Practice Continuation FAQ

A Practice Continuation Agreement (PCA) is an agreement that has its intent founded in the desire to provide, or receive, back-up and support and possible succession under difficult circumstances most often associated with the death or disability of an owner or partner. A PCA is an agreement that details the who, how, when and where in the event of an unforeseen circumstance. A PCA must often be more detailed than a succession plan because the need to "activate" the PCA is mostly because the practitioner is incapable of providing assistance, advice or counsel due to death or disability. This is not always the case as some disabilities do not necessarily prevent a practitioner from providing advice or counsel but a good PCA needs to be written and executable as if this will be the case. Because of this fact the PCA is a much more involved agreement and requires constant updating as there can be changes in any firm on a regular basis. The PCA partner providing the backup service must be kept informed of these changes as he or she will not have the opportunity to figure things out in casual and relaxed time. Everyone that enters into a PCA should consider this a legally binding agreement, regardless of whether you are the professional seeking the backup and support or the professional offering the backup. If you are the professional offering the support it is also important to consider your liability in the event you cannot provide the backup at the time it is needed. Remember if you signed an agreement to provide backup or support you now have a legal obligation to do so. We will discuss later in this PCA module some of the reasons you may want to agree to provide the backup and support. We will also discuss what the practitioner must provide to equitably compensate if he or she is seeking the backup and support. We have read many articles that declare a PCA enables a professional to transfer their practice, in the event of an unforeseen circumstance, and receive "full value". We do not agree with this statement at all. To explain why we take exception let us ask a simple question If you were the professional offering support and backup and your PCA partner suddenly died are you going to give them "full value" without factoring the disadvantage of no transition or retention assistance? Most will not. It does not mean that value should be determined based on a preconceived notion of client attrition, it simply means there needs to be a fair and equitable manner to author the PCA itself. We will also discuss this more in the following sections. For more information:

• Who Would Run Your Firm? Journal of Accountancy, c2011

To determine if a PCA could play an important role for you or your firm there are four simple questions to ask yourself:

1. Does my spouse, staff or immediate heirs know what to do with my practice if I die, become seriously ill or disabled?
2. What position will my clients find themselves in if I die or become disabled?
3. What will happen to the value of the asset I have spent years building if I die or become disabled, temporarily or permanently?
4. How many more tax seasons do I wish to continue servicing my clients on a full-time basis?

The answers to those questions will determine if you should continue your reading of this module on Practice Continuation Agreements. Question #4 has significant importance as it will differentiate between creating a PCA and the strategy of looking more toward a succession strategy. There are considerable and very important differences between the two. Below we have highlighted the benefits of a well-written and solid practice continuation agreement. A PCA can:

• Help prevent the value of your practice from completely dissipating
• Provide a degree of financial and emotional benefit to your family
• Help fulfill your professional responsibility to your clients
• Provide a period certain income continuity program if you are disabled or die
• Validate the value of your years of sweat equity and sacrifice
• Reduce potential liability from certain forms of litigation against you or your estate
• Supply back-up/support during short-term disability, partial disability, or illness to keep the practice intact
• Establish a pre-determined valuation metric for permanent disability or death
• Reduce the daunting task placed on loved ones or heirs of trying to "do the right thing" during their time of emotional distress
• Provide a degree of value protection of a large financial and/or retirement asset.

Who Needs A Practice Continuation Agreement (PCA)? Every firm without an immediate internal solution to protect the firm in the event the owner or owners die or become incapacitated. We cannot emphasize enough the need to evaluate the strategic differences between a succession plan and practice continuation agreement. If we had to offer a general rule-of-thumb, it would be that if you are 7 years or more from reducing your time commitment to your firm, perhaps you should give more focus to the PCA. If you are six years or less it may be more beneficial to consider a strategic succession plan such as a Two-Stage Deal (see below). For more information:

• Who Would Run your Firm? Journal of Accountancy, c2011
• A Two-Stage Solution to Succession Procrastination by Joel Sinkin and Terrence Putney, Journal of Accountancy, c2013

