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The ESOP alternative for CPA and accounting firms

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Private equity’s run through the ranks of the accounting professions showed no signs of slowing in 2024. But recently, employee stock ownership plans have emerged as an alternative succession strategy for middle-market firms. Long-viewed as a tax-advantaged transition tool for accountants’ business clients, CPAs are now embracing ESOPs for their own firms.

Why? Because leveraged ESOPs circumvent deferred compensation dilemmas. At most firms, new partners must pull in revenue and generate profits to gradually pay departing partners. Paradoxically, departing partners are generally among a firm’s biggest producers. As a result, a single ownership transfer period can last as long as 10 years and is often completed below fair market value.

ESOPs enable new accountants to earn equity without having to fund a deferred compensation arrangement and without having to pay out of pocket to buy-in. Instead, an employee ownership transaction can provide for a seamless, rolling transition of ownership. Partial ESOP transactions are common, enabling firms to sell targeted blocks of retiring partner stock to an employee trust. But CPA firms can only unlock the utility of an ESOP when they fully tap into the relative flexibility of these strategies.

Creating supplemental incentive opportunities

Anyone who has advised an employee-owned client knows that ESOPs are ERISA-based, non-discriminatory benefit plans. All eligible employees receive stock based on the same egalitarian formula. That makes sense for a typical business, where tangible assets are created and monetized at an organizational level. But an accounting firm’s value creation rests largely on the shoulders of its tenured partners. A standard employee ownership structure may not offer enough upside to entice or retain high-performing talent. 

Instead, CPA ESOPs are generally formed in tandem with nonqualified plans for firm leadership and top producers. These complementary structures are commonly used to create meaningful, discretionary phantom and synthetic equity opportunities.

Add-on benefits still need to be ERISA-compliant and negotiated as part of an ESOP formation. Nonetheless, supplemental plans are common fixtures at employee-owned professional service firms. These two-tiered strategies deliver short-term incentives to a firm’s established value creators, and long-term equity opportunities for all employees and future hires.

Normalizing EBITDA

Many broadly held accounting firms zero-out their net income in any given year. Meanwhile, ESOP valuations are often rooted in adjusted EBITDA multiples. To bridge this gap, firms often perform compensation scrapes, a common staple of private equity deal transactions. The resulting retained earnings will drive pre- and post-sale enterprise values.

Scrape calculations generally factor in a partner’s overall performance, productivity and tenure. A thoughtfully constructed scrape offers valuable trade-offs for impacted team members. Senior partners may take outsized reductions in their income to generate that excess retained earnings, with the expectation that they are near-term ESOP buyout targets. Junior partners can expect additional warrant or phantom stock grants that offer greater mid-to-long-term economic upside.

In addition to formalizing a firm’s valuation, EBITDA normalization and the resulting earnings retention creates a durable funding source for firm modernization and expansion. These investments are critical to continued competitiveness in an ever-consolidating industry. 

In a properly structured ESOP, these earnings are also tax-advantaged. Employee-owned firms can receive corporate income tax deductions equivalent to the value of stock sold to an employee trust. In other words, a $50 million ESOP sale should yield a firm $50 million in deductions. Furthermore, a 100% employee-owned accounting practice can effectively operate income tax-free in perpetuity.

Understanding the big picture

So, let’s study these lessons in a practical context. Consider a 300-member, $50 million revenue accounting firm with a broadly held ownership group. Thirty percent of the partner base are senior members of the firm, eyeing retirement within five years. An ESOP strategy is developed to acquire equity from these senior partners at a fair market valuation.

First, a firm-wide compensation scrape (weighted toward senior partners) is performed and yields $10 million in EBITDA. Based on prevailing industry multiples and adjustments, the firm’s assumed valuation is set at $100 million. So, there’s an expectation of a negotiated $30 million ESOP sale price for 30% of the firm.

Next, commercial financing is secured so that senior partners receive up-front cash for the equity they’ve sold. These partners will have the opportunity to defer capital gains on their sale proceeds, thanks to an ESOP-exclusive tax benefit — the 1042 rollover. Over time, the firm will pay down the bank loan on the employee trust’s behalf, using pre-tax dollars.

