More and more accounting firms are realizing that their old partnership agreements are straining to handle the challenges facing the profession these days, while those that are just starting to build their firms are looking for a more flexible, dynamic document than those that set the structures of older firms.

With both groups in mind, we convened a roundtable of four experts -- Joel Sinkin, president of Transition Advisors; Allan Koltin, CEO at Koltin Consulting Group; Russell Shapiro, a partner at the Chicago law firm of Levenfeld Pearlstein; and August Aquila, CEO of Aquila Global Advisors -- and asked for their thoughts on what should and should not be in a modern partnership/ownership agreement.


What's the standard of what should be in a partnership/ownership agreement?

Russell Shapiro: The main things to address are governance, retirement (age, notice for early retirement and retirement payments), restrictions on taking clients and employees, and capital pay-in and pay-out. These things go to whether the firm will be able to make quick, efficient decisions, build and maintain the integrity of the business, allow the next generation a chance to grow, and bring in lateral partners.

Joel Sinkin: The four main areas that an ownership agreement should focus on include:

  • Governance (voting/decision making): For example, what requires a unanimous vote, a super-majority vote, a majority, or what any partner can authorize without others' consent.
  • Compensation: How compensation is determined, is this system open or closed, how profits are distributed, etc.
  • Retirement: How are partners bought out? Is there a vesting period, a mandatory retirement age, and penalties for early retirement? How is death and disability treated? Is there a required notification for retirement? How are clients and the retiring partner's role transitioned?
  • New partner admission: How is it voted on? What are the associated costs? Is there a buy-in, or a capital contribution required?

Allan Koltin: The short list involves governance, compensation, protecting the firm (non-solicitation) and major events (expulsion of partner, sale of firm).

This is not to say there are no other important issues, but as a consultant that advises firms on the business side of partnership agreements, these clearly are the areas that dominate 95 percent of the discussions.

August Aquila: Here's a partial checklist of what should be in your agreement:

Financial issues, including the allocation of profits and capital contributions;

  • Partner issues, including both how new partners will be admitted and the termination, with or without cause, of current partners;
  • Early retirement;
  • Death and/or disability of partners;
  • How the firm will execute the buyout of a retired, dead or disabled partner;
  • What procedures the firm will follow if it is unable to resolve a conflict (mediator, arbitrator or traditional legal means);
  • Firm management issues, including election, terms, authority and responsibility of the managing partner, executive committee and compensation committee; and,
  • Momentous moments in the life of every partnership, including mergers and sale of the practice, dissolution of the practice, bringing in a new partner, and non-compete agreements.

Which areas typically require special attention or elucidation?

Koltin: Governance, compensation and non-solicitation provisions are probably the main events about which I am typically asked to assist firms. Obviously, for each one of these items, there are other connecting points. For example, the firm could have solid non-solicitation provisions as it relates to its partners, but could have no non-solicitation provision in place with staff, principals or non-equity partners, which could potentially put their firm at great risk.

Shapiro: I would say that the retirement provisions are the most involved -- determining under what circumstances the full benefits are received. Also, vesting, notice on early retirement (which should be one year), payment amounts and under what circumstances the payment amounts are reduced (for example, some firms reduce payment amounts if that partner's clients leave after the partner's retirement).

Koltin: In terms of governance, I often find that the required approval percentage to modify the agreement is so high that oftentimes only a couple of partners have to vote against a provision and the firm is stuck in the mud. I recall working with a firm once that had equal partner compensation and in order to make a change, more than 67 percent of the partners had to approve the change. Truth be known, they had three underperforming partners who probably had the best jobs in corporate America (at least in terms of their compensation level!). They basically were able to veto the firm moving to a performance-based compensation system because of the structural deficiency in how major decisions were approved at the firm.


In your experience, which issues do agreements commonly not address or give too little attention to?

Aquila: First, many do not address what happens if the firm cannot meet its unfunded retirement obligations. The agreement does not provide a way to reduce the obligations ahead of time. When the problem arises, it usually causes a major rift in the firm.

Second, dissolution -- if the practice is to dissolve, what are the steps it must follow, what are the trigger events that can cause such an action?

Shapiro: Oftentimes, how retired partners will get paid if the firm dissolves.

Sinkin: Way too often, firms address the value a partner is being bought out for, but don't have much detail on their role and obligations regarding transition prior to such time. A detailed plan for how to transition the retiring partner's entire role, from client relationships and responsibilities to other aspects of their day-to-day activities, is not addressed. Without a detailed plan, from the timing of when the transition should commence to specifics of how it is done, it is highly likely there will be hiccups in making this a smooth transition that protects the firm.


What issues do firms typically focus on or emphasize more than they should?

Koltin: I think this is a life-cycle thing. When firms are small and are moving to the managing partner concept, clearly they will be much more focused on governance. When firms go from a single office to multiple offices or from all the partners determining compensation to a compensation committee determining compensation, compensation becomes a major emphasis.

When firms age and succession planning becomes an issue, naturally the vote to merge the firm upstream comes under the microscope.

Clearly, if I had to pick one issue today, among Top 500 firms, that has their attention, it would be the definition of what a non-equity and equity partner is. Most of that discussion will be handled outside of the partnership agreement, but some agreements I've seen could probably do a better job of delineating rights and obligations within these two distinct groups.

