent) base it on a percentage of the firm's valuation, while the six who specified "Other" (12 percent) listed the following methods:

• Valuation points accrued.
• $500,000 a year for 10 years plus capital account.
• Deferred comp based on years of service.
• Book value plus continuing profit participation plus deferred comp.
• Multiple of weighted average firm earnings.
• Stated unit price.

Question 10: Payout duration. Of the 50 firms responding with non-zero answers, 33 listed the payout duration as 10 years (66 percent), making this duration the de facto "industry standard." The next most common response was a tie between five years and seven years (8 percent of responding firms reporting one or the other). The shortest payout duration was three years and the longest 15 years.

Question 11: Payout cap (as a percentage of firm revenue). (See charts.) We received non-zero answers from 43 survey participants, averaging 9.5 percent, with a low of 0.25 percent and a high of 20 percent. The most frequent response was 15 percent, followed by 10 percent. An equal number listed a cap of 5 percent, 7 percent and 20 percent.

The histogram on page 8 lists all the collected answers to this question, graphed by frequency of response. This is enlightening, as many firm managers regard the existence of payout caps as their "safety valve" to prevent destabilizing the partnership by diverting too much current cash flow to retired partners. We did not ask how many firms are currently "hitting their caps" or expect to as the Baby Boom generation exits in larger numbers over the next decade. Anecdotally, we observed that most firms are not yet relying on payout caps to limit distributions, but many expect to have them in effect in the not-too-distant future.

Question 12: How concerned are partners about an eventual buyout shortfall? (See charts.) This was one of the most interesting results of the survey. However, it is important to bear in mind that the assessment came (in general) from the managing partner, presumably a member of the senior group, and therefore reflects their sole opinion of the concern level of the younger partner group and the next generation. A horizontal firmwide survey would likely develop a different profile. Nonetheless, the major observation is that a majority (59.6 percent) of the senior partners are "unconcerned" about a buyout shortfall, while about a third (34.6 percent) are "somewhat concerned" and only a small minority (5.8 percent) are "very concerned." (Again note that the question was not specifically worded, and we might assume that the respondents were focusing more on their own buyout, rather than taking a longer or more inclusive view.)

However, it was apparent that respondents were aware of the younger partner group's concerns about a buyout shortfall, where the majority listed that group as being "somewhat concerned" about a shortfall. Regarding the next generation, this may be the least meaningful response category, as the managing partner may not be able to fully assess the concern level of a group that are not yet equity members or whose buyout will be many decades in the future.

Since the unfunded buyout issue is a topic of continuing discussion in the accounting profession, we were interested in determining if a variance existed between the larger and (comparatively) smaller firms represented in this survey. Breaking out responses separately for firms under and over $50 million in annual revenue reveals only a nominal variance in response to this question.

And we can observe that among the larger firms, no managing partner stated that the senior group was "very concerned" about a buyout shortfall in the future, but nearly 9 percent of the under-$50-million managing partners stated that it was a concern for this cohort. This may reflect the greater "financial inertia" of the larger firms and their enhanced ability to grow through acquisition.

Question 13: Buy/sell insurance coverage. It is interesting to note that over half of responding firms (52 percent) do not hold any life insurance covering their buy/sell. (Another 30 percent hold term life insurance, and the remainder are split between cash value life insurance, and a mix of term and cash value.) Among the seven largest responding firms, five, or 71 percent, hold no buy/sell insurance, while the remaining two (29 percent) hold term insurance only. This was a surprising finding among firms with revenue over $100 million per year and from 32 to 176 equity partners, as they are more likely on an absolute basis to experience the death of a partner while working or at some time during the buyout period.

IMPLICATIONS

The accounting profession is unique with respect to formally structuring partner retirements and buyouts. The majority of law firms in the United States have moved away from offering buyouts and pensions for their partners. CPA firm management has expressed concerns (often behind closed doors) about the viability of the current unfunded/underfunded buyout model as the Boomer generation moves through the retirement cycle en masse over the next decade.

With a median combined nonqualified buyout and capital obligation exceeding $1 million per partner, firm leadership expects to rely heavily upon payout caps to protect the partnership's financial health for the next 20 years or more. Because the obligation typically does not diminish when a cap is in effect, but instead simply rolls forward, some regard caps as not much more than a kick-the-can-down-the-road strategy. Moreover, from a receiving partner's perspective, the prospect of getting smaller annual payouts over an extended and uncertain timeframe is unwelcome, and that may be reflected in this survey's reported greater concern level for the younger partner group.

Jay Nisberg, Ph.D., is president of Jay Nisberg and Associates and a well-known consultant to the accounting profession.