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What would become of your business if something happened to you, your business partner or a fellow shareholder?

If an owner dies, becomes disabled, divorces, declares bankruptcy or simply retires, your business could be thrown into turmoil. Not only would family members and employees be affected, but the value of the business could fall.

There might even be a question of whether the business would survive at all. It is important to look to the future and realize that the value of a business built by long hours over many years can be significantly affected when ownership changes.

Do you and other key members of your business have an agreement describing what happens in the event of the death, disability or withdrawal from the business of one of the owners?

If you don't, develop one. If you do, keep it current.

What is a buy-sell agreement?

A buy-sell agreement is an essential part of succession planning. It is an agreement among the owners that sets down their rights with respect to each other and the business. It describes what would happen in the event of the death, disability or retirement of any of the owners.

The real benefits of a buy-sell agreement are to create the framework for choices about how to deal with shares of the company and to try to eliminate friction over price and terms.

Buy-sell agreements may ensure a fair price to the purchaser of the stock, generate liquidity to pay estate debts and taxes, and provide income to a surviving spouse. They can be funded by life insurance, and the agreement may provide the purchase price, or a substantial part of it, for the shares.

In some circumstances, the agreement may involve a future prospective buyer. A sole owner might negotiate an agreement with a prospective buyer to purchase the business under certain terms in the event of the owner's death or retirement.

Without a buy-sell agreement, the surviving spouse or other family members may have to deal with finding a prospective buyer as well as placing a value on the business.

Why should your business have a buy-sell agreement?

Buy-sell agreements are overlooked far too often. The lack of an agreement can cause unnecessary problems that can destroy a family business, such as uncertainty for next-generation owner-managers, friction with uninvolved family members and inadequate financial resources for estate taxes. Outdated agreements often cause the same problems.

But a properly structured agreement can ensure family harmony and business continuity for future generations.

One of the primary goals of a buy-sell agreement is to provide a plan in which the parties agree to terms for the sale of an asset that is notoriously difficult to value – an interest in a closely held business. The result can be to create a market for the owner's business interest.

A key part of the development of a buy-sell agreement is to look at how to fund the buying party. There is no market for the interest unless the buying party – whether another owner or the business entity itself – has the ability to buy out the selling party's interest.

Another reason to enter into a buy-sell agreement is to avoid undue disruptions in the business. Planning in connection with buy-sell agreements will often address issues of smooth management transition as well as changes in ownership. Buy-sell agreements may also help protect the jobs of your long-time employees and reduce disputes among owners and employees.

Estate tax planning is also a major factor. For example, a buy-sell agreement may contain a valuation for the business interest that will be respected for IRS valuation purposes. With little or no planning, it could be necessary to sell off assets just to pay estate taxes. A lack of planning may result in delays in administering the estate.

What are the types of buy-sell agreements?

The buyer may be an individual or the corporation, depending on tax consequences and funding availability at the time. The agreement should describe whether it will be funded, what the payment terms will be and how the price will be determined. It should also cover any other miscellaneous factors that are important to the provisions of the agreement.

There are three primary types of buy-sell agreements:

1. Cross-purchase agreements

In a cross-purchase agreement, two or more owners or entities purchase the ownership interest directly from the withdrawing party or from the estate of the deceased individual. Assume two shareholders enter into an agreement that the surviving shareholder will purchase the shares of the estate or trust. Each shareholder buys life insurance on the other owner and names himself or herself as beneficiary of the policy. Upon the death of one of the shareholders, the surviving shareholder buys the shares. The surviving shareholder then owns 100 percent of the corporation.

Cross-purchase agreements may become unwieldy if there are more than a few shareholders. The advantage of the cross-purchase agreement is that the purchasers have a higher basis in shares, which may reduce tax if they later sell the shares during their lifetime. Also, with a cross-purchase agreement, funding isn't subject to any claims of business creditors.

2. Entity-purchase agreements

In an entity-purchase agreement, the corporation and shareholders, for example, enter into an agreement that the corporation will purchase the interest of a deceased or departing owner. The corporation buys life insurance on each shareholder and names itself as beneficiary. The corporation receives the life insurance proceeds upon the death of one of the shareholders and so has liquid funds to buy the shares owned by the estate or trust of the deceased shareholder or departing shareholder.