Below are five key steps to the creation of a PCA and the supporting practice procedure and operating documents that will reasonably allow your PCA partner the best opportunity to step in for you, if need be, and provide a degree of continuity keeping the trust and confidence of your clients. Step 1: Establish a Practice Profile Create a clear and concise set of practice procedures and operating documents. Remember, your PCA partner is not clairvoyant and he or she will need more than their intuition to figure out how your practice operates. Author a detailed profile of the practice, including types of services offered, names and responsibilities of key employees, location of accounting records or files, your firm's bank account information, and location of all lease agreements and contracts currently active and appropriate PIN numbers and passwords. Create a client list that will include key contacts, contact information such as telephone number, email address and street address, etc. This information may be available through your software programs but we strongly suggest it be available in hard copy in the event your programs cannot be accessed for any reason whatsoever. Also list the specific services required and important deadlines, not just the obvious deadlines, but deadlines that are specific to the client's business or personal needs. It is also a good idea to note any other special service requirements or other important information specific to that client. Disclosure of procedures for WIP, enabling the determination of work not yet completed. How do you typically bill a client? Is it on a monthly basis, when work is completed, percentage of completion? Remember firms operate differently and you must help your PCA partner understand how your firm operates. Prepare a technology guide for your PCA partner that enables them to access and use your firm's computers and/or software systems. DO NOT FORGET to include passwords. (This is why we suggest the hard copy files also be made available). Detail the location of workpapers and client records. Do not forget to disclose the location of files stored off-site, whether it be in the Cloud or a secure file storage facility. Provide a detailed description of your firm's filing system. Who, what, where and how are the key words to focus on when authoring this description. What are your firm's office procedures for handling client information including receipt and return thereof? Prepare a description of the procedures. What are your firm's billing schedules and collection policies? One of the main purposes of a PCA is to provide continuity for the clients. Obviously receiving invoices and the expected amounts therein will instantly get a client "out of their comfort zone", if it is different than expected. Part of your PCA operating procedures must identify and disclose how you currently handle all accounts payable. Your Practice Profile should be updated at least annually and shared with your PCA partner. Step 2: Choose the form of practice continuation agreement or arrangement There are three major forms of a PCA and one major source of assistance. Below we have identified those for you. Please keep in mind there are other forms available but we have chosen the three major types and forms.

• One-to-One: A One-to-One agreement is simply that, one firm cross-agrees with another to be PCA partners. They assume the responsibilities associated with the agreement to provide one another back-up and support in the event of a circumstance requiring the PCA be triggered. It is often enacted between sole practitioners or small firms. If your PCA is with another sole practitioner or small firm please understand and be aware of the capacity and service limitations, on both sides, when executing a one-to-one agreement. This form must be analyzed in great detail as you must identify like culture, service model, billing rates, geographic proximity, service models, similar service capacity and other considerations. You must also take a long hard look at the age of each sole practitioner as you do not want to compound your risk or inability to have a sound back-up. If you are both in your 60s it is probably not a good idea to execute a plan together as your clients will meet your PCA partner and wonder if they are jumping from the frying pan into the fire. A critical part of your review is your PCA partner's capacity to replace you in a time the PCA is enacted. It is very rare two firms can have a reciprocal PCA agreement due to that factor. Typically the successor firm in a PCA agreement is larger or just starting out enhancing the likelihood they have the capacity to replace you.
• Group Reciprocating: This is an agreement between three or more separate practitioners or firms. It inherently provides more safety and is likely a better opportunity to maintain continuity by the simple fact there is usually a higher probability that your practice procedures can be matched within the group. This "consortium", if you will, is likely to have more capacity, match your current services and enable clients a better opportunity to find someone they are comfortable with. Both this and the above are not the most frequent path we suggest. Typically the practitioner seeking a PCA agreement has a deal with one larger firm and it is not reciprocal.
• Two-Stage Deal: This form is often used as a succession planning tool and can be very effective for all involved - the firm needing back-up, the firm providing back-up and the clients. This form is not triggered by a catastrophic event and therein lies its benefit. It is a legal combination of autonomy and control while presenting a united front to and for the clients. This form often provides a better valuation and support for the practitioners. This strategy is likely more attractive if you plan to reduce your time commitment to your practice in six years or less. Click here for more information about the Two-Stage Deal.
• State Society: Your state society or professional association may have additional resources or information helpful on this topic. Please check their library or give them a call.

Step 3: Identify and Approach Suitable Firms/Partners Below is a checklist of items to consider, analyze and once you believe you have your PCA partner identified: Professional and Practice Continuity - Does the potential PCA partner firm have:

• similar fee structures?
• practice philosophies?
• geographic proximity?
• appearance?
• communication policies?
• quality controls?
• practice specialties - can they support your specialties or specializations?
• staff competencies?
• firm efficiencies?

PCA Longevity - Does the potential PCA partner have:

• owners or partners nearing retirement? If so, they may not be available to provide the back-up and support you seek.
• high turnover of the staff? If so, can you be confident they will have the competency or capacity to provide back-up?
• their own succession issues or concerns? You do not want to go through this again, so make sure they are not seeking the same back-up you are.
• The skill-set to handle niches similar to those you have in your firm?
• The excess capacity and skill-set to assume your role and workload?

