Included in This Chapter:
- Assumption of a Practice on a Temporary Basis
- Assumption of a Practice on a Permanent Basis
- General Provisions
- Negotiation Considerations
Once you place a value on your practice and identify your successor, you are ready to begin negotiating and constructing the agreement. You should consider consulting with an attorney before the negotiation process begins. At the beginning of the negotiations, set forth the essential terms that must be a part of any agreement, such as warranties of other parties. If you cannot agree on these terms, do not be afraid to walk away. Remember that the level of confidence and satisfaction your agreement provides depends on your negotiating skills and strategy. As you prepare to negotiate, keep in mind that successful negotiations result in a win-win situation for both parties.
There are many elements to constructing a practice continuation agreement. Outlined below are the basic terms and conditions addressed by such a contract.
The provisions of a practice continuation agreement are tied to the basic definitions of temporary disability, permanent disability, and death or retirement. Temporary disability is a disability caused by physical or mental ill health that does not last more than approximately six months. A leave of absence for military personnel could also be addressed in the provision for assumption of the practice on a temporary basis. Permanent disability is a total disability caused by physical or mental ill health. Retirement is the termination of practice on an immediate or phased basis. These definitions must be included in the contract and must be addressed with care to allow an element of flexibility.
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Assumption of a Practice on a Temporary Basis
In the event of a temporary disability, the practice continuation agreement obliges the successor firm to provide employees to assist in the daily business of your practice. The agreement should address the temporary successor's responsibilities, including maintenance of billing and collection records; coverage of malpractice insurance; responsibility for books, records, and files; and supervision of staff. Additional protection can be achieved by purchasing disability overhead-expense coverage insurance to cover your overhead expenses if you become totally or partially disabled.
Assignment of Staff and Other Employees
The employees provided are generally at the supervisory level and have the experience and background necessary to make management decisions and to provide on-site reviews of work produced by your staff. They remain under your supervision because you are expected to return to normal practice in a short time.
Compensation Arrangement with the Successor
The compensation arrangement should specify the going rate for the management-level individual who assumes responsibility for your firm or the standard fee charged to clients by the successor firm. The fee paid to temporary successors depends on the quality and nature of the services provided and the season in which they are rendered. Fees for CPAs and non-CPAs can differ. Several state plans call for payment to a temporary successor of 75 percent of the normal hourly rate charged to clients. Other plans suggest 80 percent. However, the successor may not want to provide personnel at less than the full rate. While you are temporarily disabled, your staff should receive quality supervision and assistance. Payment of fees at a rate other than the going rate may not provide you with the results you need. On the other hand, your client fee structure may not warrant payment of your successor's full rate. However, the successor firm may be able to compensate a management-level CPA at a lower rate and still provide the quality and expertise required. This issue requires careful negotiation. When fee structures are compatible, fewer problems arise.
The contractual agreement should provide for a systematic conclusion to the arrangement for temporary services. As a rule, advance notice of returning to work is not required by the agreement, but as a courtesy, the temporarily-disabled practitioner should inform the successor of his or her return as far in advance as possible.
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Assumption of a Practice on a Permanent Basis
The provisions called for in the event of permanent disability, retirement from practice, or death are much more detailed. You have to assume your inability to deal with any element of the practice and provide for the orderly transfer of your clients to the successor firm. Payments for your practice are then made on a predetermined basis.
List of Clients
A list (as discussed here) that provides such information as the type of industry or service with which the client is associated, comparative fees per type of service for at least three years, accounts receivable collection history, types of services provided, and contact persons at the client's office, is vital not only to the valuation of the CPA practice and its ultimate sale or disposition, but also to the contractual agreement itself. The form of the client matrix may vary, but at a minimum it contains a list of clients, the value that is placed on the business of each one, and the method used to determine and assign these values (as discussed here). The list is included as an exhibit to which reference is made in the body of the contract. It is a key contract element that should be updated at least annually.
The firm's working papers must be available to its successor. These papers indicate the tax and accounting standards that have been applied to each client. They can also assist in determining the status of work in process and can enhance the value of the practice. Arrangements for the transfer of these records must be made.
