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Ownership issues in an appraisal firm.

Ownership issues in an appraisal firm include the legal form of ownership, the sharing of firm revenues, and policy items such as the entry of new co-owners. As is true of other types of professional organizations, questions of ownership can be important for appraisal firms. Information concerning ownership issues is not readily available in the appraisal literature, however, and is often communicated by word-of-mouth if at all.

The authors address ownership issues in the appraisal profession by analyzing the results of a questionnaire sent to a representative group of practicing appraisers. Specifically, 200 names were randomly selected from the Appraisal Institute's 1991 Directory of Members and 73 appraisers returned completed questionnaires. This represents a 36.5% response rate, considerably higher than a typical response rate for this type of survey. The selection process yielded names from all but seven states, and responses were received from 33 of the 43 states selected. As would be expected from a random sampling procedure, appraisers from larger states were more highly represented both in the initial selection and among those responding. Florida led the list with eight respondents, following by Texas with seven respondents, and California, New York, and Ohio with five each.

Characteristics of the questionnaire respondents are described in more detail in Table 1. As shown, 86% of the respondents are either sole owners or co-owners of their appraisal firms, while 22% of the combined ownership group (sole owners and co-owners) operate as co-owners. The percentage of co-owners may be understated in this case, because co-owners were asked to provide more information than those in the other ownership categories and thus may have been more reluctant to respond. The other information in Table 1 suggests no particular pattern among the three ownership categories with regard to appraisal designations, but a fairly clear distinction in other areas. In general, the non-owners are younger, have fewer years in the appraisal profession, work in a newer firm, and work in a firm with a greater number of employees.

NON-OWNER AND SOLE

OWNER RESPONSE

As noted previously, the purpose of the questionnaire was to gather data on ownership issues that affect appraisal firms. Because non-owners, sole owners, and co-owners have varying degrees of experience with such issues, respondents within each ownership category were asked questions appropriate for their categories. Co-owners were asked the greatest number of questions in recognition of their greater experience with a variety of ownership issues. A caveat was incorporated into the questionnaire to the effect that because state law varies considerably on many ownership issues, especially the liability of co-owners, the questions asked were not based on

[TABULAR DATA OMITTED]

the assumption that a particular form of ownership is best in all situations and in all areas of the country. In addition, the respondents were informed that the questions, while representative of ownership issues, were not designed to be exhaustive or necessarily significant in all ownership situations.

Of the ten respondents who indicated that they currently have no ownership position in their firms, only three indicated that they might obtain partial or full ownership in their firms at a future date. None who responded that ownership was unavailable indicated that this was a significant issue, however, which suggests that a reasonable percentage of designated appraisers are comfortable working as employees while leaving ownership responsibilities to others.

Of the 49 respondents who are sole owners of their appraisal firms, 29 (or 59%) operate as unincorporated sole proprietorships, 18 (37%) operate as regular corporations, and 2 (4%) operate as professional corporations. The fact that only a small number of sole owners operate as professional corporations is presumably a result of state law, which in most cases specifies which professions are allowed to operate as professional corporations. Eight of the respondents who operate regular corporations said that they have also elected Subchapter S status for federal income tax purposes. This election generally prevents double taxation of corporate profits if the firm operates within the requirements of Subchapter S of the federal tax code.

Reasons for the sole owner form of legal ownership are shown in Table 2. this was an open-ended question, as were the majority of questions in the full questionnaire; in other words, most of the responses in the questionnaire were not prompted. As shown in Table 2, many of the unincorporated sole proprietors indicated that "insufficient benefits to incorporate" and "convenience and simplicity" were primary reasons for not incorporating, while many of the owners operating as regular corporations indicated "tax advantages" were the primary reason for incorporating. Interestingly, "tax advantages" and "limiting liability" were offered as primary reasons for choice of ownership form by both unincorporated and incorporated sole-owner respondents.

Only 43% of the sole owners (or 20 of the 47 who responded to the question) would consider shared ownership. This percentage varies considerably according to the form of ownership--36% for unincorporated sole proprietors, 59% for regular corporation owners, and 0% for the two persons who operate their firms as professional corporations. For those sole proprietors who would consider shared ownership, the major criteria for co-ownership as well as the method of establishing a buy-in price vary considerably, as is reflected in Table 2. Further, it appears that many who would consider shared ownership have no formal procedure for admitting new co-owners or establishing a buy-in price.