Sinkin: Many partnership agreements have issues that make them difficult to use for managing changes in ownership, such as partner retirements. The problems we see run the gamut, including valuations, tax treatment of payments, notification periods, post-retirement client retention, and more.

The common denominator we find, though, is agreements that are written with the priority being to maximize the value of a buyout for a retiring partner, as opposed to protecting the long-term viability of the firm. If the goal of a partner group is to get the best terms and price possible when they leave, and not so much make sure the firm is able to sustain itself, a better option is to sell the firm to the highest bidder.

Going the internal succession route means using terms for the buyout that make it easy to attract and retain young talent to take over for retiring partners.

That young talent needs to have the confidence that they can afford what often will turn out to be many years of paying off retiring partners and still have a lucrative opportunity for themselves.


What sort of mistakes have you seen in firms you've worked with?

Aquila: Some firms require a 100 percent vote of the partners to do certain things, such as selling the practice. This is a major mistake, because a minority partner with 4 percent of the interest can stop the transaction. The highest percentage a firm should require should be in the 75 to 80 percent area.

Koltin: I think one that won't come as a surprise is the whole area of succession planning. Too many older partners nearing or at retirement age today have not done a good job of transitioning their clients, only to come into a windfall when and if they retire, as it relates to deferred compensation.

I find this takes place sometimes when firms have hard dates in terms of mandatory retirement (i.e., 65) and the partner (who has never revealed this) wants to continue working well past age 65 and wants to continue to receive significant compensation. Unfortunately, because of this, they oftentimes sabotage the process, which should begin three years before retirement with a healthy transition of both the client work and the relationships.

You'll often hear these partners comment, "If only the firm could provide someone capable, I could transition my work," only to learn that each person assigned to that partner for some mysterious reason isn't able to be successful in terms of getting the retirement-minded partner to successfully transition their book of business.

That being said, more recently I've seen firms putting a claw-back or penalty provision in the agreement stating that if the partner does not comply with the succession plan of the firm, the executive committee reserves a certain percentage of the retirement benefits to be withheld at their discretion.

Sinkin: As a consultant who has reviewed hundreds of varying forms of ownership agreements, I would say less than 5 percent of the agreements we review have any details on the transition roles of partners closing in on retirement.

As a result of not having a transition program, many times we have seen issues when the retiring partner surrenders their equity at a time the role has not been fully transitioned. The impact this has had varies from client losses to having to keep retired partners on longer than originally planned to accomplish transition, to name just a few.

With most firms retiring partners at fixed compensation, it is the firm's remaining partners who lose the most when these types of issues remain unsolved.

Aquila: Another thing I've seen is that over the years, the firm has 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.


What are the one or two issues or provisions that absolutely should and should not be outlined in a partnership agreement?

Koltin: Included should be the need to deal with retirement, governance and restrictive covenants. I do not think that compensation should be dealt with in the partnership agreement, other than to provide that it will be determined by the executive committee or a compensation committee.

Sinkin: An ownership agreement's main function should be to protect the firm. Many feel the main role of these agreements is to protect the partners, and while that is critical, it is the firm that must be protected as the top priority. If the firm doesn't survive, no retired partners are getting bought out, and the remaining partners are hurt or worse if the firm is damaged.

With that in mind, two things we like to make sure are in all ownership agreements (but far from limited to just these two) are caps and retirement notification periods.

A cap is a figure typically based on a percentage of gross collections, but in some cases net, that in no one year can more than X percent of revenues be paid out to retired partners. This is to protect the cash flow of the firm. If the working partners cannot pay their overhead, the retired partners face problems in getting paid as well. Caps do not typically eliminate the payment portion that exceeded the cap; they simply extend the payout period.

With notification prior to retirement, we like a minimum of two years (and preferably longer in cases where the retiring partners have a lot of partner-loyal clients) that a retiring partner must provide prior to stepping down. Combining that notice with a properly spelled-out transition plan enables the firm adequate time to transition the partner's role and retain the clients, along with general firm continuity - and you have managed some pretty big potential landmines.


Finally, how often should a partnership agreement be reviewed and/or modified?

Sinkin: A partnership agreement needs to be reviewed in detail a minimum of annually. Things constantly change, and seeing how changes may impact the partnership agreement is an ongoing mission of significance. A classic example of such an error are firms leaving the "eat what you kill" or silo mentality for the one-firm client approach, yet still having a compensation system based on the book of business a partner manages. Also, remember that your ownership agreement can be a key in attracting young talent to join your firm, or a roadblock that makes them less likely to jump in!

Aquila: Partnership agreements should be reviewed whenever a partner joins or leaves the firm. Otherwise it is smart to review them every three years or so.

Koltin: I'm not an attorney and don't play one in Hollywood, but if I did, I would urge the firm to have at least an annual or every-two-year review of the agreement. We are in a very dynamic time within our profession where firms are growing rapidly and dealing with many landscape changes to their business that probably weren't taking place in prior decades. I think firms need to view their partnership agreement as a steady but dynamic and changing document that has to also evolve with the growth and direction of their firm.

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