Selling Your Practice? Make Sure You Cover Your Tail
Mergers and acquisitions and the many issues associated with turning a practice over to new owners are hot topics right now. According to the 2013 PCPS CPA Firm Top Issues Survey, succession planning was a concern for firms of all sizes. Practitioners are aware that a proper transition of clients and staff is crucial, but it’s also important to address questions about potential outstanding liabilities.
How are past claims against a practice handled when one firm is sold or merged into another? I recently received a call from a practitioner asking just that question. She was the sole owner of a three-person firm who was selling to her two employees. She was quite concerned that uncertainties about possible past liabilities might stand in the way of the sale.
Professional liability insurance for CPA firms generally is issued on what’s called a claims-made and reported basis, which means it covers claims made in relation to work performed while the policy is in force. Tail insurance continues your coverage even after your professional liability policy has expired, which would generally be the case when a firm is merged or sold. The prior period covered may be one, three, five or an indefinite number of years, depending on the requirements of your state’s insurance commission.
As an example, Jane sells her practice to Jeff and Mary in 2013. A year later, a previous client of Jane’s practice brings a claim against her firm for work performed in 2011. The claim would not be covered under Jeff and Mary’s current liability insurance, but it is covered by the tail insurance from Jane’s policy, even though her professional liability policy was cancelled in 2013.
The first thing to know is that it’s not necessary to buy tail insurance now if your firm is not currently involved in a merger or acquisition. It is something you must think about at the time of acquisition, however. In fact, part of your negotiation in a merger or acquisition should address whether the buyer or seller will be responsible for the coverage. Find out what level of tail coverage is offered in your professional liability coverage. Customers of Aon, which handles the AICPA Professional Liability Insurance Program, who are sole practitioners and are discontinuing practice, can vest over seven years of continuous coverage to the point where their tail coverage would be free.
Of course, as part of merger due diligence, a buyer firm should investigate past claim experience and consider what it might say about the culture, practice management approach or quality control of a merger candidate. For the seller, handling tail coverage is comparable to negotiating closing costs on a home sale. It’s not something you need to worry about while living in the home, but once you’re ready to sell, it should definitely be on your list of issues to consider.
A positive note about my caller and the sale of her practice: When we spoke, she was concerned about the cost of tail insurance, but with some digging, I found that because of her loyalty to her insurance provider, Aon, it was free. For sole practitioners there is a longevity reward of 14.5% of the cost of tail insurance for every year you are a customer of the Aon plan, up to year seven, when it is then free. How’s that for tail coverage?
If you’re facing a merger, acquisition or other firm succession-related concern, the AICPA can help. Please visit the Private Companies Practice Section Succession Planning Resource Center to find solutions to help you through your practice transition. To learn more about the AICPA Professional Liability Insurance Program, visit cpai.com or call 800.221.3023.
Mark Koziel, CPA, CGMA, Vice President, Firm Services & Global Alliances, American Institute of CPAs.
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