Practice Continuation Agreements: Basic Preparations

Included In This Chapter: 

Often, the first hurdle in preparing a practice continuation agreement is procrastination. An action plan, such as the one provided here, can help you get started. Begin by reviewing this step-by-step plan, modifying it as necessary to suit your circumstances and personal goals. Be realistic about the time needed for each step and be determined to complete each one.

Once your plan is in place, your next step is to review the goals, procedures, and characteristics of your practice. Then, gather all of your client data.

Practice Analysis

An analysis of your firm may influence the type of practice continuation agreement you choose. A careful review prepares you to sit down with prospective successors and compare your respective practice philosophies, clients, marketing techniques, and personnel policies.

The following questions can help you evaluate your practice. Consider each one carefully to determine how it could affect your assessment of your firm and your negotiations with a successor. Be as objective as you can. Remember, the most effective agreement is one that complements your overall business objectives.

  • Reputation. How good is your practice's reputation for service and technical expertise? How visible is it in the community? How is your practice distinguished from the competition? Are you known to offer innovative solutions to clients' tax problems? What has been the major cause of any client dissatisfaction or client losses?
  • Specialties. What are your specialties? Have you been expanding your range of services? Do you specialize in growing fields? Will your successor need to have the same specialties to survive?
  • Rates. What are your hourly or per diem rates? Are they far above or below the market rate? How do they compare with the rates of your successor? Do you use value billing? Are you honest and realistic with your rates and write-downs? What is your realization per charge hour of fees net of write-downs or write- ups based on your billings?
  • Efficiency. How do your chargeable and nonchargeable hours compare with those of other firms? What accounts for the nonchargeable hours? What accounts for extra chargeable hours on certain engagements? How well do you control your engagements? What is your staff charge hour utilization percentage based on 2,080 hours each year? Do you exceed 1,600 hours?
  • Profitability. What have your gross fees, net income, and salary been on an accrual basis over the past five years? How do your write-ups and write-downs compare with those of your competition? What has your cash collection experience been over the past five years compared to your gross fees billed?
  • Location. Where is your practice located? Is the local economy sound? Is your practice area highly competitive? What are the lease terms of your office space? Is your rent above or below the market rate?
  • Staff. How high is the morale of your staff? How well does your staff relate to clients? How many employees are certified? Is the staff likely to remain at the practice or to leave? Have staff members signed non-competition agreements? Are salaries and benefits competitive?

In addition to the overall evaluation, there are some significant control statistics that indicate the financial health of a practice. Make them available at the time of the negotiations to facilitate comparison of practices and their operations. Significant control statistics include:

  1.    Gross fees per total personnel, including partners
  2.    Number of partners and gross fees per partner
  3.    Number of professional staff and gross fees per professional staff
  4.    Number of support staff and gross fees per support staff
  5.    Gross fees net of write-ups and write-downs per total personnel
  6.    Gross fees net of write-ups and write-downs per partner
  7.    Gross fees net of write-ups and write-downs per chargeable hour
  8.    Average chargeable hours per total personnel compared to total hours
  9.    Average chargeable hours per partner compared to total hours
  10.    Average chargeable hours per professional staff compared to total hours
  11.    Average chargeable hours per support staff compared to total hours
  12.    Average billing rate per chargeable hour per total personnel
  13.    Average billing rate per chargeable hour per partner
  14.    Average billing rate per chargeable hour per professional staff
  15.    Average billing rate per chargeable hour per support staff
  16.    Salary and net income per partner
  17.    Salary and net income per partner as percentage of gross revenue
  18.    Salaries for professional staff per chargeable hour
  19.    Salaries for total personnel per chargeable hour
  20.    Direct expenses per chargeable hour
  21.    Indirect expenses per chargeable hour
  22.    Ratio of capital to net income
  23.    Average collection period
  24.    Receivables and WIP as a percentage of gross revenue
  25.    Percentage write-up (write-down) from standard billing rate
  26.    Dollar value of write-downs, net of write-ups from standard billing rate
  27.    Percent growth over previous year
Review your firm's accrual- and cash-basis financial statements for the past five years before beginning negotiations with the successor firm. Trends must be documented and analyses made that support your claims. Remember that you are selling your firm's attributes, and that financial statements offer empirical evidence regarding the success of its operations.

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Client Information

You may have a good sense of what your practice is worth, but you cannot negotiate on that basis. It is essential that you keep good records to provide facts regarding the value of your practice and fine-tune your operations to enhance its value. Therefore, a most critical step in preparing for practice continuation discussions is to summarize basic data about each client. The importance of good client data cannot be overemphasized. It is crucial in the negotiations that follow.

Time and billing software programs can summarize, cumulatively or for defined periods of time, such information as collections for each client, each client's type of business and years with your firm, and billings by type of services rendered (for example, audit, tax, or management advisory services) as a percentage of gross fees. This information can provide an overall picture of chargeable hours, amount of work done by due date, collection delays, cash-flow fluctuations, the size and number of paying clients, and the seasonality of the practice.

This information, in turn, can be used to project the practice's operations and cash flow for several years. Such a projection is of critical interest to the potential successor and may facilitate negotiations.

Client profiles may also include an assessment of client personalities, business philosophies, and goals. You may want to segregate financial and nonfinancial information with one-page summaries for each client. This information may already be available in your client history files.

Client profiles should provide, in columnar schedule form, the following data:

  1.    Name and legal status of the individual or company (and any affiliated companies)
  2.    Public or private status of the company
  3.    Client's business
  4.    Client's location
  5.    Names and ages of principals and their equity percentages
  6.    Company structure and vulnerability to loss of a key executive
  7.    Period of time as a client
  8.    How client was obtained
  9.    Type and frequency of services rendered
  10.    Function and number of employees needed to handle the account
  11.    Extent of client's computer and software capabilities
  12.    Average fees paid in the past three to five years for regular and special services
  13.    Number of company and personal tax returns prepared for principals and others
  14.    Potential for a fee increase
  15.    Direct costs of servicing the client
  16.    Adequacy of client working papers and records
  17.    Method of setting fees
  18.    Unusual service problems
  19.    Problems with integration of staff and client
  20.    Any other desirable data in the individual case

With this information, it should be comparatively easy to develop statistics on your practice by industry, fee size, engagement type, profitability range, manpower requirements, specialized services, and other factors.

It is also important to analyze client groupings. Is any one group more likely to switch to another CPA? Is there a concentration of clients in one particular industry? Are one or two clients responsible for most of your gross fees? Have any of the clients been serviced by a potential successor? The answers to these questions could affect the assessment of your practice's value.

The importance of client information cannot be emphasized enough. The situation is even more critical if the CPA dies without a practice continuation agreement in force. Remember, even if staff is available to assist the surviving spouse in constructing client profiles, selling the practice in fewer than 30 days is critical to obtaining any significant benefit.

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