Succession Planning in Practising Firms
Author:
Phil Shohet
A key issue facing firms of all sizes today is that of succession: how to fund the retirement of older partners whilst maintaining the profitability of the practice, and making it an attractive proposition for potential incoming equity partners or purchasers. Due to the trends and influences – both commercial and social – that have brought change to the profession in the past, and will continue to do so in the future, as well as a lack of attention to succession issues, many firms will have to resolve major financial problems in the very near future.
Practices with a high proportion of partners in the 50 plus age bracket should be looking to appoint younger replacements in order to develop the business and help fund their exit routes during the next five years. However, attracting the right calibre of prospective partners is proving very difficult. Many young accountants simply do not want to make the financial commitment or take on the responsibilities and risks associated with partnership.
In addition firms need a much greater degree of specialist knowledge in prospective partners. Technical and compliance work is no longer a major growth area for most independent firms and will become even less significant in the future. Practitioners must therefore develop a much greater range of business advisory skills and be prepared to diversify into new areas of corporate and personal advice if they are to maintain business growth and profitability.
Lack of succession planning means that it is not only the firms that are facing problems; the picture for many retiring partners is grim. Reduced pension values, plummeting annuity values, insufficient funds within the practice to pay out goodwill or balances quickly and simply lack of planning mean that many partners face the prospect of working into their 70s or accepting a much reduced retirement income than they had anticipated.
Funding exit routes must be accomplished in such a way that new partners do not find themselves saddled with a burden of debt but, equally, are capable of making a positive contribution to the development and profitability of the practice. However, In a survey conducted in the independent sector by KATO in 2004 28% of the respondents stated that a sale or merger was the only way in which they could finance the existing partners’ exit routes. If this is representative of the independent sector as a whole, we are looking at the very real possibility of losing over a quarter of them in the next 10 years or so.
One of the principal reasons why many practices have succession problems is because the subject is seldom discussed, and certainly not in any formal fashion. Yet it is vital that every partner in the practice not only has a very clear idea of what he or she wants in terms of retirement, but that this knowledge is communicated to the other partners and agreed with them. Without communication there can be no personal or financial planning.
The financial remuneration of equity partners has changed very little in real terms in the last 10 years. There is a widening gap between high-earning firms and the remaining majority of average or below-average performers. This is undoubtedly one of the key reasons for the risk-averse attitude of prospective partners. Skilled and talented accountants in their thirties have a wide choice of employment prospects without the risks or financial commitment associated with an equity partnership.
The changing market for accountancy services requires the appointment of new partners who will increase the skill pool within the firm; who can take on the role of ‘trusted advisor’ to their client; who are entrepreneurial and will drive the business forward. Few firms have nurtured such talent in-house and must therefore go into the marketplace to find it. Unfortunately, the cultural divide between the big firms (where these specialist skills are largely developed) and the medium-sized and smaller firms (which need to employ them) can be vast, which makes it difficult to achieve a harmonious fit.
Firms are starting to change their attitudes and make greater efforts to create a structure and culture that will make them an attractive proposition for the young and talented people that they so desperately need, but progress has been slow. There are still far too many mired in the old ways who will soon simply be unable to compete with those firms that have changed and who are therefore unlikely to survive.
The Partnership Deed should include a detailed retirement plan, but for firms that do not have a Deed – currently around 18% of independent practices – it is absolutely vital that they have a formal, written retirement plan that is reviewed on a regular basis.
All retirement and succession strategies should be flexible enough to allow for unexpected changes in circumstances over the years. Inadequate drafting of either the partnership Deed or the retirement plan could, and often does, threaten the continued viability of the practice.