The surviving shareholders own 100 percent of the corporation as a result of owning all the shares that remain outstanding after the corporation redeems the shares of the former shareholder. Funding is provided by the business, so the business takes out only one life insurance policy on each owner. These type of arrangements can also be implemented with other types of entities such as partnerships, etc.

3. Hybrid agreements

If circumstances change or the owners don't know for sure whether the cross-purchase or entity-purchase approach will work better later, flexibility may be needed. The hybrid agreement employs a partial entity-purchase agreement and a partial cross-purchase agreement. It often leaves the option of who the buyer is until a triggering event occurs. A business may be given an option to buy all or part of the interest of a departing owner.

Another flexible approach is to give the other owners an option to buy shares or partnership interest, and then obligate the entity to buy any interest not purchased by the remaining owners. The parties may also consider periodic reviews and updates of the buy-sell plan.

What about sole proprietorships?

If your business is a sole proprietorship, the entity-purchase approach is not possible. In a sole proprietorship, if the owner dies, the business will be either sold or liquidated. However, the proprietor may plan for this situation by obligating the estate to sell the business to a purchaser, typically an employee or competitor. Or, the buyer may be a family member.

There is no particular procedure for setting the price. The parties may set the price subject to review, determine a price established by a formula, or provide for an appraisal to determine a price. An important consideration is that the valuation should withstand IRS scrutiny.

What are some issues that need to be addressed?

Structuring a buy-sell agreement is not a simple affair because of the estate and income tax issues, as well as the business and financial matters. There are issues of the relative tax brackets of the parties, the decision of whether to restrict gifts of interests in the business to family members, disparate costs of insurance due to age or health, alternative funding approaches, such as loans among the parties, and others. The possibility of a deadlock exists, as well as other concerns.

Special issues arise with the circumstances of the owners, including whether the parties are related family members. Planning also depends on whether the business is operated a sole proprietorship, S corporation, C corporation, partnership or limited liability company.

For family businesses owned by groups such as sibling partners or cousin groups, other issues make buy-sell agreements more complex. Deadlock-breaking provisions are important should there be an even number of shareholders divided along family lines.

Provisions should address what happens if some shareholders have previously sold their shares and the company is subsequently sold to a third party. A claw-back provision would provide a method for participation in an after-event transaction by sharing some of the excess proceeds with those who previously had sold their shares.

Too often, buy-sell agreements describe only what happens if a shareholder dies. More often, shareholders retire without any provision for the company to repurchase its stock. Therefore, agreements should specifically address what happens in the event of retirement, termination or disability.

Another often-overlooked provision deals with a situation in which stock goes into trust for a decedent's spouse while the company continues to be run by one or more active family members. With the surviving spouse continuing to control the company, the next-generation owner-managers may become increasingly frustrated as they get closer to their own retirement unless the buy-sell agreement spells out when they will actually become owners of the company.

What are the negatives of having a buy-sell agreement?

About the only possible negative of a buy-sell agreement is that, if the agreement is poorly structured, it might not adequately anticipate future needs and changes in the family, marital or financial circumstances. If it is properly structured, a buy-sell agreement gives the flexibility needed to address the needs of young children, disabilities, fluctuations in value and other changes.

Consult your CPA regarding a buy-sell agreement. Ideally, CPAs with knowledge of your business can work closely with attorneys to ensure that the best possible agreement is crafted.

We all know that the Baby Boomers have begun turning 65, the traditional retirement age. Over the next 18 years, all the Baby Boomers will hit that milestone.

While not everyone wants to retire at that magic age, it is a reminder that time is ticking by and that perhaps plans should be in the works to allow for retirement when the individual is ready.

Business owners are not exempt from this issue. In fact, they probably need to plan more carefully than most people so they can effectively exit the business when they decide the time is right, or when circumstances such as health concerns compel their exit. Yet, most business owners seem hesitant to discuss their exit strategy or to plan for it.

handing keys

They may have their reasons for avoiding the topic, but business owners won’t be able to avoid disaster unless they plan for the succession of their businesses. Here are a few points for the Baby Boomer business owner to consider.

