During the past 15 years, I have had the opportunity to read and analyze nearly 150 partnership agreements, and it always amazes me how outdated and inadequate so many of them are.There are basically two major reasons for this. First, many firms just fail to give adequate attention to their partnership agreements. Second, over the years, the firm may have modified its original agreement or made separate agreements as new partners entered, and these agreements are significantly different from one another. None of the agreements have been consolidated into one current agreement.
This type of environment sets the groundwork for future legal problems. Several years ago, it was estimated that over half of all small and midsized accounting and law firms lacked adequate agreements. I don't know what the percentage is today, but I imagine that it has not improved much.
I know of many firms that have been working on their agreements for years, but can never finish the project or get everyone to sign them.
Irwin Friedman, the former managing partner of Friedman, Eisenstein, Raemer & Schwartz in Chicago, always reminded me that, "There's never a problem until there's a problem."
And when a problem in the partnership arises, it's the agreement that will help resolve it. If you don't have one, resolving the issue becomes more difficult and usually more costly.
Don't use boilerplate
Firms make a serious mistake when they either use an off-the-shelf agreement or an attorney who is not familiar with CPA firm issues. Make sure that the attorney or consultant you use specializes in professional services firms.
While there are standard boilerplate sections in every agreement, you should make sure that you customize the sections that are important for your firm, taking into consideration your firm's culture and any specific needs of the partners.
Now is the time to address the tough issues that you may face in the future - termination, the death or disability of a partner, voluntary separation, expulsion, etc.
You especially want to protect the partnership against subsequent actions by disaffected partners. If you use a boilerplate agreement, you won't address the hard questions in the detail you need.
What's in your agreement?
Here is a partial checklist of what should be in your agreement. The beauty of an agreement is that you can put anything you want in it. The problems arise when you leave out key points, thinking they will never become a problem.
1. Financial issues.
* Allocation of profits: Will they be allocated equally, on ownership percentage, formula or performance?
* Capital contributions: Will there be a minimum contribution upon becoming an equity owner? How will future contributions be determined? Make clear to partners that their capital contribution is essentially loan capital, entitling them to interest thereon, rather than a share in the profits.
2. Partner issues.
* New partners: How will new partners be admitted - on what criteria; by the unanimous vote of existing partners?
* Termination with or without cause: When it comes to terminating the dysfunctional or underproductive partner, you will have serious problems if termination is not addressed in your agreement.
* Early retirement: While partners may be able to retire in their mid-50s, you usually don't want to pay retirement benefits until a partner reaches age 62 or older.
* Death and disability: How will the firm treat a partner who becomes disabled?
* Buyout: How will the firm execute the buyout of a retired, dead or disabled partner?
* Resolving conflicts: What procedures will the firm follow if it is unable to resolve a conflict - a mediator, an arbitrator, or traditional legal means?
3. Firm management issues.
* The election, terms, authority and responsibility of the managing partner.
* The election, terms authority and responsibility of the executive committee.
* The election, terms, authority and responsibility of the compensation committee.
4. Momentous issues.
There are some momentous moments in the life of every partnership that need to be addressed.
* Mergers and the sale of the practice: The agreement should address what happens upon a merger or sale of the practice.
* Bringing in a new partner: Does the agreement define the process for admitting a new partner, and how the candidate will be assessed?
* Non-compete agreements: Make sure that the firm is protected, and that unhappy partners cannot open up shop across the street and compete. Does the agreement identify penalties, such as forfeiture of the retirement account, if the partner violates the non-compete agreement, or the right to offset if a partner does not assist with collecting accounts receivable, etc.?
If you haven't looked at your agreement in a while, I'm sure you will after reading this article. Remember, there is never a problem until there is a problem. Be prepared. Get your agreement reviewed today.
August J. Aquila, a nationally known consultant to the accounting profession, is the co-author of the bestseller Client at the Core: Marketing and Managing Today's Professional Services Firm. Reach him at aaquila@aquilaadvisors.com or (952) 930-1295.
