Death in the Firm - a Cautionary Tale
What happens to a small firm when a partner dies and practice continuation planning is inadequate? Warren G. Nogle, CPA, partner, McLoughlin, Briese, Yip & Nogle, 100 Spear Street, Suite 1630, San Francisco, 94105, shares his experience. I became the junior partner of a two-partner accounting firm in San Francisco in 1988. On joining the firm, I was placed in charge of new clients and those gained through acquisitions of smaller firms as well as management and computer consulting engagements. In addition, I was responsible for staff supervision in accounting work and tax preparation. The senior partner was responsible for the old-line clients who were the firm's financial backbone. He specialized in personal financial planning and performed some management and administrative duties. The client base was composed primarily of doctors and attorneys. The firm's service mix and revenue were distributed equally among small business accounting services and individual and corporate tax returns. Computer and management consulting substantially contributed during the off-season. On March 2, 1991, the senior partner died suddenly of a massive stroke. Although we had taken some precautions in case of death or disability, our firm essentially was unprepared to cope with a partner's death. The lessons we learned may prompt other CPAs to create policies that help see them through unforeseen tragedies. BUY-SELL AGREEMENT The existence of a buy-sell agreement and two related life insurance policies was my single greatest comfort after my partner's death. However, I wasn't aware they had problems until I needed them. Our buy-sell agreement called for the firm to purchase life insurance policies for each partner, with the firm the beneficiary and the proceeds to be used to purchase part of the deceased partner's shares in the corporation. In addition, it called for an additional payout to the deceased partner's estate of up to 75% of the prior year's billings divided by the number of shares outstanding less the insurance proceeds. In retrospect, although the agreement's terms were good for my partners' heirs, they were not very favorable to me because they * Assumed retention of most of the clients. * Assumed billing increases. * Did not anticipate the recession and actual billing declines. * Assumed expansion based on current clients and referrals. In essence, the agreement looked backward rather than forward. In retrospect, I recommend using an average of the next two years' billings as 100%, with 50% credited to each partner as a favorable price to pay. This gives a better approximation of practice value and does not effectively penalize the surviving partner for surviving. Because of the agreement's flaws, the firm's financial prognosis was not very good. I strongly recommend that all firms have buy-sell agreements with insurance coverage to fund a portion, if not all, of the buyout of the deceased partner's interest in the organization, but objective third-party assistance should be used to negotiate all such agreements. The exhibit at right covers some pitfalls of forging these agreements. PRACTICE CRISES After the senior partner's death, I faced a number of problems that needed to be solved if the corporation was to survive as a viable entity. * Loss of clients. Client attrition was approximately 20% of total billings in the first six months after my partner's death and another 10% in the second six months. His clients were located throughout the San Francisco Bay area and many had been with the firm for 15 years. The senior partner had established long-term personal and professional relationships with most of his clients. Unfortunately, they still viewed me not as their accountant but, rather, as another technician on the staff. There had been no comprehensive marketing plan to introduce me when I joined the firm. …