1. Most Baby Boomers grew their careers at a time when long hours and “nose to the grindstone” effort reaped the biggest rewards. Likely successors, being from a different generation, may not have the same mentality about work, and the Boomer may see this as a weakness. The business owner may surmise that the successors won’t put in the effort necessary for success and use this to delay the selection of a successor.

2. The business is likely one of the Boomer’s greatest financial assets. Figuring out how to extract the value from the business can be a challenge. In many cases, business owners may find they are dependent on the business’s continuing success to fund their retirement. That can be scary. Planning far enough ahead allows time to put buy-out plans in place. That will help the successors and the business owner in the long run.

3. Finding a buyer may be difficult. If business owners decide that selling the business is the best option, they may find themselves competing with many others in the same boat. The numbers of people reaching retirement age at once mean that many people will be trying to sell their businesses at the same time. That may be better for the prospective buyers than the prospective sellers. When supply is greater than demand, prices fall and terms favor the buyers.

4. Execution takes time. Even if the business owner recognizes the need to plan for succession, the process is a long one. Not only does it take a substantial amount of time to examine options and decide on a path, it takes even more time to execute effectively. Selecting the right people for senior positions, training, transferring duties, and so on don’t happen overnight. And, the business doesn’t stop running while all of these “extra” issues are addressed. It is important to develop a realistic plan and timetable. It is sometimes helpful to have a consultant, coach or guide to help keep you on track and hold you accountable. The process will not always be easy, and the temptation to quit will sometimes be strong. The commitment to succeed with succession must be just as strong.

5. The first choice might not work out. Many business owners experience disappointment when their first successor choice doesn’t work out. Sometimes the successor decides to leave, and sometimes the business owner realizes that the choice was not a good one. Either outcome should not lead to despair. In every circumstance, the business owner can learn something that will make the next time better. This is, however, just another reason not to wait until the last minute to start. The process will likely take longer than you expect.

6. Baby Boomers live to work, and entrepreneurs are often consumed with their businesses. Put those two factors together, and you’ll find someone who may have very few outside interests. The Boomer business owner may not have anything to retire to. It can be scary to think about having no office to go to, no customers to call and no problems to resolve. Without a plan for what’s next, many business owners will have a hard time letting go.

While these issues are serious, they can only be solved by action – and the sooner, the better.

Technical valuation issues will always be important, but what about those special situations involving intangible values that transcend the property’s tangible market value?

Sometimes the value of a property isn’t just about measuring comparable sales or the net present value of rental cash flows. Sometimes the buyer also must consider intangible interests of the seller or third parties. Don’t forget the other guy.

On Dec. 12, 2011, the U.S. Bankruptcy Court for the Central District of California, Santa Ana Division, approved the sale of Dr. Robert H. Schuller’s Crystal Cathedral to the Roman Catholic Archdiocese of Orange County for $57.5 million.

Crystal Cathedral

The Crystal Cathedral, built in 1980, is a worship center constructed of more than 10,000 panes of glass – a unique structure that has been home to Schuller’s “Hour of Power” television ministry ever since.

Crystal Cathedral Ministries’ first Chapter 11 reorganization plan required a sale of its unique realty for at least $50 million. The ministry initially named nearby Chapman University as its buyer of choice for a “fair market value” price of $51.5 million, “all cash.”

Chapman had proposed to use the facilities for university purposes while leasing back all or part of the property to the ministry for an extended period of time. The archdiocese had proposed to purchase the property outright, leaving the ministry with an optional short-term leaseback period.

So what happened to change the outcome?

Chapman and the archdiocese both had outbid several other suitors, and their bids were similar in features and amounts. The archdiocese’s bid was slightly higher, offered an immediate closing with no additional due diligence period, and included a cheaper leaseback provision. However, Chapman’s long-term leaseback period appealed to the going-concern interests of the ministry’s leadership.

The archdiocese sweetened the deal by several million dollars. But because an immediate and more definite payment wasn’t convincing the first time, price alone didn’t seem to be the deciding factor. The determining factor seemed to be the archdiocese’s additional offer to provide a substantial set of intangible benefits favoring the ministry’s mission.

