Have an Exit Strategy

A professional practice is a business, just like any other, and partnerships are prone to fail. The cost of setting up the correct structure for operating and ultimately terminating the partnership is relatively inexpensive compared with the cost of unraveling a relationship that no longer meets the original needs, not to mention the emotional cost.

In a sense, terminating a business partnership is rather like a divorce.

Without a prenuptial agreement, it can become very messy indeed.

Silent Partners

I had lunch recently with an associate of mine who is contemplating retiring. Vincent is sixty-two and has an interest in a small insurance business. Last year he took eleven weeks of vacation and is planning on taking twelve to fifteen weeks this year. Over lunch he told me his conscience was bothering him. He felt he was not being fair to his partners by taking so much vacation time.

However, Vincent indicated that he had no intention of cutting back on vacations. He wanted to continue to take a great deal of time off in the years ahead. He went on to say that he really enjoyed the business. He didn’t want to retire totally.

I asked him what he liked and disliked about the business. We talked about his relationship with his partners. He asked what I thought he should do based on my years of experience as a business broker.

“Each person has a capacity for work,” I told him. “Let’s call that capacity a hundred units. As we get older, our capacity to work reduces. So the most important thing we can do is ensure that we’re not operating beyond our capacity at any point in time.

“Ideally,” I added, “we should work at between 80% and 90% of our capacity. This leaves us with a capacity to handle the unexpected and extraordinary. Therefore, if in our prime we can do a hundred units of work, historically then as we get older we may find we can only do eighty units of work. Therefore we should reduce the commitment to the total number of units.”

“This makes a lot of sense to me,” Vincent said.

“We then need to look at the units themselves. Let us presume that each unit has five components of work in total. And upon further examination we discover that we like doing two of the units and don’t really care about doing the other three units.”

I told Vincent that when we’re younger, our capacity for work is higher. We did the three units of work we didn’t like to do because they had to be done. As we grew older, we need to be more selective about the work we do.

“We look around to see if perhaps we can delegate those three units of work that we don’t enjoy to someone else.”

The discussion turned to his partnership arrangement. I was surprised to learn that not only was there no written partnership agreement, but there was nothing at all in writing to summarize their working relationship.

Each of the partners had their own book of business in addition to a shared book of business. They each paid their proportionate share of expenses. Each partner made a different amount of money. And each partner had a different sense of the value that should be used to calculate their own book of business.

Indeed, they had not even made provisions for the untimely demise of one of the partners. Remember, these partners sold life insurance and financial planning to their clients. Talk about the shoemaker not making shoes for his own family.

This lack of value consensus could, at some point in the future, prove explosive.

Our recommendations were quite straightforward:

  • summarize the current operating arrangements between the three partners
  • discuss changes in the operating agreements in order to compensate for extended time off being contemplated by the senior partner
  • organize an independent valuation of each of the practices and the shared practice
  • establish a buy-sell agreement between the three partners, taking into consideration the financial capability of the individual partners to pay
  • arrange sufficient life insurance to cover the values determined by the valuations
  • consider arranging long-term lump sum income disability coverage
  • do it now
  • set reasonable time lines to complete each of the above
  • retain competent professionals to complete the work in a timely manner.

Vincent became one of our clients. So did his two partners.