CO-OWNER RESPONSE

Of the fourteen co-owners, two indicated that their co-owners are their spouses, an additional nine said that their co-owners are not spouses, and three have two co-owners. The co-owners were asked about issues (researched from the business law literature, including general business texts, state corporate law, and professional journals) that appear especially important in establishing and successfully maintaining a co-owned appraisal firm. All co-owners did not respond to all questions,

[TABULAR DATA OMITTED]

and in some instances the participants indicated that they had no experience in a question area or felt that a question was not applicable to their situations.

Co-owners considered the major advantages of co-ownership to be the ability to take time off from the business and still provide continuity of service to clients (4); 1 greater efficiency (3); opportunity for a husband and wife to work together (2); split responsibilities (1); shared experience (1); shared workload and risks (1); and a greater variety of assignments providing a broader knowledge base (1). On the other hand, when asked about the major disadvantage of co-ownership, responses included disagreements over policy issues (4); a lack of focused direction for the firm (2); the strain on the personal relationship in husband-and-wife ownership (2); a fair distribution of earnings (1); extra bookkeeping (1); problems with decentralizing operations (1); and egotism (1).

Eleven of the fourteen co-owned appraisal firms operate as regular corporations, two firms operate as partnerships, and one operates as a sole proprietor, separate in the legal sense from his partner. When asked the major advantage of incorporated ownership, limiting liability was the primary response (6); with tax advantages (2); and more flexibility in selling (1) offered as other advantages. Major disadvantages included the quantity and complexity of additional paperwork (4); additional taxes on corporate profits (2); and additional accounting and legal fees (1). The one partnership co-owner who responded to this question indicated that a partnership is an efficient means of operation for a husband-and-wife team.

The three corporate co-owners who recently incorporated said that incorporation fees ranged from $750 to $5,000, with an average of $2,250. Annual corporate legal fees for eight respondents range from $100 to $3,000, with an average of approximately $1,000 per year. While neither partnership co-owner has recent experience with the legal expenses of establishing a partnership, both partner respondents indicated that their partnerships contain a formal partnership agreement. In addition, both partnership co-owners noted that the annual legal expenses associated with their partnerships are negligible.

Twelve of the fourteen co-owners operate with proportionate (equal) ownership, while two operate with disproportionate ownership. When those with proportionate ownership were asked if this form of ownership caused any problems, three noted that issues sometimes go unresolved and two mentioned that this sometimes causes problems in terms of equating income with production. When asked how tie votes are resolved, responses included by negotiation and compromise (5); by majority rule (in one three-person firm); by a coin-flip (1); and by choice of one co-owner who reserved for himself (apparently in the original co-owner negotiations) the final say in disputed areas (1). Similar results were obtaine when the co-owners were asked how major disputes are resolved.

Salaries are determined by equalizing salaries and profits (4); basing salary entirely on the dollar amount of billigs (3); basing the full stipend on profit sharing rather than on salaries (2); basing the salary amount on billings, with an additional percentage for review work (1); splitting equally except for one person's management stipend (1); co-owner decision (1); and comparison with how and what other firms pay (1). Similarly, when profit sharing is used, it is calculated by equal distribution (8) or as a percentage of billings (2). Salary and profit-sharing disagreements are resolved by negotiation (3) and majority rule (1). It is worth noting that eight respondents volunteered that they had not experienced this type of dispute in their respective firms, which in turn suggests that a salary and profit-sharing policy is generally well-structured within the corporate bylaws or partnership agreements of most of the respondent co-owner appraisal firms and is then strictly followed.

When asked if any particular process is used to admit new co-owners into the firm, seven respondents indicated that their firms have no formal process established for this purposes. Solitary responses to this question were to set the bury-in price and make the necessary legal changes; to consider only designated appraisers and sell only a minority interest; to require the new co-owner to pay for a proportionate share of office furniture; and to ask the new co-owner to purchase stock based on the dollar amount of insurance carried by the firm. With regard to how the initial contribution of capital by the new co-owner is determined, four respondents have had no experience in this regard while two said that no capital contribution is required. Other bases for admitting a new co-owner are the estimated depreciated value of the fixed assets (exclusive of the real estate) plus the value of accounts receivable; a multiple of the prior year's earnings; an analysis of retained earnings and cash flow; the value of office furniture and equipment; and an existing insurance policy.