Funding retiring partners’ exit routes can place an excessive financial burden on a practice that is not prepared. Not only must consideration be given to the source of the funds, but to ensuring that they are available in accordance with the planned retirement dates of individual partners. The Partnership Deed should stipulate the repayment term of capital and interest accounts (and whether balances outstanding are interest bearing
Perhaps the biggest difference between the expectations of entrepreneurs in company and partnership scenarios respectively is with regard to goodwill. In the company context , the value of shares is (at least before any minority discount is applied) a reflection of the overall market worth of the business, which is likely to be measured as a multiple of turnover or profit as it is to be related to the value of the underlying assets. In the partnership world, however, the only way for this to be reflected is in the nebulous and increasingly rare concept of ‘goodwill’.
However, although goodwill is a problem that may disappear eventually, for the vast majority of partners looking to retire in the next 10 years or so, but who have purchased their partnerships, it is still a vital issue as they will expect to be paid out on retirement.
Growing businesses, principally owner-managed businesses, comprise the primary target market for the independent sector of the profession. They look to their accountants to provide a wide range of services in addition to compliance work. Business planning, managing growth, raising finance, profit improvement, tax planning, retirement planning, pensions and investments and mergers and acquisitions are just some of the skills that firms will need to provide in order to maintain profits and fees in the practice.
With the emphasis moving from compliance to advisory work the trend is for some practices to divisionalise. Essentially, this involves separating compliance and non-compliance work within the practice and creating a separate company to handle all other aspects of the firm’s activities. Not only does this improve efficiency, but it creates a business with value that can provide a dividend income for the shareholders or which can be viewed as a saleable asset to create an exit route.
It is absolutely essential that firms create a practice structure that will service the needs of the clients, improve profitability and ensure continuity through effective retirement and succession planning.
Historically, accountancy practices were organised as partnerships to give comfort to clients: partnerships could be relied upon to be financially stable because, in case of default, the partners themselves would be entirely liable. However, times have changed and the notion of personal liability is becoming more and more outdated as firms look to create a practice structure that will allow them the flexibility to take advantage of opportunities in the marketplace, service their clients effectively and grow their business.
There are now a number of alternatives to the traditional partnership structure which may have a bearing on how the business is organised in the foreseeable future. For example, strategic alliances using limited company status are emerging in services such as financial services, IT and consultancy, and it is possible to become an LLP in Northern Ireland and the rest of the UK. The marketplace for accountancy services is now extremely competitive and firms must place greater emphasis on getting the framework right for delivering services and improving profitability.
A significant part of the growth management strategy must be directed at ensuring that the firm is growing in the right direction rather than simply accepting growth for its own sake. Once a critical mass has been achieved there is every opportunity for greater selectivity in taking on new business, but unfortunately many firms have an inability to turn away any potential client – even those that do not fit in with the firm’s growth strategy. The result is that, although the firm may grow in size its profitability may actually be reduced.
Firms also need to know exactly where their profits are coming from in order to both identify strengths and weaknesses within the client base and to plan the production of work. Using the Pareto analysis practices can analyse the type of work within the firm, the size of clients and their profitability
Despite the fact that, in the last 10 years or so, the majority of practice growth in the independent sector has come about through merger or acquisition, some of the most successful firms have achieved spectacular growth in terms of both size and profitability by organic means. The secret of their success lies in their attitude to their most vital asset - the people who work in the practice.
Developing the existing partners, developing potential partners within the firm or appointing new partners is key to the firm’s future success. The full utilisation of existing skills and the development of new ones should be applied to every member of the firm’s staff.
The process of identifying the need for new skills within the firm is inextricably linked to the business planning process. Reviewing the firm’s clients will highlight not only the areas in which the firm should be offering added value services, but the skills that need to be developed in order to do so. An effective performance management system will quickly identify those people who either have those skills or the potential to develop them. It will also identify where firms need to bring new talent into the practice; including new partners.
The key is to be objective about what the practice really needs and then find someone who meets those needs. Without exception, those firms that have achieved successful organic growth have done so because they have created a ‘business of value’: not only in terms of their financial worth, but also in terms of the value they offer to employees, business partners and clients at every level.