Succession Planning for Small
Accounting and Tax Practices 

Resources to Help Prepare for and Execute Succession

by Jon A. Hayes, Executive Director
staff@michigantap.net

This resource page provides information and links to help prospective buyers and sellers of accounting and tax practices navigate the process.

December 18, 2020 -- In my 35 years of managing the Michigan Tax and Accounting Professionals (formally known as the Independent Accountants Association of Michigan), the one area I see most neglected, especially by small firm owners, is the succession and transition of their practice. That has been further exacerbated by the COVID pandemic that compelled many older practitioners to retire without having a plan in place. In many cases, owners resigned themselves to simply walk away, often from a lifetime business investment, without getting a dime.

I find it heartbreaking that someone could make such an investment and not get a rightful return just because they failed to devise and follow a plan for succession. Our goal here is to provide "food for thought" and motivate you to develop or revise a business plan, craft a succession plan that compliments that business plan, AND to begin actively working that plan. If COVID has taught us all anything, it is that nothing is guaranteed.

Major Ingredients a Good Succession Plan 

For many small business owners, maintaining positive cash flow and a stable balance sheet can be an ongoing battle that consumes virtually all of their time. Retirement often seems like a distant speck on the horizon, let alone plans to hand over the business. Establishing and then periodically revisiting a sound business plan greatly aids in crafting succession. Here is a link on what you should have in your business plan: 

How To Write A Business Plan 
Seven Keys to Building a Successful Practice (includes details on business plans and business development options)

For business owners that are at or near retirement, the issue of succession cannot be ignored. Many factors determine whether a succession plan is necessary, and sometimes the logical and easy choice will be to simply sell the business lock, stock and barrel. However, many owners prefer the thought of their businesses continuing on even after they’re gone.

Choosing a successor can be as easy as appointing a family member or assistant to take the owner’s place. It can also be very complicated if there are several partners/employees or family members from which the owner will have to choose, each with various strengths and weaknesses to be weighed and evaluated. In this case, lasting resentment by some or all of those not chosen may result, no matter what choice is ultimately made. It can doom the succession before it even begins if not handled correctly. 

Determine How Much the Business is Worth 

When business owners decide to cash out (or death makes the decision for them), the first task is establishing a set dollar value for the business, or their share of it. This can be done via appraisal by a certified public accountant (CPA) or by an arbitrary agreement between all partners involved. If the portion of the company consists solely of shares of publicly traded stock, then valuation of the owner’s interest will be determined by the stock’s current market value. 

Life Insurance: The Standard Transfer Vehicle 

Once a set dollar value has been determined, life insurance is purchased on all partners in the business. Then, in the event that a partner passes on before ending his relationship with his partners, the death benefit proceeds will be used to buy out the deceased partner’s share of the business and distribute it equally among the remaining partners. 

There are two basic arrangements used for this. They are known as “cross-purchase agreements” and “entity-purchase agreements”. While both ultimately serve the same purpose, they are used in different situations. 

Cross-Purchase Agreements 

These agreements are structured so that each partner buys and owns a policy on each of the other partners in the business. Each partner functions as both owner and beneficiary on the same policy, with each other partner being the insured; therefore, when one partner dies, the face value of each policy on the deceased partner is paid out to the remaining partners, who will then use the policy proceeds to buy the deceased partner’s share of the business at a previously agreed-upon price. 

How a Cross-Purchase Agreement Works 

Imagine that there are three partners who each own equal shares of a business worth $3 million, so each partner’s share is valued at $1 million. The partners want to ensure that the business is passed on smoothly if one of them dies, so they enter into a cross-purchase agreement. The agreement requires that each partner take out a $500,000 policy on each of the other two partners. This way, when one of the partners dies, the other two partners will each be paid $500,000, which they must use to buy out the deceased partner’s share of the business. 

The obvious limitation here is that, for a business with a large number of partners (five to 10 partners or more), it becomes impractical for each partner to maintain separate policies on each of the others. There can also be substantial inequity between partners in terms of underwriting and, as a result, the cost of each policy. There can be problems even if there are only two partners. Let’s say one partner is 35 years old and the other is 60 years old; there will be a huge disparity between the respective costs of the policies. In this instance, an entity-purchase agreement is often used instead. 

Entity-Purchase Agreements 

The entity-purchase arrangement is much less complicated. In this type of agreement, the business itself purchases a single policy on each partner and becomes both the policy owner and beneficiary. Upon the death of any partner or owner, the business will use the policy proceeds to purchase the deceased person’s share of the business accordingly. The cost of each policy is generally deductible for the business, and the business also “eats” all costs and underwrites the equity between partners. 

Three Reasons to Have a Business Succession Plan

Creating and implementing a sound succession plan will provide several benefits to owners and partners:                
 

1. It insures an agreeable price for a partner’s share of the business and eliminates the need for valuation upon death because the insured agreed to the price beforehand. 
    
2. The policy benefits will be immediately available to pay for the deceased’s share of the business, with no liquidity or time constraints. This effectively prevents the possibility of an external takeover due to cash flow problems or the need to sell business or other assets to cover the cost of the deceased’s interest.
    
3. A succession plan can greatly aid in allowing for timely settlement of the deceased’s estate. 
    

Preparation is ALWAYS the Key 

Proper business succession planning requires sound preparation. Business owners seeking a smooth and equitable transition of their interests should seek a competent, experienced advisor to assist them in this matter. 

More Succession Planning Resources:

Two-Step Succession Plans: Why They Work Well for Small Practices

The Best Succession Plan is to Build a Better Practice

Seven Steps to a Successful Succession

Succession Planning During COVID

Practical Advice for Selling Your Accounting and Tax Practice

COVID Has Changed the Way Accounting and Tax Practices are Priced

Family Succession Planning for the Lost Generation 

Staffing and Succession are Main Concerns of Accounting Firms