Billing, personnel, and all other files (both paper and electronic) must also be transferred to the successor firm. One of the most difficult problems can be locating the files and identifying the information they contain.
Books and Financial Statements
Because the entire practice is being transferred, the successor must have access to all of the predecessor firm's books. This includes subsidiary ledgers such as payroll and accounts receivable. It is also advisable that the firm's financial statements on an accrual and cash basis for at least the past three years be available. Tax returns should also be available. Note that the same information regarding the successor firm should be available to the predecessor during negotiations and, later, during reviews of the agreements.
Work in Process and Accounts Receivable
One of the most difficult areas to define in a CPA practice is the work in process. Usually, it is valued separately. Payment therefore depends on the ability to identify and determine the status of the work in process. Accounts receivable records are also vital in the transfer of a firm's clients. The parties to the agreement must decide who will be responsible for collecting the accounts receivable and whether the accounts will be valued and sold to the successor firm. If the successor agrees to buy them, they must remain separate and apart from the successor firm's accounts receivable records. Provisions should be made for any service fees that may arise in the collection process.
Equipment and Supplies
CPAs sometimes do not follow the advice they give their clients and fail to employ an identification system for their office furniture and equipment. Generally, all they have available is their depreciation schedules. Unless a good identification system is in place, the surviving spouse, executor, or successor firm will find it extremely difficult to identify these items. A fixed-asset subsidiary ledger, if it contains a record of dates of purchase, costs, serial and model numbers, and peripheral attachments, can also assist in assessing this element of the balance sheet. If supplies are to be sold to the successor firm, they need to be organized to allow an inventory to be taken.
Current leases of a CPA firm can be negotiated for settlement with the lessor, usually by the surviving spouse or executor's paying approximately six months' rent in advance. Sometimes even the permanently disabled practitioner or the successor firm can negotiate release from a lease. Generally, however, the successor does not need a second office in the same city and does not want to have to negotiate the settlement of the lease. To ensure client retention, a transitional lease may be advisable. Landlords will generally agree, for a price, to the reassignment of a lease. Advanced lease planning could allow the lease to automatically terminate within 30 days of your death. CPA firms also lease equipment (such as copying machines and scanners) and have secondary leases for storage facilities. Assumption of payments and lease terms for these must also be addressed by the agreement.
Good employee records are vital to a CPA firm's operations, but some firms neglect them. Records should be available containing, at a minimum, employee contracts, salary scales, personnel policies, equal-opportunity practices, and performance and salary reviews. Most agreements contain a provision for the firm's personnel to be hired by the successor and to be retained unless they prove incompatible with the new firm. It is extremely important that your staff understand that the agreement provides for their transfer to the successor firm.
Liabilities and Malpractice Insurance
Existing and contingent liabilities must be identified, including any current professional liability lawsuits. Most agreements address this issue specifically. Successor firms do not want to be associated in any way with professional liability lawsuits brought by clients or with some contingent liabilities.
When a practice is to be continued by another practitioner, decisions have to be made concerning policy limits, deductibles, types of risks covered, and settlement provisions. Of particular importance to you will be the purchase of tail coverage to protect against claims made after the expiration of the former malpractice policy. Because you are no longer practicing, premiums for tail coverage are usually reasonably priced. Work closely with your insurance broker and attorney so that you can obtain the full protection of your malpractice insurance policy.
Any debts, such as notes payable or current liabilities, should also be identified in detail. Before negotiations can be completed, these debts may have to be negotiated with the creditor. Some debts cannot be assumed, and new ones may have to be created or substituted.
Property and Casualty Insurance
This element of the agreement is of special interest to the successor firm. Proper coverage must be in force and expiration dates must be known to ensure protection of assets before and during transfer from one office to another. The surviving spouse or heirs also need coverage to be in force until they have disposed of any assets not transferred. A well-organized insurance file containing records of all current policies is recommended.
Fees and Billing Information
The standard fees of your firm and your successor need to be known during negotiations. Compatibility between these fees in the marketplace is required to ensure client acceptance. The fee structure of billings and the billing procedures themselves are also vital to client retention. Finally, utilization of personnel is determined principally by the fee structure.