Chemistry - Does the PCA partner have:

• similar firm culture and personality?
• like-minded practice procedures?
• similar client service practices and procedures?

Excess capacity - Does the PCA partner have:

• resources necessary to replace you in either the short term or the long term? In this day, very few firms have excess capacity, but if your potential PCA partner leverages their current capacity to the point of being overextended there is a probability there will be no time available whatsoever to focus on your practice or your clients. Be careful.

Step 4: Implement the agreement or arrangement This is not a "do it yourself" situation, please have experienced counsel or an M&A accounting consultant assist in the process and draft the agreement. When completed it is very important to:

• Discuss and disclose to and with all parties (spouse, staff, successor/partner, legal counsel, peer reviewer, clients, etc.)
• Communicate in writing the responsibilities of all involved. Keep this communication updated and constant.

Step 5: Check in with the firm at least annually to make sure it is still willing and able to carry out its obligations and to update your PIN codes and other information. We suggest a review be performed a minimum of every 12 months. In advance of this review, prepare a series of questions that will help you identify any internal changes to the firm of your PCA partner that might give you cause for pause to continue the arrangement. Your PCA partner may still be ready and willing to act as your PCA partner but they may no longer be a good match. This happens often as firms adopt different niche services, make commitments to expand outside their current geographic location, the partners age, the staff changes over, or they no longer provide a service that is important to you. For more information:

• Who Would Run Your Firm? Journal of Accountancy, c2011
• How to Select a Successor by Joel Sinkin and Terrence Putney, Journal of Accountancy, c2013

Main Terms to Negotiate and Include in Your PCA include:

1. A clear definition of the circumstances which trigger the activation of the PCA and any other components contained therein. A clear and concise agreement as to the definitions of short and long-term disability is critically important to incorporate in the agreement. There have been horror stories surrounding this topic and we will share but one circumstance that will help identify the potential problem when disability is not completely defined.
   • A practitioner was in a car accident and due to his injuries was unable to perform services for his clients. His PCA partner stepped in per the agreement and provided best efforts under duress as it was at the beginning of the tax season. The injured professional missed the entire tax season and unfortunately did not have another CPA on staff that could review and sign the client's tax returns. He did have some staff that could assemble and prepare tax forms that were not requiring higher level knowledge. That meant the PCA partner almost doubled his workload during tax season and significantly increased the workload of his own staff. After tax season the PCA partner felt the disability and length of time the injured professional was out of the office and required his back-up triggered his right to purchase the practice. The injured professional recovered to the point he felt he could resume the responsibilities of managing and running the CPA firm, once again and of course had no intent to "sell" his practice. It ended up in litigation and was not pretty. Make sure you have a clear, concise and agreed upon definition of disability, short, long and the trigger point for a buy-out.
2. The successor's obligations, which is usually focused on managing client relationships and providing ongoing client services as well as making sure the work is produced. In the agreement make sure those responsibilities are clearly defined.
3. The compensation to be paid to the PCA "partner" firm if the support is temporary. Specifically identify a very fair and equitable compensation for your partner which should include:
   • compensation for utilization of his or her staff if need be
   • profit-sharing during the period of service
   • hourly rate for the PCA partner
   • compensation for unusual service needs of your clients
   • compensation for non-billable time if the agreement is based on an hourly rate
   • how a referral will be credited during the time your PCA partner has assumed responsibility for your client base
   • how a client will be handled that informs you they wish to be serviced by your PCA partner even if you now have back client service responsibility
     • How will the buy-out of that client be agreed upon
   • Remember, if you don't pay your PCA partner enough to cover you, they may lose motivation to jump in to the degree needed. If they are maintaining your asset while under a temporary disability, that is more important than how much income you make in the short term.
   • Discuss an override for your PCA partner in the event they do not wish to purchase your practice but will assist in the transition of the practice to another CPA or CPA firm, assuming you are incapable of handling. This is a very beneficial inclusion in the event of your death as it helps relieve your heirs of the emotional burden of negotiating something they know little about.
4. The terms of the acquisition if the PCA partner firm is expected to buy the practice. These terms should include but are not limited to:
   • WIP
   • A/R
   • growth of billings
   • client retention period (most PCA agreements have lengthy client retention programs since there was a lack of transition by the owner)
   • staff retention
   • practice payment terms such as payment period and practice multiple
   • formulas for value and other financial considerations
   • retention of location
   • Non-compete and/or non-solicit terms
   • Cross indemnifications
   • Cash up front in the form of a down-payment or advance if any (post PCA agreements do not have cash upfront)

