Understanding what Your Partnership Agreement Should I nclude Terrence Putney, CPA, CEO

1. Understanding what Your Partnership Agreement Should Include Terrence Putney, CPA, CEO Transition Advisors

2. Accounting Transition Advisors National Consulting Firm working exclusively with accounting firms on issues related to ownership transition

3. Partners and Associates Terrence Putney tputney@transitionadvisors.com CEO 866-279-8550 Joel Sinkin jsinkin@transitionadvisors.com President 631-493-0022 Bill Carlino wcarlino@transitionadvisors.com Managing Director – National Consulting Services 914-273-4327 Transition Advisors, LLC

4. Transition Advisors, LLC Russ Best rbest@transitionadvisors.com 913-962-2563/214-453-1200 Nancy Egan negan@transitionadvisors.com 814-807-1290 Partners and Associates Mark Basinski mbasinski@transitionadvisors.com 866-279-8550

5. Partners and Associates Peggy Tyers ptyers@transitionadvisors.com 905-823-1585 Marcia Miller mmiller@transitionadvisors.com 954-465-7429 Mike Farinelli mfarinelli@transitionadvisors.com 1-866-279-8550 Kay Conklin kconklin@transitionadvisors.com 1-866-279-8550 Transition Advisors, LLC

6. If there are 50 things you need to think about in a transaction……. ……the smartest of us will think of only 35

7. Key Elements to a Partnership Agreement Compensation Governance Death/Disability, Retirement Termination Unwinding the Partnership

8. Goals of Partner Compensation Motivate partner behavior to achieve desired strategic and financial results Create motivation for top performance Build a strong partner team through retention of the best performers, removal of non-performers, and attracting new talent

9. Committee-based • Leader-based • Equal • Seniority • Pure Formula • Cross Evaluation • Equity-based Types of Compensation Plans

10. Types of Compensation Plans ◊ Equal Often used in new partnerships formed from scratch Promotes collegiality Requires substantially equal contribution to be sustainable Long term, often fails to promote high performance

11. Types of Compensation Plans ◊ Equity-based Often used in new partnerships formed with existing books Promotes short term stability Requires substantially static contribution to be sustainable Long term, often fails to promote high performance; easily can get out of balance

12. Types of Compensation Plans ◊ Seniority Based on tenure Often similar to Equity-based as equity normally accumulates based on seniority Unit-based plan where units accumulate over time Tends to reward for past performance more than current

13. Types of Compensation Plans ◊ Pure formula An accountant’s dream Relies mostly on pre-determined, objective measures Promotes clarity and certainty Leaves out hard to measure, subjective elements of performance; tends not to be team oriented Can be manipulated in many cases

14. Types of Compensation Plans ◊ Cross Evaluation Relies on each partners evaluating each other Appearance of fairness-democratic Requires knowledge of other partners’ contribution Tends to lump most partners into an average rating Tends to avoid hard discussions about performance

15. Types of Compensation Plans ◊ Leader-driven Managing Partner decides Requires strong managing partner and trust in their decision-making ability Most flexible … can be very effective In closed system, can lack transparency which can lead to mistrust and lack of needed feedback

16. Types of Compensation Plans ◊ Committee-driven Appropriate for large firms Works well when knowledge of all partners’ contributions is not readily available to each partner or the managing partner Allows for flexibility and fair vetting of issues Can lack needed transparency Can be inefficient

17. Equity: What Does It Mean? Compensation Profit Sharing Decision making Internal buyouts External buyouts

18. Different Types of Partners? Full Equity – Senior Full Equity – Junior Income partners Of Counsel Using the term Principal

19. Governance Decision making Unanimous vs Super majority vs Simple majority Financial Commitments

20. Governance By way of example … Super majority Admission of new partner Simply majority Expenses in excess of certain amount Unanimous Dissolution or sale

21. Retirement ◊Voluntary Mandatory age / Vesting Partners desiring to stay on after retirement and how that impacts their role, compensation and buyouts Valuing equity Equity Compensation Funded vs unfunded

22. Right Financial Arrangement Backwards Valuation Reward your retiring partners fairly for their years of sweat equity BUT Don’t expect your remaining partners to borrow or take a step back in compensation to do it.

23. Right Financial Arrangement Available capital is the retired partner’s foregone compensation. Three uses for that capital: • Pay the retiring partner off. • Cost of replacing that partner. • Some upside for the remaining partners for assuming the obligation and the extra work.

24. Right Financial Arrangement The basic assumption is: • An owner is earning compensation as an owner, even with lowered time commitment, and NOT at the same time, being bought out. OR • The owner is being paid for their equity and is still working is being paid as a non-owner. It’s hard financially to do both at the same time.

25. Right Financial Arrangement Example: Retiring partner comp and benefits $300k Replacement resources $120k Remaining capital $180k You need to decide how much can be used for buyout and how much should be left behind.

26. Example • Firm volume $1.9 million • Retiring partner equity 45% • Retiring partner comp & ben $275,000 • Capital account $175,000 • Payout retirement over 5 years (works out to $171,000 per year) • Cost of replacement resources $125,000

27. Example • Year 1 net cash flow: $275,000 less $125,000 equals $150,000 of available capital $150,000 less $175,000 (cap acct) less $171,000 (retirement) equals $146,000 of negative cash flow • Years 2 thru 5 net cash flow: $150,000 less $171,000 equals$21,000 of negative cash flow

28. Example Alternative plan: • Pay capital over 5 years • Pay retirement over 10 years

29. Example • Years 1 thru 5 net cash flow: $275,000 less $125,000 equals $150,000 of available capital $150,000 less $35,000 (cap acct) less $85,500 (retirement) equals 29,500 of positive cash flow • Years 6 thru 10 net cash flow: $150,000 less $85,500 equals $64,500 of positive cash flow

30. Retirement ◊Terms Payout periods Retention periods Tax structure Caps Penalty buyouts Premature exit Exit without appropriate notice Getting “booted” out

31. Definition of temporary disability vs permanent • Where insurance fits in re disability • Death • Where insurance fits in re death Death or Disability

32. Termination Voting Grounds Non-Competes What is cause?

33. When is it appropriate and not appropriate? • How long can they be invoked • Allowing partners to leave with clients • Handling of: • Original clients • New clients • Firm name • Staff • Liabilities • Leases De-Merger Clauses

34. Other Thoughts External Sale/Dissolution Roles and responsibilities Hold harmless Non-competes Arbitration vs lawsuits Restrictive covenants: Leaving with or without clients

35. Transitioning Clients What are the clients’ fears? Is the partner/owner I trust still there? Is it going to cost me more money? Is the staff I am accustomed to working with part of the successor firm? Change IS A DIRTY WORD THE EMPHASIS NEEDS TO BE ON continuity NOT THE LOSS OF, BUT THE gainOF …

36. Miscellaneous It is a living agreement? Limit retirement timing Create benchmarks, time frames Replace the role, not the body

37. For More Information Please visit our website for resources including FREE reports, whitepapers and case studies. Terry Putney tputney@transitionadvisors.com 1-866-279-8550 www.TransitionAdvisors.com