Should you finance buyouts with capital or outside financing?

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Traditionally, when partners of a CPA practice are ready to walk away for retirement (or is being eased out the door), the other partners have the responsibility to determine the best way to finance buyouts; should they share the financial burden by dipping into the practice’s capital and at least temporarily reducing the value of their own shares of equity? Or is there another option?

In a well-capitalized practice, that approach doesn’t create much heartburn. However, in a practice that doesn’t have a lot of wealth just sitting around waiting to be handed to a departing partner, it can cause quite an impact. Yes, the remaining partners should gradually see a recovery in the value of their shares, but besides their own unease with the reduction, having less working capital can create operational problems for the practice. And, should more than one partner happen to retire within a short time frame, those buyouts could create more cost than the remaining partners are willing to assume.

No one would argue that a partner doesn’t deserve his or her fair share upon retirement. After all, the very concept of partnership is built upon receiving a substantial financial reward for the many years of building a practice and earning a reputation. New partners are willing to make their initial investments and put in their time because they know that reward will be there for them when it’s their turn to step down. But when retirements jeopardize a practice’s continued viability, that creates a problem for both the retiree and those who remain. If the remaining partners are unwilling to fully fund what their retiring counterpart believes he or she deserves, no one comes out ahead.

That’s why some practices are exploring a different approach to partner buyouts. Instead of dipping into capital to cover the cost, they’re turning to third-party financing. The rationale is simple: rather than pay the cost of the buyout all at once, the partners are able to give the retiree the full payout, and then fund its cost over several years.

Presumably, if the departing partner’s clients can be served by a lower-cost employee, then the profitability of those clients should increase. If everything is structured correctly, that increased profitability should more than cover the cost of the financing. Once the debt has been retired, the increased income will put the practice in even stronger financial shape, ultimately enhancing the value of the remaining partners’ equity.

Of course, buyouts are complicated, and practices would be well-advised to consult with experts who have led similar practices through the process, rather than trying to structure an approach on their own. It’s also critical to work out the plan well before a partner announces that he or she is ready to call it a day. Considering alternate strategies to finance buyouts such as third-party financing rather than just doing what’s always been done may create better opportunities for everyone involved.

Oak Street Funding has provided capital to finance buyouts to hundreds of clients. Contact us to learn more about how we can help you.