First, the archdiocese showed the court that the ministry probably wouldn’t be able to sustain the leaseback option under the Chapman plan, suggesting the existence of a significant risk to bankruptcy creditors. The bankruptcy documents don’t reveal if that was an important factor in the final decision.

Next, the archdiocese offered several concessions appealing to the ministry and its supporters. For example, the archdiocese promised to maintain the architectural and aesthetic integrity of the unique Crystal Cathedral facility when adapting the facility to the Catholic Church’s strict worship requirements. The church offered to maintain a permanent office in the facility for the founder, Schuller, for his lifetime. It promised to use and maintain the elaborate pipe organ – one of the largest in the world.

The church also promised to lease back certain portions of the facility to the ministry at bargain prices, to maintain permanently the Memorial Gardens as a nondenominational burial ground and honor existing contracts, to maintain and improve the nondenominational library, as well as making other concessions that promised to retain indefinitely the nondenominational religious purpose of the Crystal Cathedral facility and mission.

These concessions were offered in a spirit of cooperation between the archdiocese and the ministry, without compromising the church’s distinct worship requirements. In addition, the archdiocese offered one of its other existing facilities to the ministry as an alternative facility, at a bargain lease price with a purchase option, providing continuity for the ministry following bankruptcy.

While the Bankruptcy Court would decide whether to approve the ministry’s plan of reorganization and the real estate sale under the plan, to a great extent the sale decision was left to the ministry and its creditors, deferring to their business judgment.

Despite having additional risk because of uncertainties regarding the post-plan due diligence period and possible resulting price adjustments, the ministry initially decided to sell to the neighboring university with the hope of continuing the ministry in the Crystal Cathedral for the foreseeable future.

The bankruptcy pleadings suggest that an overriding consideration in ultimately selling to the archdiocese was its willingness to work in cooperation with the ministry.

The archdiocese would maintain in perpetuity the religious integrity of the ministry’s trademark Crystal Cathedral rather than over a limited 15-year period, while carefully transitioning the worship sections to meet the special religious needs of the Catholic Church.

The bankruptcy sale of the Crystal Cathedral is one example in which creatively leveraging goodwill and the intangible benefit of continuing the seller’s vision into the future triumphed over the initial pragmatic concern for merely buying more time to continue operations.

In this case, the Catholic archdiocese didn’t just negotiate a business deal. It won the deal by thinking of the other guy – by creating a partnership that will let the Crystal Cathedral Ministries’ 56-year vision live on in harmony with that of the Catholic Church.

Gregory T. Douds is a CPA, attorney and county judge in Georgia. In this article, he pulls from all areas of his background to provide ideas for alternatives to expensive expert witnesses.

I have represented clients in hundreds of hearings and trials in the Georgia and Maryland courts, as well as in the U.S. Bankruptcy Court. Never once have I put up an expert witness.

That was never a strategy choice, but rather a cost-benefit decision for my clients. (Or simply their lack of money.)

Once I put on my CPA hat and testified regarding a federal pension allocation in a divorce trial – at the last minute and for a low fee – with success. I’ve also heard hundreds of civil cases as a county magistrate where I’ve seen too many attorneys struggle while missing some obvious solutions.

Many of us have faced this evidentiary dilemma. So what are some creative ways to handle the absence of valuable expert testimony at trial? I will use familiar Georgia law for examples – substitute your own state’s statutory and common law for your needs.

Low BudgetThe Evidence Code Is Your Friend

Too many trial lawyers don’t pay attention to the nuances and exceptions affecting evidence laws. Careful research of the evidence laws of your jurisdiction can reveal ways to get evidence before the court without expert testimony.

The key is to use your available witnesses to their best advantage, to identify for the court legal reasons why certain things should come into evidence, and to be prepared with legal references to overcome anticipated objections.

Remember, most lawyers will argue “hearsay,” “best evidence,” or “lack of foundation,” without really being adept at arguing those objections against someone who comes prepared with statutes and case law for particular points of evidence.

