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March 1992

Practice continuation plans: a neglected necessity. (Management of an Accounting Practice)

by Zalenko, Neal F.

    Abstract- Practice continuation plans (PCPs) can prove to be invaluable to individually owned accounting firms in ensuring their continued operations following the retirement, disability or untimely death of key partners. The PCP serves as a contingency plan in the event of mergers or sales of practices. The PCP functions like a mixture of disability insurance, nonfunded life insurance, purchase and sale transactions, and reversible living trusts. A study of PCP usage in the accounting profession shows a number of CPA organizations expressing satisfaction with their PCPs, while others have chosen to do without such services based on lack of interest. This mixed reaction to PCPs is shown in the small number of state societies providing PCP services to members. The chief factors to be examined in planning a PCP are provided.

PCPs are important mostly to individually owned CPA firms. Large firms have PCPs imbedded in their partnership agreements. Even two-partner firms have a PCP; the surviving or healthy partner remains to carry on. The sole proprietor, however, needs a PCP when death or disability makes continuity of the practice problematic.

Most of us have witnessed the untimely death of a firm's mainstay and the consequent trauma that renders the family incapable of disposing of the affairs of the practice in an orderly fashion. Business mail and phone calls go unanswered; professional and staff personnel lose their direction; some employees may even take advantage of the situation; clients' needs go unmet; and clients shift to other firms. The quick decline and collapse of the affected firm and its intrinsic value is often followed by a hurried sale or abandonment of the practice. This is a classic case of "physician, heal thyself' which can be cured by the formation of a PCP.

Know Your PCPs

A PCP is an arrangement between one CPA firm (probably a sole proprietor), the first party and another CPA firm, (sometimes the sole proprietor's employees) and the second party, whereby both parties agree to the terms and conditions under which the second party will absorb, service and pay for a disabled or deceased practitioner's business. In the event of untimely death, disability, or even in the case of planned retirement, a PCP can maximize the value of an accounting practice. A PCP operates like a combination of a revocable living trust, a buy-sell agreement, unfunded life insurance, and disability insurance. This entire transaction is sometimes accomplished under the auspices of a society-sponsored plan.

GeneraI P ovisions A PCP usually has several standard provisions. Upon his or her death, the plan participant's estate is ordered to dispose of the practice to a prearranged buyer at a predetermined price. In the event of disability, the PCP designates who will maintain the practice and how long before a sale is appropriate, the remuneration to be paid, as well as any other details of the arrangement.

In either event, death or disability, the PCP generally provides for pre-signed letters notifying clients of the situation and the practitioner's successor.

Terms for the disposition of the practice also include the means for valuing the assets to be transferred--including clients, receivables, supplies and furniture-the sales price, and the time period for the payout. For example, one popular formula suggests that the sale of a practice should be based upon a percentage of the prior year's (or average of several prior years') accrual basis fees, less uncollectibles, spread over a period of four or five years. The successor firm would then pay 20% to 25% of the fees earned from these accounts over four or five years, with total compensation limited to an agreed percentage of the net fees earned by the practitioner during the prior year or average of a number of prior years of operation. The percentage of net fees earned is generally negotiated based upon the fee source (taxes, audit, compilations, consulting, etc.), quality of the clientele, geographic location of the practice, and any other factors that might come into play in the particular practice. One society's analysis of the percentage of net fees earned showed a range 80% to 100%, but the range can vary significantly.

Following is a discussion of a study we conducted regarding existing PCPs that identifies some of the related problems and makes suggestions for items to be included in your plan.

The Study

We set out to determine the nationwide use of PCPs by asking each society whether it has a formal or informal PCP and how it develops or promotes the plan. One result-a100% response to the questionnaire-- indicates the importance of the issue. But another result61% have no plan at all--indicates that tILe role of many societies in PCPs often involves providing only ad boc, emergency assistance for the continuation of a practice after the sole proprietor suffered an untimely death or disability.

Research Methodology. We reviewed one society's formal PCP and discussed the plan and its alternatives with the society's executive director and the staff responsible for it. We interviewed several PCP participants (including widows of participants). We also interviewed CPAs who acquired the participants' practices, attorneys who negotiated the transfers of ownership, and CPAs who recently joined or withdrew from PCI's. We then developed a questionnaire to gather data regarding the experiences of other societies with PCPs.