The above are the most common inclusions in a PCA but please note your firm may be unique and therefore require additional inclusions or considerations. This is a reason we stress the use of an experienced M&A professional or firm when creating your PCA. For more information:

• How to Value a CPA Firm for Sale by Joel Sinkin and Terrence Putney, Journal of Accountancy, c2013
• Who Would Run Your Firm? Journal of Accountancy, c2011

There is a very important acknowledgement that one needs to make if they are seeking a PCA partner to provide back-up and support. That acknowledgement is that the PCA partner gets all the headaches and does not really reap the rewards, especially if the reason for triggering the PCA is short-term disability. Therefore you must make this attractive or they won't do it... and neither would you if the shoe was on the other foot. In summary... be realistic! An agreement creates attractive value by taking into consideration the following:

• The deal structure of the PCA. Certain industry studies have declared as many as 20% of clients will leave in the first month their professional is not available. Another 24% will leave in the second month. We cannot attest to the accuracy of these numbers, but we do know there is significant attrition risk and clients do leave. Therefore the most likely deal structure will be a straight collection deal.
• Most likely the multiple will be less than market value of a similar practice in a non-distressed scale because there is the probability of little to no transition assistance not just of the client relationships but of understanding the specifics of the distressed firms' practices and procedures. Therefore much more time and resource utilization will be required of the successor firm.

Other variables impacting the valuation:

• Tax consequences - what will the tax structure for the purchase be?
• Down payment - If a down payment is negotiated it must be reasonable because of the attrition risk and cash flow uncertainty. Most PCA agreements have no down payment.
• Treatment of A/R and WIP. If I am the successor firm I acknowledge the A/R belongs to you but what is my anticipated working capital requirement? Does the distressed firm have a larger A/R file which would roll to him or her for a significant time thereby forcing me to produce many months of working capital while the A/R goes to them? Not attractive if that is true. Will there be a loan of a percentage of the A/R to the successor firm thereby reducing their need to come out of pocket? It would be a short term loan so the seller (or heirs) receive benefit of the A/R as soon as possible but a short term loan of A/R makes this much more attractive to the successor firm and therefore it is likely a better offer will be made for the purchase.
• The profitability of the practice, the firm's metrics and the payout period.
• What will be included in the purchase if that is triggered?

Here is a list of items to review and please keep in mind you cannot negotiate the value under today's circumstance which is that you are well and healthy. You must make allowance for the risk and workload the successor is assuming. Other assets, either acquired or required, to be included

• Furniture, fixtures, equipment
• Leases and location
• Staff joining the new firm or not joining

Participation in Future Growth

• Fee increases from prior services
• Fee increases for new services
  • An override on the sale of your practice to a PCA partner who is acting as a guardian of the practice until it can be sold to someone else. It is our professional and experienced opinion that, in the event of your disability, death or illness the PCA partner should receive, at a minimum:
• • • A significant percentage of the profit if not all of it in certain situations
    • A significant percentage of the collections

Remember, especially in the case of temporary disability, it is more important your PCA partner keep your asset alive and doing well, than for you to make money on their efforts during the initial stages of an enacted PCA agreement. In the event of its exercise, a PCA is a distressed situation at best, and it's likely that the practice has or will sustain losses - i.e. financial, client, reputation, time, retention and referral network. It is also highly probable that you are most likely unavailable to perform any meaningful transition or service. The bottom line is that if you don't make the financial component of the PCA attractive, why would anyone agree to do it? For more information:

• Who Would Run Your Firm? Journal of Accountancy, c2011
• How to Value a CPA Firm for Sale by Joel Sinkin and Terrence Putney, Journal of Accountancy, c2013

There are several must do's if you enter into a PCA with another professional or firm:

• you must be realistic
• you must design an attractive compensation agreement for your PCA partner
• you must realize you are trying to alleviate or eliminate the enormous amount of stress placed on your family and staff during a very difficult time
• you must acknowledge the PCA is a living agreement that needs to be completely reviewed semi-annually or annually
• you must consistently update the PCA practice procedures manual you will have created for your PCA partner
• you must consistently communicate to those surrounding you - staff, family, successor firm, etc. - the who, what, where, when and why
• you must acknowledge that firms that are passive with regard to keeping their PCA Partners updated typically have poor results
• you must acknowledge that a PCA is not a succession plan - it is an agreement that is designed to try and replace you immediately and there are many issues and challenges to doing so. A succession plan is a scaled opportunity to realize the highest value, purchase price, client retention and growth of opportunity. A PCA cannot provide these same benefits

A good deal is a fair deal and all must be represented in the PCA itself --- you, your staff, the successor or PCA partner and the clients. For your information:

• Who Would Run Your Firm? Journal of Accountancy, c2011