Judicial Notice: A small number of specific items are judicially noticeable by statute. But common law is replete with examples of common-knowledge information that can, and cannot, be judicially noticed. In Georgia, you might need an expert’s testimony about the weather, but the time of sunrise and sunset can be judicially noticed. (Consider using the testimony of your witness corroborated by newspaper weather statistics for a particular day.)

There are many common law examples of judicially noticeable facts relating to weather, science, geography, political facts and other facts of common knowledge.

Lay Opinion Testimony: Although a common subject of objections, lay opinion testimony as to market value is admissible in Georgia if the witness has had an opportunity to form a ““correct” opinion. The trick is to support the opinion with the documents that led to it, such as automobile blue-book values, repair estimates or the client’s research notebook.

In one case, the defense expert was an experienced professional insurance adjuster who used a method supported by case law. The pro se plaintiff testified based on online Kelley Blue Book research, repair estimates and her own experience with the car. The defendant’s case law only supported the notion that the expert’s method was reasonable as a business policy, but not as to a particular car.

Common law showed the pro se plaintiff’s methods to be admissible and credible, and she won her case.

Learned Treatises: Soon, Georgia law will permit the use of statements made in learned treatises to be read into evidence and used for the cross-examination of expert witnesses. Some other states already permit this use of learned treatises. An example might be to use a copy of a Chilton’s auto repair manual as a learned treatise to defeat the testimony of a plaintiff’s automotive expert on cross-examination. If your client has lifetime experience as a backyard auto mechanic, his testimony might carry substantial weight and credibility.

Statistics and Actuarial Science: A Georgia statute provides that the American Experience Mortality Tables shall be admissible as to life expectancy in a civil case, and common law says that in a death action the jury may apply those tables using any method of calculation it knows to be correct.

Perhaps your witness is a company officer with financial experience, your client’s CPA or your client himself. He might not be an actuary expert, but he still might be accepted as an expert in finance, or his lay opinion might be good enough, given a proper foundation. His Excel spreadsheet using the American Experience Mortality Tables might persuade a judge or jury.

Date and Time: Stern’s United States calendar and Stafford’s Office Calendar are admissible in Georgia as to dates and times between them without further proof.

Use of the Other Side’s Expert: So your opponent has an expert and you don’t? Just use intensive cross-examination to ask about chain of custody and other deadly issues. If you’re careful not to ask the open-ended question to which you don’t know the answer, your cross might turn the decision.

Much of the work has been done for you by statute, and experts aren’t always needed to make proof to the judge or jury. Subpoena records from the other side as needed, and take maximum advantage of your available witnesses’ knowledge and experience.

The lawyer with the best evidentiary skills can make a great case on a small budget.

Some employers who are seeking to snare top talent offer deferred signing bonuses – often in the form of loans – to key employees.

The loans are scheduled to be forgiven later, after the employees prove their commitment to the new organization.

cf0312cA recent Tax Court case (Robert J. Brooks, et ux. v. Commissioner, TC Memo 2012-25, Jan. 26, 2012) deals with just such a loan and serves as a reminder that employer loans that are later forgiven usually result in taxable income to the employee.

In this case, Robert Brooks received a loan of more than $500,000 from his employer. The employer promised to forgive the entire loan – including interest – if Brooks stayed employed for the full five-year loan term. He stayed and the employer forgave the loan.

Brooks included the forgiven loan principal and accrued interest as income on his tax return. But later, Brooks had second thoughts and claimed that, although the forgiven principal was income, the forgiven interest was not. The entire amount forgiven was $650,342, including $506,300 of principal and $144,042 of accrued interest.

The tax law generally treats the discharge, or forgiveness, of debt as income, but there are exceptions. One is that a debtor does not realize income from forgiveness of debt to the extent that payment of the liability would have provided a deduction. Under this rule, a cash-method taxpayer will not realize income upon the cancellation of the accrued interest that would have been deductible if it had been paid.

Brooks argued that the interest his employer forgave would have been deductible under Code Section 212, which allows individuals to deduct all the ordinary and necessary expenses paid or incurred for the production of income. Brooks said the loan’s purpose was to give him a stake to showcase his skills as a stockbroker to produce income for himself and his wife.

