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client recently asked me an interesting question: How many CPA firms make retirement payments to former partners and what is the ratio of those payments to net fees?
To answer the question, we used The Rosenberg MAP Survey and looked at the 81 firms with net fees over $2 million. Forty-five of the 81 firms (56%) made payments. Those 45 firms made retirement payments equal to 2% of net fees. Only one firm was higher than 5%.
A Huge Challenge
The CPA profession faces a huge challenge in the next five to years. Firms with less than $8 million in annual fees will become obligated to pay billions of dollars to retired partners under the terms of their largely unfunded retirement/buy-out plans. Can the firms afford it? Do older partners have faith in their younger partners’ ability to keep the firm running and honor retirement obligations? Do younger partners have that ability?
In my experience, this situation is exacerbated by two additional problems. First, many firms have severely flawed retirement plans. They call for inflated payments to retiring partners because payments are determined by arbitrary methods such as ownership percentage, pay-equal, or fixed payments, none of which properly take into account what the retiring partner did to earn these benefits. When younger partners look at the impending obligation (usually 2-5 years before someone is about to retire), quite naturally, they balk and tension builds exponentially.
Second, CPA firm partners have never been good at developing younger partners. The dwindling supply of quality, experienced CPA staff only aggravates the problem. A significant percentage of CPA firms do not have enough younger partners to take over the firm when the older partners retire. So, even if a firm has a rational retirement plan, it’s unlikely that the plan will be executed because the firm doesn’t have the ability to make the retirement payments.
These issues form the core of the chess match that is being played out at firms throughout the profession. Many firms are opting for a way out—merging into larger firms.
A Dual Perspective
One of the most compelling aspects of this issue is the dual perspective it requires. First is the older partners’ perspective: How do you define their retirement payments and how do you develop staff into partners that will write them retirement checks, all of which is termed succession planning.
The other perspective — that of younger partners and partner prospects — is given short shrift by most firms. But firms need to consider how younger partners and partner prospects will react to retirement arrangements. If they don’t think it’s a good deal for them, then they won’t want to be partners. My sense of the CPA industry is that younger partners and partner prospects are taking a much tougher look at retirement agreements. The concept of valuing goodwill for retirement purposes as one-times-fees is being questioned more than ever before.
Questions being asked include:
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Is the buy-in too expensive?
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Are the amounts and terms of the retirement benefits reasonable?
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What if the pre-retirement partner’s clients have such a strong commitment to that partner that the other partners doubt their ability to retain those clients after the partner retires, regardless of the transition efforts made?
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Is the older partners’ performance commensurate with their compensation? An older partner who’s “coasting” is a turn-off to younger partners, who see this partner getting his retirement benefits twice — once via over-compensation while an active partner, and a second time when he or she retires.
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Similarly, what has the pre-retirement partner done to earn the retirement benefits? If the partner has a strong presence in the firm and is a vital contributor throughout her senior years, few partners will have difficulty cutting retirement checks for this person. But if the partner has been a marginal contributor to the firm for years and has few solid client relationships before entering the transition period (because the senior staff really have the relationships), the younger partners may ask: “What are we paying for?”
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One way that payment of the retirement benefits has historically been palatable to younger partners is the fact that when the older partner retires, the retiree’s compensation gets split among the remaining partners. But if the older partner continues to work indefinitely or begins to receive retirement payments while still working a significant workload, then the younger partners get discouraged at being unable to take over the older partner’s clients and income.
In the CPA firm partner retirement area, a version of the “you can’t have our cake and eat it too” syndrome has evolved. If firms want younger partners to write their retirement checks, they have to be reasonable about when they retire and how they will ensure that clients stay. They must develop and nurture their firms so that younger partners will not question the value of the goodwill that has evolved. If they don’t, their succession planning options will be severely limited.
The Rosenberg Associates is a management and marketing consulting firm serving CPA firms and law firms, as well as other companies and organizations. Marc Rosenberg can be reached at marc@rosenbergassoc.com.
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