By Hillel Rosen
No matter what size, all professional partnerships should have a properly articulated and transparent agreement in place
It seems obvious that every accounting firm should have an up-to-date partnership agreement that reflects the firm’s current practices. However, too often this is far from the norm and for many small to medium-sized firms it is the exception rather than the rule. Unfortunately, the wake-up call often arrives in the midst of a crisis or a difficult challenge, when the relevance of a current and effective agreement becomes clear. Crisis management aside, an up-to-date partnership agreement is an effective means of communicating a firm’s goals and objectives in a transparent fashion to all stakeholders.
A partnership agreement sets out the objectives and functioning of a professional partnership, establishing the rules of decision-making in such matters as compensation, governance, partnership entry, pension plans, partner expulsion, retirement and noncom-pete provisions. It delimits the responsibilities of the managing partner and the executive committee, defines the terms of their appointment and provides a formal mechanism for reappointment or removal. If partners can-not reach a consensus regarding any important issue, they can fall back on the formal procedures of the partnership agreement. The agreement must first and foremost address the current reality of a firm. This requires reviewing the partnership agreement every few years to ensure it adequately reflects recent developments in the market or the firm’s practices. It would be a rare occurrence that nothing has changed since the last update. Inconsistencies between the firm’s current practices and what is described in the partnership agreement should be highlighted and addressed. It is helpful when one of the firm’s partners (perhaps someone with a legal temperament or training) is appointed to oversee this review process and act as guardian of the agreement. Maintaining an up-to-date agreement is more difficult than it probably should be. All too often, a firm will re-examine its partnership agreement, circulate draft revisions and initiate discussions amongst the partners. However, when the busy tax or audit season arrives, efforts trail off and little is ultimately accomplished.
It is said that the best agreements are those that you never look at, or to which you never have to resort. To achieve such a status, an agreement must clearly articulate all partnership issues and be communicated to all concerned, namely partners and aspiring partners. The partnership’s decision-making criteria must be demystified in order to avoid any frustrations and obtain a buy-in, which is less certain than ever among the younger generation of practitioners. In particular, firms must be very specific in spelling out what qualities they value in a partner, as well as their qualitative criteria for making partner. Firms are generally becoming more sensitive to the needs of younger professionals and must strive to clearly set forth and share these criteria with their aspiring partners. Simply informing partnership candidates that “we know partner material when we see it” will generate great frustration among a firm’s young talent.
Indeed, there is no reason for a partnership agreement to be cloaked in secrecy, as it is essentially the description of a firm’s governance and decision-making process.
Partnership agreements can take on many forms. It is truly a case of one size not fitting all, and there are no definitively right or wrong models.
Compensation is, of course, a critical item in any partnership agreement. There are perhaps three classic approaches with many variations:
As no two firms are alike, these three classic partnership models have many variations, which can all function successfully.
The appointment of a managing partner is one of the most important issues a partnership agreement must address, as this partner must build consensus among the firm and lead the team of partners in its pursuit of common objectives. The length of a managing partner’s appointment and the maximum number of terms are difficult aspects that must be appropriately circumscribed, otherwise firms risk falling prey to the adage that the term of the last managing partner was 18 months too long. Similarly, a firm may seek a consensus on questions regarding the retirement or the expulsion of a partner. It may not wish to invoke the clauses of its partnership agreement in such matters, but having a legal framework to resolve stalemates is a distinct advantage.
Pensions may constitute a far greater liability than many accounting partnerships may imagine. Many small to medium-sized firms may not have done a proper actuarial valuation to determine the present and future costs of their firm’s pension schemes. Aside from the financial aspects, pensions constitute a philosophical issue that a firm must address in its partnership agreement. Younger practitioners often view pension programs as somewhat paternalistic and may wish to manage their retirement needs on their own. In addition, many younger practitioners may not see themselves as lifers at their firms. A long-term vesting period may seem unattainable. They also often object to long-standing agreements that provide for the compensation of their firm’s original partners upon retirement. These two factors — financial and cultural — are responsible for a trend among professional partnerships to abandon the firm-sponsored pension plan. The chosen pension solution should ultimately depend on how partners perceive their sophistication in managing their own affairs, and what they feel the firm should provide, if anything, to partners upon retirement.
Mandatory retirement, noncompete covenants and other exit provisions
Another difficult issue is mandatory retirement. Should there be mandatory retirement and if so, at what age? This question is often tied into a variety of issues. The more a firm’s compensation system is based on objective elements of performance, the less compelling the case for mandatory retirement. Similarly, there is often greater resistance to noncompete clauses where an accountant is obliged to retire at a relatively younger age. As well, pension plans (or the absence of) clearly have an impact on the attractiveness and practicality of imposed retirement.
The partnership agreements of accounting firms typically contain various noncompete provisions, but the full extent and practicality of the enforceability of the same remains an issue. In the case of a partner eligible to receive a pension upon leaving the partnership, the noncompete clause is a logical extension of the agreement, since he or she will continue to be paid by the firm. In any event, the inclusion of exit provisions (such as noncompete clauses) in a partnership agreement is important to the context in which a partner’s departure is negotiated. Firms often tailor a departing partner’s exit to that person’s specific situation. If he or she does not wish to negotiate, the firm can rely on fail-safe exit clauses specified in the partnership agreement. These constitute an incentive to reach a settlement.
An alternative to a plain vanilla noncompete clause is a mechanism whereby the departing partner must compensate the firm when he departs with a client in tow. These clauses provide for the readjustment of the financial arrangements with a departing partner according to pre-agreed formulas so as to compensate the firm for its loss of revenue. For example, if a partner leaves, taking a client whose annual billings were $200,000, the partner must agree to make compensatory payments over time to the firm, representing a percentage of lost revenue. In practice, these payments would be subtracted from the partner’s return of capital.
A partnership agreement offers partners a framework to pursue consensus and to entertain more civilized discussions when conflicts arise. All its clauses must be properly articulated and fully transparent in order to avoid frustrations in the firm’s ranks. After all, both partners and aspiring partners have a right to know how the partnership will be governed, what objectives it has established and what qualities are valued in its partners. The paternalistic era, when a partnership agreement was shrouded in mystery and a young professional was simply informed that he or she had been named partner, has passed. Aspiring partners are now asking detailed questions about the agreement and wish to understand all its intricacies in clear terms before they buy in.
Hillel Rosen is a partner with Davies Ward Phillips & Vineberg LLP in Montreal
Technical editor: Stephen Rosenhek, co-managing partner, RSM Richter in Montreal