Accounting For Partnership Firm

[Avenall Trejo]

Apartner in a law firm, accounting firm, consulting firm, or financial firm is a highly ranked position, traditionally indicating co-ownership of a partnership in which the partners were entitled to a share of the profits as "equity partners". The title can also be used in corporate entities where equity is held by shareholders.

In law firms, partners are primarily those senior lawyers who are responsible for generating the firm's revenue. The standards for equity partnership vary from firm to firm. Many law firms have a "two-tiered" partnership structure, in which some partners are designated as "salaried partners" or "non-equity" partners, and are allowed to use the "partner" title but do not share in profits. This position is often given to lawyers on track to become equity partners so that they can more easily generate business; it is typically a "probationary" status for associates (or former equity partners who do not generate enough revenue to maintain equity partner status). The distinction between equity and non-equity partners is often internal to the firm and not disclosed to clients, although a typical equity partner could be compensated three times as much as a non-equity partner billing at the same hourly rate. In America, senior lawyers not on track for partnership often use the title "of counsel", whilst their equivalents in Britain use the title "Senior Counsel".[1]

Accounting firms were traditionally established as legal partnerships with partners sharing the profits. Today, the financial and consulting services firms which originated from accounting firms, such as the Big Four accounting firms, retain the title of Partner as a senior position and to indicate a profit-sharing status. To become a partner is considered a significant career milestone.[3]

Many major investment banks were historically structured as partnerships, and some such as Goldman Sachs maintain a class of "partners" at the top of their corporate hierarchy. In such firms, the "partners" are typically the highest-compensated managing directors as well as more senior executives.[citation needed] The term is also used for senior executives in the private equity industry. In these industries, partners are often compensated millions of dollars per year.[5]

A partnership is a business structure that involves two or more individuals who agree to a set distribution of ownership, responsibilities, and profits and losses. Unlike the owners of LLCs or corporations, partners are personally held liable for any business debts of the partnership, which means that creditors or other claimants can go after the partners' personal assets. Because of this, individuals who wish to form a partnership should be selective when choosing partners.

Partnerships have several benefits. They are often easier to set up than LLCs or corporations and do not involve a formal incorporation process through a government. This has the added benefit of not being subject to the same rules and regulations that apply to corporations and LLCs. Partnerships also tend to be more tax-friendly.

In limited partnerships (LPs), general partners manage operations of the firm and have full liability. Limited (silent) partners are not involved in day-to-day operations and enjoy limited liability. A limited liability partnership (LLP) is different from an LP. In an LLP, partners are not exempt from liability for the debts of the partnership, but they may be exempt from liability for the actions of other partners. A limited liability limited partnership (LLLP) combines aspects of LPs and LLPs.

Partnerships are often best for a group of professionals in the same line of work where each partner has an active role in running the business. These often include medical professionals, lawyers, accountants, consultants, finance & investing, and architects.

This article will cover the basic provisions in a partnership agreement including capital requirements, governance, restrictive covenants and retirement payments. It will also cover advanced topics such as transitioning from an equity based retirement model to a deferred compensation retirement model and claw-backs of retirement payments. My goal is for the reader to think about their own partnership agreement and provide tools and ideas to enhance their agreement.

All partnership agreements have some basic form of governance. The basic premise is that absent an agreement to the contrary, the partners have all the authority to act on behalf of partnership. However, in most partnership agreements, partners elect to cede certain of their powers to an executive committee and/or a managing partner. Even then, the partners usually retain certain prerogatives and rights. Those rights generally include election of the managing partner and the executive committee (and maybe other committees) and approval rights over major transactions and expenditures. These major transactions may include merging in of a smaller firm, new partner admissions, partner expulsions and significant financial matters (like borrowings in excess of a certain amount and/or capital expenditures over a certain amount). In most firms, the executive committee is the governing body with the authority to make or delegate all decisions (except the partner reserved decisions mentioned above) and the managing partner is responsible for day-to-day management. However, for firms that have a strong managing partner (this is often the case for founding partners), the partnership agreement will set forth certain things that the managing partner has the authority to do in his/her own right beyond the day to day business decisions. For example, the partnership agreement may provide that the managing partner has authority to bring in lateral partners or consummate small mergers.

As firms grow, governance tends to become more centralized. That is, there is less authority for the partners and more authority for the executive committee. This is a more efficient way to manage, but it means that partners lose autonomy. Also, as the firm grows, the election process itself becomes more complex. There may be a nominating committee for executive committee positions and the managing partner role. There may also be a run-off election process and there may be requirements for department representation. Recently we have seen requirements for gender diversity on executive committees. In a recent agreement, the firm allowed any partner to nominate himself/herself, but required prior approval by the executive committee. Terms, term limits and staggered terms are addressed in more complex agreements.

Retirement benefits typically have a vesting period. It is not uncommon for the vesting to be over a 20-year period. Some firms give partial or full credit for years as an income partner. Of course, merged-in partners will be given credit for the period of time they were a partner at their old firm. Death and disability usually should not accelerate vesting, although in some firms they do.

The retirement payment payout period is typically 10 years. Additionally, the total aggregate amount payable to retired partners each year is capped at some portion of the annual revenue or net income of the firm (for example, 4% of the revenue of the firm). This is to ensure that the firm continues as a financially healthy organization while it is paying out the retired partners. Sometimes, founding partners have better terms on their buy-outs. Retirement payouts typically do not accrue interest, although this is not universal.

Many firms obtain life insurance on their partners in order to fund some or all of the buy-out payments. I think there is logic here in that on a death, there is less time to transition the business. There is usually a discussion around whether the partner has the right to take their insurance after retirement. Most firms do not allow for this.

Restrictive Covenants (non-competes and non-solicits) are what create a significant part of the goodwill of an accounting firm. Contrast this with law firms that are not allowed to have restrictive covenants. Few law firms have retirement payments because they cannot enforce restrictive covenants. Client relationships are also longer lasting and more deeply embedded with accountants than with lawyers, which provides another reason why accounting firms can support a retirement payment and law firms generally cannot.

In addition to a restriction on client solicitation, I like to add a restriction on solicitation of referral sources. For many accountants, referral sources are as important as the clients themselves. This is particularly true in certain practice areas, like litigation support. Referral source non-solicits may be harder to enforce, but in most cases are worthwhile. We usually counsel against pure non-compete agreements. They are hard to enforce as courts often view them as not being needed to protect the business interests of the firm and it is easier for a court to enforce something that the judge thinks is reasonable, and true non-competes are sometimes viewed as being unreasonable. There are exceptions to this. In one case we prepared a non-compete in a designated geographical area and for a certain industry for which the firm had developed proprietary tools and a large market share of clients in that industry. Restrictive covenants last anywhere from two to five years depending on the state. Some states will allow them to last for the duration of the buy-out period. Another technique is to provide that all future retirement payments are forfeited if the former partner solicits clients, even after the restriction period.

Amendments typically require a supermajority vote of the partners, regardless of whether voting is per capita or based upon a percentage interest (two-thirds seems to be the right percentage in most cases). Additionally, there may be restrictions on amendments to reduce retirement benefits to partners who are near the mandatory retirement age, unless a majority of those more senior partners agree to the reduction.

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