In Practice - Succession issues - The grim reaper

A quarter of firms may perish, according to a new survey from Kato Consultancy in association with Accountancy, which shows the magnitude of serious succession issues facing firms.

Shrinking pensions; insufficient capital in the practice to pay out retiring partners; a dearth of high calibre new partners prepared to invest in the business; problems with client retention as partners retire; no hope of early retirement; no possibility of continuing independence.

These are just a few of the retirement and succession problems facing independent practices according to a recent survey undertaken by KATO Consultancy in association with Accountancy.

Not only did the number of respondents far exceed expectations - a sure sign that this whole issue is very much front-of-mind with partners - but the sheer number of problems that they had identified and were struggling to find solutions to was also much greater than expected.

It is now some years since the profession first woke up to the fact that there was a succession problem developing in independent firms with their significant proportion of ageing partners. Investigation into the situation revealed a range of causes and there is now a considerable amount of help and information available to practitioners. However, the results of this survey show that the problem is now more acute than ever as firms have failed to address the issue and, as a result, are now facing a bleak future.

The majority of the firms taking part in the survey ranged in size from four to 10 partners although there were five sole practitioners and eight firms with over 20 partners. But no matter what the size of firm, one thing was abundantly clear; no-one is expecting to be able to take early retirement. With only three exceptions every partner was expecting to work until 60 or 65 (and some until 70). Although for a few accountancy is a real labour of love (as one respondent remarked: 'They will have to carry me out of here in a wooden box!') for the vast majority the reasons are purely financial. Lower earnings than expected over the last few years, the bottom falling out of the pensions market and the problems finding new partners prepared to invest in the practice mean that they simply can't afford to stop working.

This explains why 33% of respondents said that their retirement expectations had changed over the last three years: and not for the better.

The deed is done

In theory retirement arrangements should be set out in the partnership deed, yet 18% of the firms taking part in the survey had no deed at all.

This means that each partner will have to negotiate their own terms on departure. The practice may be able to afford generous terms for the first to retire, but the others will want parity when their time comes, and changes in the economic climate could cause serious problems and even threaten the firm's future.

However, the survey revealed that simply having a partnership deed does not provide all the answers. Indeed, 53% of those with a deed admitted that it did not include a partnership retirement plan. Those with a retirement plan were asked what they would like to obtain on retirement compared to what is included in the deed and 40% admitted that they would prefer different arrangements. The majority of their concerns related to the timescale of payments for goodwill or capital accounts, but several were now hoping to carry on working in a consultancy capacity following retirement as a substitute for inadequate pension arrangements.

Goodwill is still an issue for a large number of firms with 35% expecting to receive goodwill payments on retirement. Some partners, however, are going to have to wait a very long time before repayment is completed.

Although a few partners expected to be paid out over one or two years, some were going to have to wait 20 years for their full entitlement. Let's hope they live to a ripe old age!

Calculating goodwill

It was interesting to note the wide range of methods firms are using to calculate both goodwill and annuity payments: 40% of average profits in last five years; 1.5 x profit share; 50p-60p on practice turnover; 1 x gross recurring fees; 80% of average previous three years' profits share; 1/60th of the partner's share of the profits from each of his/her 20 years adjusted by RPI, are just some of the formulas used. Several said that goodwill payments would be agreed on discussion with the partners which will probably make for some interesting partners' meetings. Likewise, those who already have a fixed sum agreed in their deed may find that by the time retirement looms the calculations made several years ago are no longer so attractive.

When it comes to funding retirements there are only a limited number of options and many firms are going to find the process extremely painful.

As one respondent so graphically described the situation, the only way he and his partners were going to fund their retirement was: 'by stitching up the next generation!'

Over half - 52% - of firms expected incoming partners to provide a significant proportion of the funding, but with the lack of potential candidates that proportion will almost certainly be a great deal less than they had hoped.

The existing partners will have to dig much deeper into their own (or the firm's) pockets. Some expect to rely on bank loans, while others will look to sell blocks of fees: this could be logical if the retiring partner is the only specialist in a particular niche area, but in general reducing fee income is not a very positive step.

However, for 28% of the firms in the survey there is only one option: sale or merger. If this is representative of the independent sector of the profession as a whole we are looking at the very real possibility of losing over a quarter of them in the next 10 years or less.

Although financial matters were by far the most contentious issues, partners had other pressing concerns regarding the effects that partner retirements would have on the practice. By far the most important was the problem of finding the right calibre of people to bring into the partnership.

Equity partnership does not have the allure that it did 10 or 20 years ago. In addition to the fact that potential partners are now far more risk averse, the earning power of a partnership in an independent practice has not kept pace either with salaries in the commercial sector or prospects as a salaried partner in a large firm. Partners are well aware that they need to recruit quality people with the ability to develop the business as well as a good range of specialist technical skills: these people are proving extremely hard to find.

Partners are also worried about how their clients will fare once they have retired. In many cases they will have had a long and close business relationship and may well have become friends. It is therefore absolutely vital that the practice can effect a smooth handover to a new partner otherwise the client may well decide to take their business elsewhere.

Continuity of client care was a concern expressed by 20% of the respondents.

And they are right to be concerned. It is not simply a matter of handing over the retiring partner's clients to a new partner. The services they require will depend on their needs going forward and the partnership as a whole will need to consider the handover process for each client on an individual basis.

It is also worth noting that many retiring partners will have clients of a similar age who have grown up with the firm and these clients will therefore also be looking at retirement avenues which may include business disposal.

Grim reality

The overall picture painted by these results is a grim one, but although many of the firms that took part in the survey have accepted the fact that they cannot survive independently (and indeed, for a few, sale or merger had always been the preferred option), for those that wish to do so there is still hope. Provided they can add real value to their business and make themselves more attractive to the potential partners with real commercial skills to grow the practice then they will not only survive but prosper.

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