Steps are also taken to make younger partners whole post-scrape. A stock appreciation rights plan is developed to deliver formal equity-sharing opportunities to established team members with longer time horizons. They’ll also have opportunities to sell their retained equity to the firm’s employee trust in the future, potentially with rights to exchange some of their shares for warrants. New partners will receive standard ESOP allocations and consideration to take part in the firm’s supplemental incentive program (at leadership’s discretion).

Either through retained equity or ESOP shares, the firm’s next generation of leaders will have concrete opportunities to monetize their stake in a more efficient, employee-owned firm — one that is retaining earnings for internal investment or potential acquisitions and realizing enhanced cash flow, fueled by the ESOP’s tax incentives.

From initial conception to final negotiations with an independent trustee, the transaction takes roughly six months to finalize. An experienced ESOP investment banking advisor and knowledgeable ERISA counsel help keep everything on track. In the end, retiring partners gain liquidity while remaining team members earn broad-based equity upside and additional incentives in a firm that’s primed for greater competitiveness — one in which all staff are rowing in the same direction to grow the practice over time.

What makes a good CPA ESOP candidate?

ESOP strategies are generally geared for top 500 accounting firms that aspire to sustainable, long-term growth. There must be an appetite for broad-based ownership and a willingness to build internal capacity. To build an employee stock ownership plan is to bet on yourself.

It’s not the right shareholder liquidity solution for every firm. But for forward-looking firms with leadership teams that seek market leadership for the foreseeable future, employee ownership represents a powerful tool. ESOPs take the industry’s greatest challenge — attracting, retaining and rewarding talent — head on, while aligning all staff behind a common goal at independent, CPA-led firms.

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Accounting

IAASB tweaks standards on working with outside experts

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The International Auditing and Assurance Standards Board is proposing to tailor some of its standards to align with recent additions to the International Ethics Standards Board for Accountants’ International Code of Ethics for Professional Accountants when it comes to using the work of an external expert.

The proposed narrow-scope amendments involve minor changes to several IAASB standards:

  • ISA 620, Using the Work of an Auditor’s Expert;
  • ISRE 2400 (Revised), Engagements to Review Historical Financial Statements;
  • ISAE 3000 (Revised), Assurance Engagements Other than Audits or Reviews of Historical Financial Information;
  • ISRS 4400 (Revised), Agreed-upon Procedures Engagements.

The IAASB is asking for comments via a digital response template that can be found on the IAASB website by July 24, 2025.

In December 2023, the IESBA approved an exposure draft for proposed revisions to the IESBA’s Code of Ethics related to using the work of an external expert. The proposals included three new sections to the Code of Ethics, including provisions for professional accountants in public practice; professional accountants in business and sustainability assurance practitioners. The IESBA approved the provisions on using the work of an external expert at its December 2024 meeting, establishing an ethical framework to guide accountants and sustainability assurance practitioners in evaluating whether an external expert has the necessary competence, capabilities and objectivity to use their work, as well as provisions on applying the Ethics Code’s conceptual framework when using the work of an outside expert.  

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Accounting

Tariffs will hit low-income Americans harder than richest, report says

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President Donald Trump’s tariffs would effectively cause a tax increase for low-income families that is more than three times higher than what wealthier Americans would pay, according to an analysis from the Institute on Taxation and Economic Policy.

The report from the progressive think tank outlined the outcomes for Americans of all backgrounds if the tariffs currently in effect remain in place next year. Those making $28,600 or less would have to spend 6.2% more of their income due to higher prices, while the richest Americans with income of at least $914,900 are expected to spend 1.7% more. Middle-income families making between $55,100 and $94,100 would pay 5% more of their earnings. 

Trump has imposed the steepest U.S. duties in more than a century, including a 145% tariff on many products from China, a 25% rate on most imports from Canada and Mexico, duties on some sectors such as steel and aluminum and a baseline 10% tariff on the rest of the country’s trading partners. He suspended higher, customized tariffs on most countries for 90 days.

Economists have warned that costs from tariff increases would ultimately be passed on to U.S. consumers. And while prices will rise for everyone, lower-income families are expected to lose a larger portion of their budgets because they tend to spend more of their earnings on goods, including food and other necessities, compared to wealthier individuals.

