Buy-in and Buy-out of Accountants to an Accounting Group
By Matt Dickstein
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Accountants come and go from larger accounting groups. When an accountant enters a practice as a shareholder or partner, the practice should prepare for the accountant’s exit. The exit is inevitable. In this article, I give one simple rule for structuring the accountant’s buy-in to a practice and the later buy-out of the accountant’s shares from the practice.
Buy-in should mirror buy-out. If an accountant buys-in to an accounting group at $X, the group should buy-out the accountant at the same $X. In other words, you should use the same formula to determine both an accountant’s purchase price for shares in a practice, and the accountant’s buy-out price when leaving the practice. The reason for the rule is fairness. Neither the practice nor the accountant should get a windfall from the buy-in and subsequent buy-out.
Founders are the primary exception to the rule. Founders usually get a special deal because they built the practice and made it valuable. In the start-up years, a founder’s compensation is low and he or she suffers higher risk, so it’s fair for the founder to receive the full buy-back price later on.
The Purchase Price for Buy-in and Buy-out
The buy-in & buy-out prices (when taken together) can be high (for example, $100,000-in and $100,000-out), or they can be low ($10-in and $10-out), depending on the practice. In most practices, the price is either a formula that approximates fair market value (FMV), or an arbitrary or nominal number.
I’ve seen many different buy-in and buy-out prices. I’ve seen a practice with a nominal price of $10 for both buy-in and buy-out, and what’s more, the structure worked! Most practices, however, base the price on FMV. An FMV buy-in / buy-out price will equal the percentage share of the practice to be bought or sold, multiplied times the value of the practice. Since you are in the business, I won’t bore you with an explanation of FMV.
The accountant can pay the buy-in price, and the practice can pay the buy-out price, in cash or in installments. If an accountant pays for shares in cash, the accountant should receive the buy-out in cash (to the extent that practice liquidity permits this). Likewise an accountant who buys-in to the group over time using installment payments (e.g. a promissory note or salary reduction) should receive a buy-out in installments (e.g. a note or deferred compensation).
Many groups pay the buy-out price as a combination of the buy-back of shares and deferred compensation, for tax reasons. Deferred compensation can be useful if an accountant paid the buy-in through reduced salary because at buy-out, the practice gets to deduct the deferred compensation, which evens out the tax benefit.
If the practice pays a part of the buy-out price through a promissory note, the maturity of the note should be long enough that it does not overburden the practice yet short enough so the departing accountant does not wait too long for closure (e.g. 2-4 years).
Competition After Buy-out
A California practice can impose a non-competition clause on the departing accountant. In California, a non-competition clause is legal if it occurs as part of a bona-fide buy-back of the accountant’s shares. Some practices take very seriously the threat of competition, but other practices don’t really care. It depends on the nature of the practice and the market.
If a practice does not demand a non-competition clause, it should at least regulate the process by which the departing accountant leaves. The practice should control how the accountant communicates with referral sources, employees and clients. The practice needs an orderly and professional process for separating the accountant from the practice. You don’t want either side (whether the departing accountant or the accounting group) to poison the other’s well.
For more on non-competition clauses, read May an accountant compete against his or her former practice? and also, Stealing employees.
The practice’s corporate documents should state the terms of the buy-in and the buy-out. Ordinarily you cover the buy-in in a Purchase Agreement, and the buy-out in a Shareholders Agreement. See also, Shareholder buy-sell agreements for accountancy corporations.
To learn a little more about the process by which a group should bring in a new accountant, read Bringing a new accountant into a practice.
You need an experienced attorney to implement my rule for buy-ins & buy-outs. Do not do this alone because there are many considerations and choices that I don’t have time to cover in this short article.