The Tax Court acknowledged that Brooks engaged in a large number of stock trades, which Brooks pointed to as proof that he used the loan to buy a portfolio of stocks. He argued that his actions proved that the forgiven interest would have been deductible as an expense for the production of income.

The IRS countered that Brooks did not trace the flow of money from the loan to his investments. Without evidence showing use of the loan proceeds to buy stocks or securities, the IRS contended that Brooks didn’t prove he would have been entitled to a deduction.

The Tax Court agreed with the IRS. Interest expense generally is allocated to the associated debt. The court said it had to look at how Brooks used the loan proceeds to determine whether the interest related to the debt would have been deductible.

Brooks did not give the court enough information to make the determination.

Your law firm is not just a convenient place for you to practice your profession – it is a business that provides opportunity, financial wealth and satisfaction to you and your employees.

As such, you need a business plan that envisions the firm’s future so you can properly operate your business to reach your goals.

Business PlanComponents of a good plan

A good business plan contains certain key components. It should:

  • Focus your firm’s future opportunities
  • Outline your firm’s specific goals
  • Specify the methods to be used to accomplish your goals
  • Define time frames to accomplish your goals

Your plan should be in writing and communicated so that every member of the firm can see it, identify with it, and move in accordance with its direction. It forms the framework for marshaling your people and financial resources to move the firm toward meeting its goals.

Focus your firm’s future opportunities

Your law firm, like every other business, has the freedom and opportunity to change its course of direction every day of its existence. Because your business has nearly unlimited possibilities, the following two items are key points you must decide on and commit to in your business plan.

1. Type of practice – Too often, law firms enter an area of law defensively, when an important client demands services the firm does not offer. The most basic component of your plan should define which areas of law your firm will develop and which areas will be referred out to strategic partners or alliances.

2. Size of practice – Regardless of which fields of law your firm decides to practice, you must also decide how large the firm should be. This will depend upon the capability of your firm’s people and your financial resources. How should the firm be structured internally? How many office locations are desired or necessary? Where will the money and time come from to build and manage the practice size right for your firm? Ideally, these decisions are made up front and documented in a well thought out plan.

Outline your firm’s specific goals

For example, let’s say your firm has dabbled in construction litigation and decides to develop a department servicing this field. At the same time, you are overflowing your present office space, but your lease is not up for three years. Lastly, the founding partner of the firm is nearing retirement and no succession plan is in place.

These three situations may seem completely separate at first glance. However, all three can be related to one or both of the two previous issues – type of practice and size of practice. All three affect the firm’s partners, employees and financial resources and should be dealt with in the business plan.

Specify the methods to be used to accomplish your goals

Once goals have been identified, steps must be taken to accomplish them. Who will staff the new department? Who takes over for the founding partner? Are new lawyers or support staff employees necessary? How much money will the people and facilities cost?

Define time frames to accomplish your goals

The planning process should identify time frames for action to accomplish each goal. The new construction litigation department may be desirable but may be deferred for six months. However, the office space and lease issues will not go away and demand immediate attention. The founding partner may have a goal for retirement that allows the firm to work out a plan over the next two years.

All of these goals must be prioritized and put on a timeline so that the firm’s resources are used efficiently.

Your first step toward planning for your law firm’s future is to develop your business plan. Then, revisit it at least annually to rethink and reset your firm’s goals. Refer to the plan often, modify it as needed, and use it as one of your firm’s most important management tools.

Business plans can be adapted to suit the needs of large or small firms, but it is important that every firm have one.

Do you have partners in your practice who will be retiring within the next five to ten years?

What's Your Firm WorthIf so, it’s time to start developing a transition plan for when the time comes.

Understanding how the value of your practice is determined can help you plan for a smooth transition as well as implement strategies to retain or increase your firm’s value.

The price actually paid for a law firm may differ from its value. This can be due to many factors. Since valuation and value concepts are derived from financial theory, it may have little to do with agreed-upon price.

The valuation approaches and methodologies for valuing a law practice are the same as for any other professional practice. These include asset-based market data and income approaches.

