January 03, 2024
Quite often partnerships show partners’ capital accounts as holding significant sums of money. For example we recently had a firm where the partners had capital accounts with £150,000 each in and the partners were firmly of the opinion that if they were to sell the practice then the practice would be worth at least the value of the capital account. A capital account is usually a positive balance in the accounts and it is there to show what money the partners could have taken at some stage but chose not to, or an amount they have put into the business at the outset. This is quite a simplification of what is a much more complex accounting principle, but the very quick answer to the question as to whether your practice is worth what the capital account is holding is that no it is not.
Show me the money
The only way your firm is worth the figures in the capital account is if there is something on the other side of the balance sheet showing why the practice is worth the sums in the capital account. So for example, if your practice owns premises worth £400,000 and each partner has a capital account showing £200,000, then a buyer can immediately see that the capital account reflects an amount of the assets in the business.
Profits long gone
However, very often the capital account will show a balance based on profits that could have been taken in years gone by but left in the business by the partners for tax purposes or for investment in the business, but now on the balance sheet there is no sign of any assets counteracting the capital account. This means that although in theory the capital account holds money owing to the partners, there is no way for the partners to extract that out of the business unless somebody gives them hard cash when they make the purchase. This is unlikely to happen if a buyer can not see assets to realise or a significant amount of potential in the business to justify paying the partners capital accounts.
Difficult concept
It is a very hard concept to explain to partners because in their minds they see their value in the business as being the amounts in the capital accounts, and these are of course figures that have been prepared by their accountant.
Unfortunately buyers don’t see it in the same way and capital account figures are very rarely worth the paper they are written on simply because there is no evidence for them being realisable by the partners.
Our usual advice regarding your capital account is to speak to your accountants and clarify exactly what figure is in the capital account and for what reason. However based on our experience of law firm sales, if your firm has a capital account balance then when you come to sell your business it is important to discount this completely, unless you own something that is reflected in the accounts and shows evidence that the amounts can be realised. It is very rare to see the latter and so the general advice has to be that the capital account figure is unlikely to reflect the value of the business.
Valuation
How you value your business is a completely different matter entirely and is why we offer paid valuation services to our accountancy and law firm clients. There are a large number of different factors to take into consideration.
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