Art of Accounting: More on buying a practice from an estate
I’ve written a lot about the topic of acquiring a practice from a deceased accountant’s estate — possibly ad nauseam. However, as much as I have seen, new things keep popping up that I am sharing here.
Preface: My advice to an accountant who wants to acquire a practice of a deceased accountant is to either pass on it, or follow the plan in my practice continuation tool kit, which is to pay 20 percent of collections for work done in the next five years. No down payment, no interest, capital gains taxation to the seller and no retention guarantees. This is fully explained in that tool kit (see below to get a free copy).
Here are a few more examples:
• An accountant died, and the family lawyer said she would handle the sale. When the buyer suggested a price based on my 20 percent of collections for five years method, he was told this was too low and they were looking at an offer of two times the previous year’s gross payable, with half upfront and the balance in one year. This was an out and out lie since no one in their right mind would offer 200 percent of the billings and the payment terms were a wide stretch. Further, there wasn’t much time for multiple offers to be made since the 20 percent offer was made about three weeks after the death. No good can come from “negotiating” with liars and my suggestion was to stick to the offer and give a two-week withdrawal if it wasn’t accepted. Note that the sale of a deceased’s practice is a terribly rapidly wasting asset. The longer it takes to notify clients of the transition, the fewer the clients who will remain.
• Many sellers want a shorter payout period than five years. That is obvious and a desired way for a seller. There are two problems with this. One is that if a client is lost after the payments are made, there is no recoupment and there will be an overpayment for the practice. Second, the payments will not match the cash flow and it will cause a shortage during the early years. A very general rule of thumb, per me, is that 40 percent of the cash flow pays for expenses, 40 percent pays for the salary of the owner or partner, and 20 percent is the profit. If more than 20 percent is paid, it will cut into the take-home pay of the purchaser. This will put added and unnecessary pressure on the buyer. Also, my model offers favorable tax treatment to the seller and a 15-year amortization of the payments to the buyer, which will cost added taxes upfront. I don’t recommend a shorter payout period than five years.
• In one case an accountant became suddenly disabled. His brother-in-law immediately took over the few larger clients and tried to sell, on behalf of his sister, the remaining bulk of the clients who had much lower fees. This cherry-picking made the typical deal untenable and the practice was misrepresented since not all of the practice was being presented to the prospective buyer. This would eventually cause repercussions since some of the smaller clients fell on the family tree of the larger clients. On top of this the wiseass cherry-picker wanted a shorter payout period with an upfront down payment. Note that I am still friends with him, just not as close to him as I used to be.
• In many cases a sole practitioner dies, leaving the practice and one or two employees. If an employee is able to take over and continue the practice, then he or she would be the most logical person to acquire the practice. The issue is that they likely have no money, little if no experience running a business, and possibly no desire to be an entrepreneur but feel they have to become one to maintain their income source. In these cases the deceased’s family should recognize this and also realize that the greatest retention would be by selling to the employee, and a quick sale should be consummated. A problem arises if the family’s advisor plays the “I am a big shot negotiator and whatever I ask for should be accepted because I know what I am doing” game. This quickly spreads into the lying tactic, greatly delaying the process with a real threat of the practice unraveling and the employee losing their job. In the meantime the employee is still working but clients start to leave. Two things can then happen: 1) The employee gets another job, wiping out any chance of a reasonable payment to the family; or 2) the employee starts her or his own practice, taking many of the deceased’s clients. Note that for the latter, there is usually no employee contract or restrictions on taking clients. While I am not addressing any of the legalities of this, it is possible there will be threats of a lawsuit followed by a compromise settlement, greatly adding stress and destroying the relationship with the survivors and the memory of the deceased. If the compromise will occur, then why not do it right away and get the deal done on a friendly basis?
• I have a question: If there is no agreement and the practice will be sold, my question is who is the seller? It would seem that the practice would become an asset of the estate. The will would need to be probated, which would delay consummation of a sale. If there was no will, the delays would be considerably longer. Therefore, with no practice continuation agreement, a sale would be delayed longer than it should be. From a practical standpoint, a transfer can be agreed to, subject to ratification when the estate representative is approved. With a practice continuation agreement, the price, terms and details can be completed quickly. If there is no practice continuation agreement, it would be unlikely that the widow, widower or executor would do anything without retaining an attorney and possibly someone to value the practice and explain how such transactions flow. Besides adding time to the transfer and cost to the survivors, such “consultants” might want to assert their so-called expertise to indicate their importance. In my opinion, such people are “legends in their own minds” and hinder the success of the transaction. See above.
• One type of buyer who adds complications to the transfer is financial services buyers. These are more interested in the tax clients buying annuities or giving them assets to manage. They usually offer a higher price and down payment with little retention guarantees. After they go through a tax season and see the potential, they drop or lose most of the uneventful clients, making the final ultimate price much less than it would have been from a buyer who wanted to maintain the tax practice.
• Note that in all cases the deceased hurt their family and placed them in a bad situation by not making easy minimal arrangements for the sale if there was an untimely death or disability. The family should be penalized, not the buyer. Anything that makes the price and terms better for the family at the expense of the buyer transfers the deceased’s disregard for their family from the survivors to the buyer. This is an unfair situation for the buyer and they should not assume it. Never lose sight when dealing with a family that the deceased was irresponsible and negligent, and you are trying to bail out the family so that they would get something. Don’t do a bad deal because you feel sorry for the family. You did not cause the situation — the irresponsible accountant did! I might have an edge of cynicism here because I’ve seen too many such instances where the family gets much less than they could have and the buyer loses out on what could have been a great opportunity.
• Irrespective of whatever is written above, when the buyer is very anxious to acquire the practice, they will throw caution into the wind and rush into a bad deal that is overpriced. If there is high retention, then no matter what they paid, it will work out OK. However, unless all the stars are perfectly lined up, they will have made a bad deal that they will lose out forever afterwards, and they will then become adherents of saying that you can’t get a good deal from a dead accountant’s family. Duh! That’s what I have been suggesting all along.
These examples really happened. It is hard to make this stuff up. If you want a free Word file of my Practice Continuation Tool Kit, email me at GoodiesFromEd@withum.com.
Edward Mendlowitz, CPA, is partner at WithumSmith+Brown, PC, CPAs. He is on the Accounting Today Top 100 Influential People List. He is the author of 24 books, including “How to Review Tax Returns,” co-written with Andrew D. Mendlowitz, and “Managing Your Tax Season, Third Edition.” Ed also writes a twice-a-week blog addressing issues that clients have at www.partners-network.com along with the Pay-Less-Tax Man blog for Bottom Line. Ed is an adjunct professor in the MBA program at Fairleigh Dickinson University teaching end user applications of financial statements. Art of Accounting is a continuing series where Ed shares autobiographical experiences with tips that he hopes can be adopted by his colleagues. Ed welcomes practice management questions and can be reached at (732) 964-9329 or firstname.lastname@example.org.