Succession Issues in the smaller firm

Small independent practices are currently facing a crisis which could be as great a threat to their continued existence as anything they have had to contend with in the last twenty years or so. The problem is succession: how to fund the retirement of older partners whilst maintaining the profitability of the practice and making it an attractive proposition for potential incoming partners.

In the last few years the profession has changed dramatically. Technical and compliance work is no longer a growth area for small firms – particularly now that the audit threshold has been raised again. For the majority of practices with a client base consisting mainly of owner-managed businesses and small companies there is an increasing emphasis on added value work (ie. consultancy services that the client views as adding value to their business) as their main source of profitability. The modern practice now needs to offer a wide range of skills and partners need to be businessmen as much as technicians.

Society too has changed: we marry later, have children later and would like to retire sooner. If that retirement is to be comfortable we need to start planning earlier.

For a great many practices the most crucial factor is one of age. With 45% of partners aged 45 or over, accountancy has become a middle-aged profession. A significant proportion of partners will be looking to retire in the next 10 years or so, and many firms will simply not have the financial resources to cope with the exodus.

From our own experience with a wide range of smaller practices we have identified the most pressing concerns as:

Access to suitable people to replace outgoing partners
Insufficient resources to maintain reserved area working
Insufficient breadth of skills to service future client needs
Out of date Partnership Deed (or no Deed at all)
No retirement plan for the partners
No agreement on the treatment of goodwill
Partnership annuities and pensions are too onerous

It would be logical to assume that firms affected by any of these issues would have identified the problem some time ago and devised a succession strategy to overcome it. Unfortunately this is far from the case. Despite the fact that in the last few years they have been highlighted as a major problem both in the press and by the ICAEW, a great many firms have given little or no thought to retirement and succession. The Partnership Deed (if it exists at all) is sometimes out of date or contains no strategy for succession; there is no retirement plan for the partners and no agreement on the treatment of goodwill. The financial burden placed on incoming partners in order to fund retirements will therefore make the firm a very unattractive proposition for any young potential partner.

All in all, small firms are facing a serious problem and many of them will struggle to find a way out that maintains both their profitability and their independence. In recent years M&A activity in this sector of the profession has increased dramatically and succession issues are likely to ensure that this trend continues.

A look at the legal profession shows a very similar picture. Figures released by the Law Society show that the number of sole practitioners and firms with up to four partners has fallen by 5% in the last five years, and those between five and ten partners dropped by 10%. By contrast firms with up to 25 partners rose by 3% and larger practices by 17%. This represents an extremely active M&A market and means that firms looking to solve their retirement and succession problems though a merger are likely to find a considerable number of potential partners.

However, even if firms are not in a ‘forced sale’ situation and have time to plan ahead, there are many pitfalls to be avoided if a successful ‘marriage’ is to take place. Any practice contemplating this route would be well advised to exercise extreme caution in the selection of an appropriate firm.

For those who would prefer to solve the problem organically, and have sufficient time on their side, there is no doubt that recruiting talented young people as potential partners is the key to a successful succession strategy. However, as many firms have discovered during the last few years it is often extremely difficult to find the right people. The lure of an equity partnership in a small firm is not what it used to be. In real terms, the financial rewards have not increased materially in the last 10 years and many younger people feel that the risks of partnership far outweigh the advantages. For young accountants in their thirties, probably with the responsibilities of a mortgage and a young family, there is no incentive to take those risks when a position in industry and commerce or as a salaried partner can be just a lucrative.

Whether recruiting from outside or appointing new partners from within the firm there is always the danger that the existing partners will be looking for “people just like us”. Where all the partners have worked in the same practice for many years they may have become insular and resistant to changes in working practices. What they actually need are partners with the specialist and business development skills that are necessary both to grow the practice and to meet the future needs of clients for business advisory services.

Increasing numbers of accountancy practices are looking to incorporation as a means to improve the efficiency of their business and its attraction to potential partners, but this is not a short-term solution to succession problems.

For the vast majority of small practices the exit routes available to them are:

The admission of a new partner; promoted from within or recruited
The admission to partnership of a team of partners from another firm
Merger or sale to another practice, either a larger or a smaller firm
Sale of proprietorial interests to a corporate vehicle such as a ‘consolidator’ or financial institution
Incorporation of the practice followed by the issue of shares or loan notes to a third party investor, or by flotation on a Stock Exchange