It's often referred to as the Holy Grail of an accounting firm - a crucial, almost revered document that legally defines the organization and serves as the cornerstone for many critical areas of its operation - yet, inexplicably, many firms rarely refer to it, or neglect it when it's badly overdue for an update.

It's the partnership agreement, the roadmap that determines firm governance, compensation, retirement, restrictive covenants, partner election and termination, capital contributions, and equity vs. income partners, among many other things.

"If you don't have one, you're basically screwed," quipped consultant August Aquila, who heads Aquila Global Advisors in Minneapolis, and has both lectured and written on partnership agreements. "I've seen too many cases where a firm didn't have one and when there was a critical issue like a death or disability or a partner buyout, it nearly took a civil war to resolve it. The overriding concept of the agreement is to protect the partnership and not favor any one partner. Get the partners to talk about what they want in a PA. Take it to a lawyer to have it drafted."

Complicating the whole issue is the fact that no two partnerships are exactly alike, and thus there is no standard model that encompasses the concerns and objectives of all accounting firms.

"Some managing partners never look at their agreements for years," said Marc Rosenberg, principal of Chicago-based consultancy Rosenberg Associates. "Most firms have their agreements solely written by lawyers, who often don't understand certain things about CPA firms. I probably review 10-20 agreements a year, and I can't remember the last time I saw one that was up to date."

Russell Shapiro, a partner in the Chicago law firm of Levenfeld Pearlstein who draws up two to three partnership agreements per year, agreed about firms' recalcitrance to keep the pact current. "There's a huge hesitation to make changes, because you often require a supermajority of partners to make them," he said. "A lot of times you have two classes of partners: those who are young and who want to grow the firm, and the ones who are on the cusp of retirement."

Shapiro said that updating the agreement or redoing it usually requires a six-month time frame, a commitment that can often usher in procrastination.

"Many times I'll advise them and say, 'Let's just scrap what you have now and start over,'" Shapiro said. "So we prepare the changes and then there's a lot of interaction with the partners. There are often big issues that require a lot of discussion."

He suggested that firms form a partnership agreement committee comprised of two partners from the "older" generation, two from the "younger" generation, and one "neutral" partner. An outline should be developed that offers security for the older generation of partners and control for the younger generation.

 

RETIREMENT CONCERNS

"What happens in retirement?" asked Shapiro. "Can the partner get his capital back over a short period of time? How long is the vesting period before you're able to collect? If you have a multi-state firm, the agreements have to work everywhere."

"Retirement is usually where the meat [of the partnership agreement] is," echoed Rosenberg. "In other words, 'How much do I get when I pull out of this thing?'"

Shapiro and others said that the primary questions surrounding the partnership agreement often focus in such areas as mergers, next-generation growth, and non-compete and non-solicitation restrictions that affect departing partners.

"Most of the well-drawn-up partnership agreements will have a good geographic restriction with regard to non-compete, like a 25-mile radius or something similar," said Rosenberg. "But for non-solicitation of clients, most firms will demand 125 percent of that client's fees as standard if the departing partner wants to take them."

A partnership agreement will often have a similar provision for solicitation of staff, with the fees ranging from anywhere from 50 percent to 150 percent of that person's salary.

"The non-solicitation provision has come under greater scrutiny," explained consultant Allan Koltin, chief executive of Chicago-based Koltin Consulting Group. "Firms are now having their partnership agreements reviewed by legal counsel every couple of years to make sure they are still consistent with current state and case law, especially in the non-solicitation area. I'm seeing more firms asking anywhere from 1.5 times to two times the annual fees of any clients that departing partners might take with them. You may not get two times fees, but it's a better starting point [for the firm] if you end up compromising on a lesser number."

Koltin also said that as firms grow and mature, they are moving their agreements from a "partnership" approach of governance to more of a "corporate" style of governance, allowing for a smaller number of people to make management decisions.

"I think when a firm gets to a certain size, 'Less is more' is better," he said. "As long as the partners trust the leaders, they are willing to 'let go' on a lot of decisions."

With the spate of accounting firm mergers over the past several years, Aquila said that one of the key points an agreement has to address is the dissolution of a partnership in an upstream merger.

Another common consideration is outside investments by the partners. "In one case, a partner owned 70-80 apartments and explained that it was a passive investment," Aquila said. "But it turned out he was managing the buildings as well. So that was a conflict that had to be resolved."

Another time, a firm wanted to terminate a partner for violation of the partnership agreement. It turned out the partner was going through a divorce and a court eventually sided with the spouse and determined that the firm could not fire him because the spouse had a financial interest in the firm and the agreement.

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