Food prices could rise by 2.6% in the short run due to tariffs, according to an estimate from the Yale Budget Lab. Among all goods impacted, consumers are expected to face the steepest price hikes for clothing at 64%, the report showed. 

The Yale Budget Lab projected that the tariffs would result in a loss of $4,700 a year on average for American households.

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Accounting

At Schellman, AI reshapes a firm’s staffing needs

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Artificial intelligence is just getting started in the accounting world, but it is already helping firms like technology specialist Schellman do more things with fewer people, allowing the firm to scale back hiring and reduce headcount in certain areas through natural attrition. 

Schellman CEO Avani Desai said there have definitely been some shifts in headcount at the Top 100 Firm, though she stressed it was nothing dramatic, as it mostly reflects natural attrition combined with being more selective with hiring. She said the firm has already made an internal decision to not reduce headcount in force, as that just indicates they didn’t hire properly the first time. 

“It hasn’t been about reducing roles but evolving how we do work, so there wasn’t one specific date where we ‘started’ the reduction. It’s been more case by case. We’ve held back on refilling certain roles when we saw opportunities to streamline, especially with the use of new technologies like AI,” she said. 

One area where the firm has found such opportunities has been in the testing of certain cybersecurity controls, particularly within the SOC framework. The firm examined all the controls it tests on the service side and asked which ones require human judgment or deep expertise. The answer was a lot of them. But for the ones that don’t, AI algorithms have been able to significantly lighten the load. 

“[If] we don’t refill a role, it’s because the need actually has changed, or the process has improved so significantly [that] the workload is lighter or shared across the smarter system. So that’s what’s happening,” said Desai. 

Outside of client services like SOC control testing and reporting, the firm has found efficiencies in administrative functions as well as certain internal operational processes. On the latter point, Desai noted that Schellman’s engineers, including the chief information officer, have been using AI to help develop code, which means they’re not relying as much on outside expertise on the internal service delivery side of things. There are still people in the development process, but their roles are changing: They’re writing less code, and doing more reviewing of code before it gets pushed into production, saving time and creating efficiencies. 

“The best way for me to say this is, to us, this has been intentional. We paused hiring in a few areas where we saw overlaps, where technology was really working,” said Desai.

However, even in an age awash with AI, Schellman acknowledges there are certain jobs that need a human, at least for now. For example, the firm does assessments for the FedRAMP program, which is needed for cloud service providers to contract with certain government agencies. These assessments, even in the most stable of times, can be long and complex engagements, to say nothing of the less predictable nature of the current government. As such, it does not make as much sense to reduce human staff in this area. 

“The way it is right now for us to do FedRAMP engagements, it’s a very manual process. There’s a lot of back and forth between us and a third party, the government, and we don’t see a lot of overall application or technology help… We’re in the federal space and you can imagine, [with] what’s going on right now, there’s a big changing market condition for clients and their pricing pressure,” said Desai. 

As Schellman reduces staff levels in some places, it is increasing them in others. Desai said the firm is actively hiring in certain areas. In particular, it’s adding staff in technical cybersecurity (e.g., penetration testers), the aforementioned FedRAMP engagements, AI assessment (in line with recently becoming an ISO 42001 certification body) and in some client-facing roles like marketing and sales. 

“So, to me, this isn’t about doing more with less … It’s about doing more of the right things with the right people,” said Desai. 

While these moves have resulted in savings, she said that was never really the point, so whatever the firm has saved from staffing efficiencies it has reinvested in its tech stack to build its service line further. When asked for an example, she said the firm would like to focus more on penetration testing by building a SaaS tool for it. While Schellman has a proof of concept developed, she noted it would take a lot of money and time to deploy a full solution — both of which the firm now has more of because of its efficiency moves. 

“What is the ‘why’ behind these decisions? The ‘why’ for us isn’t what I think you traditionally see, which is ‘We need to get profitability high. We need to have less people do more things.’ That’s not what it is like,” said Desai. “I want to be able to focus on quality. And the only way I think I can focus on quality is if my people are not focusing on things that don’t matter … I feel like I’m in a much better place because the smart people that I’ve hired are working on the riskiest and most complicated things.”

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