In the asset-based approach, value is based upon the cost to reproduce or replace the asset. Each asset of the law practice is valued separately and then aggregated. The liabilities and obligations of the practice are also aggregated and then subtracted from the total asset value to arrive at the net asset, or book value of the practice.

Goodwill is an intangible asset that the practice has developed over time based upon its reputation and the quality of the service provided. But goodwill is not considered part of the book value of the practice, and therefore the asset approach is lacking in this regard.

The market data approach is a comparative valuation model that relies on the use of financial data from either public or private sources. Unfortunately, there is not enough market data available for the legal industry to ensure that the information is reliable.

In the absence of sufficient market data, the fee or revenue multiplier approach is often used. However, as with the aforementioned goodwill argument, this approach may not be appropriate because it does not consider attributes that are unique and specific to the firm, such as the reputation and expertise of its partners.

Profitability, which is defined as the firm’s earnings after all expenses – including a reasonable compensation paid to its owners – measures both the goodwill reflected in its billing rates and operating efficiencies.

Therefore, an approach based on profitability, such as the income approach, is generally considered the most reliable method for valuing a law practice. This approach estimates value based on earnings or cash flows and produces a value for the firm as a whole, including tangible and intangible assets, less liabilities.

Partners should focus on a number of factors to retain or increase the value of their firm, including:

Reputation Is your firm reliant on the reputation of the retiring partners? If so, a transition plan is needed to ensure that younger partners are developing relationships with key clients and gaining experience in their area of expertise.

Expertise Is most of the intellectual capital of your firm with retiring partners? This can be an issue if your firm has a mandatory retirement age.

Firms should reconsider this policy and allow partners to work longer or part-time. Implementing formal transition, mentoring, management and leadership training, as well as recruiting programs, is important. Compensation and incentive plans encouraging retiring partners to transition their book of business are also good options.

Practice Areas Is your firm a collection of silo practice areas? A team approach to servicing client needs may be the solution so clients become comfortable dealing with other professionals at your firm.

Clients Are there consistent, significant write-offs each year on certain client accounts? Retention of this type of client should be examined.

Profitability Can the firm sustain into the future? A review of the financial statements with the firm’s CPA should include an examination of the profit margins, realization, projected cash flow and overhead expenses. Additionally, an analysis of the fee structure and the revenue flow may be warranted. The firm must be in a good financial position to buy out equity partners at retirement without affecting the ongoing operations of the practice.

Some other factors to consider include the competition, your location, quality of the work product, workflow, efficiencies, lease terms and the condition of the office space. An evaluation of the overall strength of the firm and its ability to generate earnings will ultimately maximize the firm’s value. Additionally, ample time to implement strategies to transition management responsibilities and clients will ensure the best possible value.

Your CPA is a vital member of your legal team. But when should you call your CPA for assistance?

The short answer is, “Whenever business issues or numbers are involved.”

Here are five ways you can involve your CPA in litigation and practice management matters to help you realize greater profit and have a healthier practice.

CPA Firm1. Business and Asset Valuations

In matrimonial cases, CPAs use available financial documents, such as tax returns and bank statements, to help attorneys understand a spouse’s true financial position. These documents often contain clues that can be used to identify and estimate the values of bank accounts, real estate or other assets.

In commercial cases, CPAs provide estimates of business values under various scenarios. For example, the value of the business (if it continues in operation) can be compared with the value of the assets in a sale or liquidation.

2. Cash Flow Analyses

One common service provided by CPAs is cash flow analysis. Your opponent’s cash flows can be analyzed to determine the best settlement option that will maximize recovery for your client while minimizing the strain on the opponent – ensuring your client has the best chance to make a full recovery.

CPAs also provide valuable insight into your law practice cash concerns. They review accounts and procedures to help you manage your practice to enhance your cash receipts and control your cash payments.

3. Tax Reviews

Whenever you have a document or transaction that has tax effects, you should consult your CPA to determine the full scope and find alternatives to minimize tax problems.

Your CPA can review documents to ensure the narrative is consistent with the desired tax outcome and that you have not overlooked important tax considerations. Tax reviews can be very important when drafting marital property settlement agreements or conducting real estate or business transactions.

