Be crystal clear about the details to ensure your agreement is airtight.
This article first appeared in The CPA Insider.
A few years ago I read The Snowball: Warren Buffett and the Business of Life by Alice Schroeder. One of the business adventures the Oracle of Omaha encountered in his career happened when he bought a company from an 89-year-old seller without a noncompete agreement. Whatever the reason for this huge oversight—perhaps the seller’s age played into Buffett’s decision-making—it proved to be a costly mistake. A few years later the seller opened a competing business literally next door.
When I learned about this story, I could not believe that such a savvy businessman could spend millions on an acquisition without any sort of noncompete agreement. Apparently though, Buffett learned his lesson. When he negotiated a new deal years later with the same seller, he was sure to include a noncompete agreement.
This story demonstrates (1) the importance of noncompete agreements, and (2) that even experienced buyers make mistakes. If you are going to buy a CPA firm, you’ll want to make sure that your noncompete agreement will protect you if the seller decides to get back into public accounting. The noncompete agreement should be negotiated and agreed upon when you and the seller are negotiating all of the sale terms such as price, payment terms, and transition assistance.
4 points to keep in mind
When buying a CPA firm, be sure to consider these key issues that relate to noncompete agreements:
- Make sure your noncompete agreement contains a provision for distance. The main purpose of a noncompete agreement is to prevent the seller from serving the clients of the business that is being sold. Most noncompete agreements contain a provision for distance that stipulates, for example, that the seller not serve clients within a certain metropolitan area. This provision is necessary even when a seller agrees not to seek the business of previous clients. In theory, if a seller opened an office next door to her old practice, but agreed not to serve her past clients, then her new practice should do the buyer no more harm than if another CPA began competing in that same location. In reality, though, her opening a practice right next door would be very confusing to clients. Moreover, it would be very difficult to police and track whether the seller was in fact accepting previous clients. Including a distance component to a noncompete agreement can prevent this kind of situation. (In our hyperconnected world, however, distance is becoming less and less of a factor.)
- Be sure that your noncompete agreement is enforceable under your local laws.Most jurisdictions will not enforce noncompete agreements that cover too much geography or too long a period of time, so check your state or provincial laws to determine whether your agreement is enforceable. (As a general guideline, most of the agreements my practice sees last about five years and cover roughly the metropolitan area where the accounting practice operates.)
- Ascertain the seller’s intentions. Pay very close attention to the seller’s plans for after the sale. Don’t simply listen to what the seller is saying. Look at his life circumstances as well. Often, how a seller behaves during the negotiations of the noncompete agreement can give the buyer a glimpse of the seller’s struggles with exiting or his or her commitment to leaving public practice for good. Here are two scenarios that illustrate this point:
Example A: The seller is 75 years old, and his spouse retired last year. They have just purchased a retirement home in Palm Springs, where their daughter also lives and is expecting their second grandchild in a few months. He and his wife have both had successful careers, and they have lived below their means and have plenty of savings to enjoy a comfortable retirement. He is retiring in order to move and to spend time with his grandchildren.
Example B: The seller is 55 years old, and she is just tired of the demands of practicing. She says she may take a few months off and then look for a job in industry. She likes some aspects of public practice, but gets overwhelmed with the administrative and managerial responsibilities.
- The owner in Example B may do exactly as she’s indicated. She may go into industry and never pose a competitive threat. Or, after some time off, she may feel refreshed and decide to return to public practice. However, the owner in Example A, who’s older and has a firm retirement plan in place, is far less likely to become competition.
- If the seller wants to keep some of the business, make sure the noncompete agreement is specific and clear. We generally recommend that sellers hand over their entire business to buyers, but they often wish to keep a few clients or, in some cases, entire segments of the practice. Sellers who are older, for example, may want to keep working but lack the energy or desire to do so full time. Keeping a small handful of clients can be a way for them to stay helpful and useful to others while easing into retirement. Other clients sell segments of their practices to focus on areas that they have more desire to pursue. Wealth management is the most common example. Our experience with these sellers has been very positive when they have a successful history with the segment that they want to pursue. In both these cases, though, buyers need to make sure sellers are crystal clear and specific about which clients they are keeping and why. The noncompete agreement should include a complete list of all of the clients being kept by the seller and should include a description of the services that the seller will be allowed to provide after closing. And, as always, keep in mind that noncompete agreements executed as part of the sale of a firm can have tax consequences.
The noncompete agreement is a critical component of every deal, whether it’s buying or selling a practice or negotiating an agreement with a partner, shareholder, or key employee. It’s one area even an icon such as Warren Buffett can’t afford to overlook.
Brannon Poe, CPA, is the founder of Poe Group Advisors, an accounting practice brokerage firm. He is the author ofAccountant’s Flight Plan: Best Practices for Today’s Firms and On Your Own! How to Start Your Own CPA Firm, and blogs at poegroupadvisors.com/blog.