Partner Agreement Provisions

A program for emerging professionals Section 6

Ownership/buy-sell agreement

Whenever there is more than one partner/owner in a business -- any business -- a variety of issues stem from corporate governance that can potentially have a serious effect on the relationship between the partner/owners.

These issues also affect the value of their ownership interest. An accounting practice is not different.

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Thinking through these potential issues, having specific mechanisms for dealing with them, and formalizing decisions made concerning them in legal documents as part of the corporate organizational process can prevent serious problems during stressful times. The actual form and title of the agreement will vary according to the legal structure of the practice. If it is a corporation, the agreement will most likely be a buy-sell agreement or a shareholders agreement. If it is an LLC, these provisions will be included in the operating agreement.

Here are some of the most common provisions that should be covered in these documents:

1.Valuation -- There will be many instances in an ownership/buy-sell agreement for an accounting firm where one partner may be required to buy out the other(s). A good agreement provides a specific mechanism for this. Generally, there are three methods commonly used for providing these valuations: ? A third-party valuation when a triggering event occurs ? An annual third-party valuation ? Assigning a valuation formula A valuation formula is the easiest and least expensive option. The legal provision for a third-party valuation is usually written in such a way that if one of the partners doesn't like the valuation done by the company, the dissenting party can pay to have a second valuation done. If the parties still do not agree, then a binding third valuation can be required. As you can imagine, this can become quite expensive and time consuming. There are business conditions that might be better served with a formal valuation rather than a formula. Like when there is valuable intellectual property not reflected in the financial statements, if the business is on a rapid growth trend, or if there are hidden assets. One might also include adjustments for specific applications of the valuation (regardless of how it is derived) where the base valuation might be discounted or given a premium. For example, if partner/ owners are critical to the operation of the firm, and said partner/owner leaves without the consent of the others, it might trigger a buyout at a discount. Conversely, if a minority partner/owner were let go without cause, that might trigger a buyout at a premium.

pensation -- How compensation is determined can be a significant source of conflict between partners/owners. Compensation should be thought of in the broadest sense -- not just salary and bonuses -- but also benefits and perks. When there are numerous partner/owners, and when there are disparities between larger and smaller partner/owners, having the compensation subject to a partner/board approval process can be advisable. Another device that can prevent problems is using a rational compensation program that defines the requirements and performance of jobs being done, and segregates what is paid for a job and what is an incentive for performance from what is paid out as return on investment.

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3.Death, disability and divorce -- There should be provisions in the partner agreement that require the practice to buy back ownership interests and the partner/owner (or his/her estate) to sell the ownership interests under any of these three events at the price set by the valuation methodology. There should also be terms of payment for any of these share purchases that balance the needs of those who will get the funds with the needs of those still running the practice and is tied into the available cash flow of the practice. If there are any proceeds from insurance, these should offset the amount being paid out. Frequently these provisions are designed when there are family member heirs who have not been in the practice. The other partner/owners in effect do not want to become partners with these family members. In the case of divorce, often there is a provision that may allow the divorced partner to buy back the ownership interest that his/her divorced spouse sold to the practice. Your state board may be actually require this.

4.K ey person insurance -- To the extent that it is economically feasible, the governance agreement should require life insurance be maintained on each major ownership holder to the extent of the value of his or her interest. A disability buyout policy is desirable as well, but often these are prohibitively expensive. There are two ways of doing this. The accounting practice might be the beneficiary of the policies with the proceeds used to fund the buyback of shares the agreement mandates. Or the individual partner/owners might own and be the beneficiary of the policies to fund their required buyout of ownership interests. Give thought to having sufficient insurance to provide more than the buyout of shares. The loss of a key person can require a practice to incur substantial expense to replace that key person's functionality. It is a good idea to have insurance funds to cover that risk.

5.Minority/majority ownership protections -- As soon as you have more than one partner/owner in an accounting firm, there is the potential for abuse on the part of either the minority or majority owners depending on how major decision-making is structured. If there are no rules to the contrary, whoever has the majority can pretty much do what they want including hiring/firing, borrowing, buying/selling assets, and taking on obligations. Owners should discuss and decide upon where limits should be placed to protect minority shareholders, and where freedom should be left so partner/owners who are senior management can make proper decisions for the business. Some of the areas that might be covered in this section might be:

? Taking on borrowing (including leasing) ? Purchasing any asset or entering into any liability contract more than a certain amount ? Acquisition or merger with any third-party firm ? Sale of the firm or essentially all the assets of the firm

6.A djustment for involuntary termination or partner departure -- Frequently the job an owner/partner has is critical to their financial well-being. Conversely, a partner/owner's work is critical to the success of the firm. There should be provisions that cover what is done if a partner/owner is let go involuntarily, or if they leave without the consent of the other partner/owners. This is more common than one might think with professional service firms. You should consider if there are penalties for taking clients or staff. Do you want non-disparage clauses? There should be definitions for what could cause an involuntary departure, perhaps tied into the acts discreditable of the code of conduct.

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