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What is claw back?

It’s vital that you understand this important concept when it comes to buying or selling an accountancy practice.

Virtually all practices being sold will have a claw back clause in the Sale Agreement, which is a risk-sharing agreement between buyer and seller. It protects the buyer if clients leave during a specified period (usually the first year) with the result that the business is not worth its selling price.

When a practice is sold, a percentage (usually 50% for micro-practices) is paid up front, then the remaining 50% is paid a year later. In some deals payment is made in three instalments: one third upfront, one third on the first anniversary of the sale and the final tranche on the second anniversary.

If the vendor is selling for, say, £100,000 in a one-year agreement, at a multiple of once times, he will receive £50,000 (£50k x 1.0) on completion and the other £50,000 a year later.

If some clients leave in the first year and the fees retained on the first anniversary are, say, just £90,000 then the new owner can net off this shortfall and pay a lower second instalment of £40,000. In the case of a claimed shortfall, the vendor has the right of discovery‚ the right to look at the files, before he agrees to the lower second payment.

The definition of a shortfall is when, at the end of the warranty period, the fees which were sold and purchased have not materialised, and are not likely to materialise – then a shortfall has occurred. This takes into account a situation where, say, a client has not made his books available so that the work can be undertaken.

Often the two parties will agree that if a client indicates that he is going to move on to another accountant, the purchaser will tell the seller so that he, the seller, might try to recover the situation ‚ the logic being that there is no point in the clients fee being lost to both parties.

Although it sometimes happens that the new owner will find that, at the end of the first year, he has billed more fees than he purchased, for the same work undertaken for the same clients, the seller cannot normally claim a claw-forward. After all, the new owner has bought the goodwill which entitles him to benefit from any increase in business.

It makes sense for the seller to sell the aggregate sum of the fees sold i.e. £100,000 not the individual clients‚ that way there is an automatic trade off between clients who have contracted with the new accountant or been lost, with those clients that have expanded and given rise to more fees being billed to the same clients. New clients do not go into the kitty for the purposes of calculating the claw back. After all, new clients will have joined the firm as a result of the goodwill already purchased.

The vendor can limit his potential loss to a certain extent, by adding a clause in the contract to say the new owner will not raise fees by more than an agreed percentage during the warranty period.

Legal advice should be considered before entering into a Sale Agreement, especially where a claw back clause is included. It is in the best interests of the new owner to have the longest claw back period possible, while it is in the best interests of the seller to have the shortest.

Any fees that were lost during the first year are normally deducted pound-for-pound (times the multiple). As it is a sellers market, the seller will not normally agree to the claw back operating over the second and subsequent years. But nothing is written in tablets of stone.

It is normally written into the Sale Agreement that if the new owner wishes to make a claim under the claw back clause, he must inform the seller in writing of an intended claim before the first anniversary. Then the seller will then have the right of discovery to satisfy himself that this is a fair claim.

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