Succession planning for CPAs and accountants

When accounting professionals think about leaving their practice, whether through retirement or as part of a career change, many find themselves unprepared for the future. They fail to consider that they might face claims for professional malpractice after their departure.

To navigate these changes as smoothly as possible, professionals need to address succession planning, policies for retiring partners, and changing insurance needs before anyone decides to retire.

Unprepared for the future

Many smaller accounting firms operate in a silo model. Each partner can make his or her own decision about when to retire and the conditions of retirement. However, firms that lack a succession plan may find themselves facing a crisis when one partner decides to leave the business, whether due to retirement or other factors.

According to the American Institute of CPAs (AICPA) Multi-Owner Survey Report, 74% of multi-owner accounting firms anticipate facing succession planning challenges in the next five years. Still, only 44% have taken steps to address those challenges.

Prepare to face these challenges. Discuss transition policies before anyone is close to retirement. This approach generates the most productive conversations, prevents departing partners from perceiving conversations as an attempt to reduce their compensation, and allows the retiring partners to plan for their retirement with a degree of certainty.

Accounting firms should consider establishing policies and rules for retired partners. The policies should specify the privileges and restrictions that will be placed upon them if they continue to work with the firm in a different capacity, or on their own. By doing so, conflicts and misunderstandings can be avoided. Also, retiring partners can continue to provide value to the firm after a change in ownership.

Barriers to succession planning

The AICPA Multi-Owner Survey Report identified two primary obstacles to succession planning among accounting professionals: lack of penalties for improperly transitioning clients, and concerns about the future generation’s ability to take over.

Penalties are broadly defined and may include non-solicitation or non-compete agreements, a financial charge for each dollar of annual revenue taken, and financial charges for employees that are taken. Yet 64% of respondents had no penalty in place for partners who leave and take clients, staff, receivables, or work-in-progress.

The other barrier to succession planning among accounting firms lies in a perceived lack of younger firm members who are ready to step into leadership roles. However, the report states that this barrier is improving. The number of respondents who identified the issue as a concern declined from 42% in 2012 to 33% in 2016.

While there may be valid concerns about next-generation partners who could step up to fill leadership roles, these concerns can often be addressed by senior partners taking an active role in up-and-coming mentoring members of the firm.

Other times, the lack of new leadership exists because current leaders are unwilling to get out of the way. Mandatory retirement age can be a step towards minimizing future problems as it forces leaders to address succession planning and to create a clear structure and timeline for a leadership transition. 

Address risks proactively

Start with a formal succession plan. An effective succession plan usually takes 3 to 5 years to execute. To ease the transition, allow owners to focus on other essential aspects of the firm’s business, such as leveraging relationships to promote future growth.

Here are a few items to consider:

  1. Protect the firm’s assets: If an outgoing partner takes clients or staff, there should be penalties in place.
  2. Client relationships: Keeping clients happy and communicating with them throughout the transition process will help long-term.
  3. Clear policies: What is allowed of former owners, and what is not allowed? Retired partners need to know their roles.
  4. Critical Items: Partner agreements, retirement obligations, and insurance needs should be addressed.

Indemnification and Tail Coverage for Accounting Professionals

Accounting partners who plan to leave an accounting firm should ask that the remaining partners indemnify them and carry liability coverage covering both active and former partners. Accountants who are retiring or selling their practice should also consider extended insurance coverage, known as “tail coverage,” that will protect them and their partners for some time after their departure.

Tail coverage provides the departing partner with insurance coverage in the event they are named in a lawsuit. Departing accounting partners should carry a minimum of $1 million in tail coverage for five years after they leave. These recommendations are based on the average size and timing of professional liability claims against U.S. accounting professionals.

These figures might seem excessive. Consider that the longer a claim takes to develop, the larger it usually is. Some statues have a statute of limitations beyond five years. Looking for seven years or unlimited tail should be a good option for coverage.  

Practice Continuation Agreement

An unexpected event can happen at any time. CPAs and accounting professionals need a practice continuation agreement (PCA). Whether it’s death or disability, temporary or permanent, the PCA will allow the firm or trusted professional to take over the practice for a period of time. It’s especially vital for small firms that have no additional backup.

No insurance coverage?

Without insurance, the opportunities available will be limited in selling or merging the practice. The reason for this is the inability to secure an extended reporting endorsement to the policy (tail coverage). Potential successors may be reluctant to acquire the practice without tail coverage available.

Protect the legacy

A professional liability insurance policy and a written partnership agreement are crucial elements of an effective succession plan. Firm leaders should seek comprehensive and clear guidelines in their partnership agreements. These agreements should specify minimum insurance requirements that will protect both the firm and potentially part of the departing partner’s source of income in retirement.

Retiring accountants will face potential liability risks associated with prior services performed. These risks can linger for years after services are delivered.

Insurance brokers and accounting professionals need to communicate if there’s a significant change in practice. Having different options will protect CPA and firms, as individuals transition to retirement.

Brokers who partner with McGowan gain access to an experienced team of insurance professionals who understand the nature of the accounting industry.

Learn more about our Errors and Omissions (E&O) Insurance Policies for Accountants and contact us today for answers to insurance and succession planning questions.