The questionnaire was sent to the exective directors of every society. PCPs were defined as pre-signed agreements, with pre-established consideration, whiclL tendered the practitioner's keys, office files, and other critical documents to a designated CPA firm upon the participant's death or disability, thereby assuring business as usual.

Survey Resulting. The survey ascertained if each society had a formal or informal PCP. A formal plan is one that has been approved by the society's board of directors, is included in official documents, and spells out the specific actions to be taken. An informal plan may be anything from ad hoc intervention by an officer of the society to unspecified supervision by a committee.

Fewer than half the societies have any kind of PCP. The structure and format of current PCP varies widely. Most informal plans are developed and monitored through committees. For example, the duties of one committee include "furnishing assistance to temporarily disabled practitioners and assisting in the orderly transfer of the practices of deceased members." Some informal plans simply delegate responsibility to an ofricer of the society. One such plan charges the society president with the duty of acting "in response to specific circumstances to protect the disabled or deceased member's practice."

The results indicate a large variance in the perceived effectiveness of PCPs. While some state societies are generally pleased with their PCPs, others have discontinued them because of a lack of interest. One executive director stated that "our PCP doesn't work. Nothing happens until a CPA dies, and by the time the society.' hears about it, others (e.g., law, vets, and family) are in control."

Most society directors indicated that they would like to see further development and promotion of PCPs. One director, whose society. dropped their plan, suggested that practitioners develop and adopt their own PCPs. Practioners could form PCPs bv working through their society's practice continuation (or equivalent) committee, local chapter, or by just seeking out others who would be interested in a PCP.

Analysis of Operative Plans

Twenty-one PCP's function under the auspices of their societies. We analyzed the existing plans and identified the following key factors to be considered in developing a PCP:

* Releases society members from liability associated with administering PCPs;

* Chooses from an adequate spectrum of CPAs to administer the plan (i.e., from recommendations of disinterested parties);

* Selects appropriate billing rates and compensation structures for PCPs, including payment terms and penalties for late payments;

* Establishes methods for valuing accounts receivables and work in process;

* Provides, including notice, for canceling the agreement;

* Defines what constitutes a disability or a recovery from a disability (e.g., a statement signed by two licensed medical doctors);

* Provides for disposing of the seller's debts (e.g., immediately at the time of the transfer of the practice);

* Covenants not to encroach upon clients if the practitioner recovers from his or her disability (e.g., no encroachment or at least two vears); and

* Provides access to keys to the office and information including client lists, client tax returns, working papers, financial statements and other books and records, employee records, and listings of existing insurance policies and contingent liabilities.

Private PCPs

So far, our presentation has assumed that societies take the lead in establishing PCPs, primarily b.v serving as a catalyst for their adoption and promotion. but local practitioners can, and should, make their own arrangements with people they know and trust. It is, after all, their future that is at stake. Because the contemplated transaction is not a merger, liking the requiring CPA firm is not necessarily a critical issue. Instead, the seller should ascertain that the acquiring CPA firm has the financial means, integrity and ability to service the accounts on short notice and to pay the pre-agreed price. Similar motivation and contract language are used for both private and society-sponsored PCPs.

Practitioners may let it be known or advertise that they are available to participate in a PCP and seek prospective candidates from their colleagues and business associates. Each particip.tnt could become a candidate to either acquire or sell. In fact, many CPA firms might be willing to enter into a PCP agreement as the acquiree or successor firm in order to forge ties between both firms. Having established the relationship, the possibilities for merger or acquisition are enhanced during the lifetime of both parties. While the cost of establishing a PCP is probably minimal, the potential rewards for both parties could be significant.

Timely and Orderly Continuation

Practitioners should always plan for the future disposition of their practices through a sale or merger. We are not discussing the appropriate time to sell a practice in order to maximize its value. Rather, a PCP should be used independent of the timely and orderly sale or merger of an accounting practice. A PCP, in essence is a back-up plan, an insurance ,tgreement in the event that a timely orderly sale of a practice has not occurred. Figure I contains an example of PCP and is based upon a review of the literature and an analysis of society sponsored PCPs.

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