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Art of Accounting: Finding the flaws in your exit strategy

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Solo owners and partners of small practices can end up working until they drop, selling their practice (including a merger leading to a fairly quick buy-out), transitioning the practice to long-time employees, or hiring or bringing in someone who would eventually acquire the practice. I want to discuss hiring or bringing in someone, which I will call an "exit strategy."

Before I start, I want to say that I am against the exit strategy. I will describe it and provide a step-by-step analysis with pros and cons, and you can come to your own conclusions. Also note that regardless of my skepticism, there are always exceptions.

I believe there is an inherent conflict between wanting the best deal when you exit and wanting the best arrangement during the time you are working. Most people generally cannot have both. Accepting that, the practitioner should then decide whether to operate their business in the manner that best fits their personal wishes and work style and maximizes their present income, or in a way that potentially maximizes the backend value. 

The tradeoff is that you might not get as much for the practice in the back end as you could or would like to get. For example, if you were to "build" the practice in a way that maximizes your exit value, it would most likely cost you more currently, inhibit the way you would want to work and might restrict the complete freedom you presently enjoy. For instance, you might need a layer of reviewers, an added administrative person, extra procedures or a change in your relationships with your clients and staff.

With a current strategy, it is you and the staff and the overhead structure that you presently have and are comfortable with. The work would be done as at present without your involvement changing. Your choice of staff would suit your work style and desire to optimize your current income. If you are not fully satisfied with your current staff, processes or workload, you can act to remedy that, but it would be your choice of how you currently operate and not part of an exit strategy.

If you let an exit strategy drive the decisions, you likely would look to hire people suitable to buy you out. For example, you might hire a more experienced staff person than you currently need or can afford who appears qualified and able to become a partner at some time, or at a fixed time, in the future, and who would be there to buy you out when "that time came."

Instead of having the right people at the right position with the criteria of how well they perform and make your life easier, you would need to evaluate people on how well they can bring in business, handle clients, manage staff, carry on in your absence and how able they might be in the future to make buy-out payments to you. This would include having to, and being forced to, spend time evaluating whether they can grow into that partner role, and how well they would be able to handle all of their eventual responsibilities. In this type of environment, every new person hired would have to be viewed as being something other than you likely would need right now to operate your practice. 

An added thing to be considered is whether this exit strategy person developed a side practice along the way. If they did not, then my contention is that they are probably not entrepreneurial and therefore they could be the wrong person for you. If they did, you would have to make sure they would not spend inordinate time on those clients to the detriment of working on your clients.

Let me suggest a cost for this, with my estimates to illustrate the exit strategy. If the extra annual costs for the next 15 years would be $50,000 (or $250,000 or whatever amount depending upon the size of your practice and projected growth) to enable you to be properly bought out when you decide to exit, it would cost you $750,000. Is that money you could recoup in your eventual buy-out?

Further, there are no guarantees that it would work out. There is also a big assumption that the right people are available and just waiting to buy you out, and will be able to buy you out when you decide to retire. If you are lucky enough to hire the right person, they likely would not be satisfied waiting around for you to pull the plug. The right person (or possibly the not-so-right person) would be pushing you to make them a partner sooner than you might have projected or sooner than you want to. 

And what happens if you have to retire prematurely? You would need to fully work this out. That will then become a plan to accelerate whatever plans you have, since the mechanism will have been worked out. Keep in mind that human nature always will have a big influence on any plans made today for future execution. The younger future owner would want to replace the older present owner quicker than the older owner would usually prefer. 

Suppose the designated successor dies prematurely. All the plans are wiped out and you would need to start over. You should be better organized at that time, so you would not be starting from scratch as you might have done initially, but that would be little compensation for the premature loss.

Employing an exit strategy in some manner puts a ceiling on the length of time you can work; otherwise, the pot at the end of the rainbow might not be there for the younger person waiting in the wings. Also, if they are as good as you expect, how could you expect them to remain in the wings indefinitely? 

If you decide to hire two people instead of one, the dynamics will be multiplied. I mentioned it earlier, but I want to emphasize that you would be spending an inordinate amount of time to bring them along and into the mold you want them to be in. This reduces your time and their time that is available to manage your practice, bring staff along, service clients and for marketing. 

A question that might be on your mind is whether you could bring in someone as a partner who has a smaller practice, available time and skills you could use in your practice. This is a possibility, but this is more of a current strategy to expand your practice and not an exit strategy. If your motive is to do this as your exit strategy, then it is just a slightly different, but accelerated, version of my exit strategy listed above.

That leaves the other choices in the opening sentence of this column, which are all doable based on your timetable and circumstances. Think about your choices and how they would be triggered or implemented and how long you think you would like to work and under what conditions. This is something you will only get one shot at getting right. Do not rush the decision and do not rush doing something that would be difficult to extricate yourself from.

Do not hesitate to contact me at emendlowitz@withum.com with your practice management questions or about engagements you might not be able to perform.

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Practice management Succession planning Ed Mendlowitz Retirement planning
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