4. Interpreting Business Transactions

Your opposing party or counsel often will give a positive spin to business transactions in settlement negotiations or litigation. Chapter 11 bankruptcies are particularly susceptible to this type of characterization because of the pressure on management to produce an acceptable plan of reorganization.

The positive spin is not necessarily made in bad faith, but the client must be protected from the potential harm of accepting such characterizations at face value. CPAs are uniquely capable of seeing beyond the spin to understand the true nature of the transaction. Financial documents can reveal important considerations that are not always easily discernible by attorneys.

5. Law Office Management

Possibly the most important need for a CPA is in the area of law office management. CPAs can help attorneys with:

  • Partner compensation disputes
  • Associate and staff compensation levels
  • Employee retention issues
  • Control of expenses
  • Lawyers’ trust accounts
  • Improvement of collections
  • Maximization of billable hours

By Laura P. Ewart, CPA, valuations supervisor at CPAmerica

In virtually all matrimonial litigation cases in which one spouse is a business owner, the expert retained in the case must analyze and report on two issues.

The first issue is the value of the business owner’s interest in the company. The second is the amount of cash flow the business owner is receiving from the company.

Cash FlowCash-flow analysis is necessary to determine income for the calculation of alimony and child support. We typically analyze the last three years of the business owner’s cash flow.

Our starting point for a cash-flow analysis is the salary the business owner receives from the company, as well as distributions and/or loans the owner is taking.

The next step is an analysis of the company’s general ledgers to determine what perquisites may exist that should be included in the business owner’s cash flow. Any payment of items that are for the personal benefit of the business owner or the owner’s family is considered cash flow to him.

Examples of these payments include automobile expenses, travel and entertainment, mortgage or other personal obligation payments. The key phrase to remember in this analysis is “personal benefit.”

Our firm was recently retained by the husband in a matrimonial matter. The husband owns and operates a construction business. A prenuptial agreement exists in this case and, as per the agreement, the business is an exempt asset. Therefore, a business valuation was not necessary. However, a cash-flow analysis was still required for support purposes.

The Findings

At our initial interview, the husband told us his business had plummeted over the last few years, and he was not capable of continuing to earn what he has historically.

Operating within the construction industry in today’s economy may make this a reasonable scenario. However, an analysis of the cash flow from the business revealed he continued to receive $200,000 to $300,000 per year.

As the expert, we must reconcile what the client is saying to us with what we are seeing in the records we are provided.

Analyses of the historic trends of the company are consistent with what we were told. From 2008 to 2009, gross sales dropped $12 million, and from 2009 to 2010 it dropped another $5 million. Correspondingly, net operating income fell from a profit of $100,000 in 2008 to losses of $850,000 in 2009 and $460,000 in 2010.

The question is, how is this business owner sustaining this level of cash flow given the financial situation of the company?

An examination of the detail of the revenue and expenses in all three years was conducted to confirm profits were not deflated by payments for personal items.

Our findings were that the losses were being caused by continued high insurance premiums, labor burden costs and several other fixed costs not yet decreased while revenue dropped sharply. The reconciliation was found in the trend analysis of the balance sheets.

In 2008, the company assets consisted of cash of $1.3 million and accounts receivable of $3.6 million. Also in 2008, the net equity of the company was $750,000. In 2010, the assets had fallen to $300,000 of cash and $300,000 of accounts receivable and equity to a negative $600,000.

The liquidation of these assets over the last three years had been funding both the operations of the company as well as the business owner’s cash flow. Therefore, while the business owner’s cash flow does not appear to be affected over the last three years, it will not be able to continue beyond the exhaustion of the assets. This disclosure is imperative to our report.

Each case has nuances that require the keen analytical skills of the expert. Careful planning and procedures can help assure that you have captured all the relevant data needed to issue useful reports that will help resolve the issues of your case.

Time-keeping and billing can be the bane of an attorney’s existence. But even worse is having to work an additional 10 or 20 hours because a client failed to pay his bill.

Faster billing means faster and larger collection of professional fees. Unfortunately, it’s almost a universal truth that professional billings are often neglected by lawyers because they feel like unprofitable chores. The review time cannot be billed, and the review process is pure drudge work.

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