Payment for the Practice
When considering the sale of your practice, you must be reasonable in your assessment of its value and realistic in the payment structure you demand. You must keep in mind that the object of your negotiations is a practice continuation agreement that protects your assets and provides something to your surviving spouse or heirs. To this end, you may need to sell your practice at a buyer-friendly price. You must also remember that the value of your practice will dissipate in fewer than 30 days after your death and that it will not last much longer than that if you become permanently disabled and are unable to tend to its affairs. It is essential in your negotiations and in the drafting of the agreement that payment steps are clearly outlined. Consideration of tax issues and responsibilities is also critical.
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These general provisions should be included in your agreement:
It is extremely important to have this element addressed in your contractual agreement. A noncompetition clause penalizes your successor for taking away any clients in the course of the temporary disability engagement. The penalty is usually expressed in terms of dollars to be paid for each client taken. This is generally no less than 150 percent of the cash fees collected from those clients during the previous year. You should seek the advice of an attorney as to the enforceability of any restrictions you are thinking of including in the agreement, because rules vary from state to state.
Termination of the Agreement
Most agreements allow for termination by either party within 30 days of sending written notice to the other's last known business address. However, you can select any termination period. You need this provision to allow you to void the contract in the event of the discovery that your successor has been involved in controversial issues that might jeopardize retention of your clients. A significant change in financial conditions at either firm could also warrant termination of the contract. There may be other instances in which you wish to draw up a new agreement, for example, in order to transfer the practice to a particular staff person who has gained the respect of clients. The successor may also want to cancel, for example, if his or her health deteriorates.
The parties can agree that any dispute or claim concerning the contract will be settled by arbitration. These proceedings would be accomplished by other CPAs not party to the contract, with the costs to be borne equally by each firm.
This element of the contract ensures that your clients are notified of the agreement. It should be stressed to them that the services they have been receiving will not be interrupted in the event of your untimely departure from the practice. Notification should be performed by your firm and should make the point that much thought has gone into finding a successor firm that will provide comparable services at comparable rates. It is even advisable that both you and your successor visit key clients before the agreement is consummated and inform them of the possibility of a transfer and what they can expect. Even if it is not a stipulation in the contract, it is extremely important that your surviving spouse or heirs be notified that you have executed a practice continuation agreement. The attorney for your estate should also be notified if he or she did not review your practice continuation agreement before execution. This is, however, a situation that should be avoided.
If possible, the permanently disabled practitioner should assist in the orderly transfer of clients, advising the successor on the nature and status of the engagements. This encourages a smooth client transition and strengthens the relationship between the successor firm and the clients. It also increases the chance that your clients will remain with the successor firm, resulting in payments for your practice.
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The following issues may arise during the negotiations.
Generally, your staff is paid by your estate through the date of transfer and by your successor thereafter. Employee benefits, such as accrued sick pay and vacations, are important for morale and should be addressed carefully.
Check with your state board of accountancy about your successor's use of your firm's name on letterhead, business cards, and similar documents.
You may want your successor to purchase decreasing-term life insurance in an amount equal to his or her debt to your estate when the transfer takes place. This protects your heirs in the event that your successor dies before completion of the payment terms. Your estate should be the beneficiary. The successor should also have disability and general-practice insurance. The cost of the insurance must be considered in relation to the derived benefits.
Telephone, Box Numbers, and E-Mail
To help maintain continuity, transfer your firm's telephone number and post office box number to your successor upon implementation of the agreement. Consideration should also be given to setting office e-mail to forward to your successor.
Consider circumstances peculiar to your own or your successor's practice during the negotiations. For example, some specialized work may not be transferable. If you practice out of your home, the disposition of assets and the use of the premises by your successor probably need to be dealt with differently than if you operated out of a separate office. Whatever the special circumstances, they should be considered and included in the agreement.
Incorporate the practice continuation agreement into your will and estate, and consult a competent attorney to draft your agreement and review all related documents at the conclusion of negotiations. Click here for a sample agreement.