When asked if their firms have a formal buy-sell provision in the event of a co-owner's death, seven responded affirmatively and seven responded negatively, with two of the negative responses received from co-owners who are part of a husband-wife firm. Of the seven who operate with a buy-sell provision, six fund this agreement with life insurance so that the remaining co-owner or co-owners are not required to pay for the deceased co-owner's portion of the business out of personal funds. With regard to how the value of the co-owner's share is determined, four respondents said that the amount paid is tied to the dollar coverage provided by the life insurance policy. Other responses were to base the value of the co-owner's share on a prearranged formula or on the decision of the remaining co-owners.

In the event that one of the co-owner should wish to retire or simply leave the firm to pursue other interests, five respondents have no policy. In other cases, the buy-out agreement is invoked (3); the corporation dissolves (2); and the shares can be purchased by the remaining co-owners or any outsiders pending approval of the other co-owners (1). If one of the co-owners is affected by a permanent disability, five respondents have a stated policy and seven do not. Of the respondents with a stated policy, two said that they simply file for the disability insurance proceeds, one indicated that the disabled co-owner is required to sell his ownership to the remaining co-owners, one stated that the disabled partner would continue to receive his proportionate share of the firm's profits, and one did not elaborate on the firm's stated policy. Of the fourteen respondents, eight carry disability insurance on all the co-owners.

In two firms, a new co-owner would be required to sign a non-competition agreement if the new co-owner should voluntarily leave the firm, while nine firms did not require such an arrangement (with three not responding). Such a covenant not to compete for a specified period of time within a particular market area is fairly common in many professional fields, but apparently is not a major consideration among the surveyed co-owners. Further, when asked if any particular assets of the firm are specifically identified as such, and are not to be shared with a departing co-owner, only four responded affirmatively. Eight responded negatively, one indicated that the policy in this area is currently unresolved at his firm, and one noted that the question is not applicable in a husband-wife firm. The two respondents who identified the particular assets that are considered proprietary said that license agreements, file materials, and software are specifically restricted.

Eight firms carry errors and omissions insurance or some other form of professional liability insurance. One of the respondents elaborated by saying that at his firm it is believed that such insurance is simply a cost of doing business. Two others noted that clients increasingly require this insurance before they will negotiate a contract for services. On the other hand, one respondent felt that errors and omissions insurance is too expensive; another suggested that the coverage on a typical policy is too limited; and still another noted that, at least in his view, errors and omissions insurance invites a lawsuit.

None of the respondents to the questionnaire indicated that in their firms co-owners are required to work a minimum number of hours per week on the appraisal business, and none stated that an absence of policy in this regard causes any unusual problems. Several respondents volunteered the notion that a desire for profit keeps the co-owners motivated. Eleven of thirteen respondents indicated that co-owners in general have the same long-term goals, work ethic, and commitment. The two problems mentioned in response to this question were a divergence in long-term goals and a divergence in motivation.

When asked if any additional significant issues regarding multiple-person ownership exist that were not specifically covered in the questionnaire, two respondents mentioned the issue of how to effectively integrate family members into the firm. Another respondent pointed out that access to private financial data must be provided when new co-owners are considered, and that a subsequent loss of control must be acknowledged when new co-owners are accepted.

ADDITIONAL

CONSIDERATIONS

In the choice between partnership and corporation, liability is an especially significant issue. The questionnaire results suggest that this is a major criterion among the sole owner and co-owner respondents when choosing the legal form of ownership. Professional liability exposure can be divided into three major categories: 1) acts performed personally and by personally-supervised employees; 2) acts performed by co-owners and by employees under their supervision; and 3) general business obligations. Incorporation generally does little to diminish liability exposure when acts performed by an appraiser or by employees supervised by that appraiser are in question. Exposure in the other areas of liability, however, may be reduced by incorporation, although statutory law and judicial interpretations vary greatly from one state to another. In some cases, liability exposure laws tend to discourage co-owners from seeking assistance and support from their fellow co-owners, which works against the general intent of co-ownership.

Corporate owners often are required to sign personal guarantees in dealing with creditors, especially financial institutions, which close the gap between liability protection offered for non-corporate forms and that offered for corporate forms of ownership. In addition, legal experts are quick to point out that creditors might be able to "pierce the corporate veil" of incorporated firms to get to the owners' personal assets. This would occur primarily when a separate status has not been maintained for a corporation or when a corporation carried insufficient capital for creditors seeking redress.

Income tax consequences should also be considered when choosing a legal form of ownership. These include the tax consequences of pension plan selection as well as the tax deductibility of health insurance premiums and other fringe benefits. For these reasons, prospective owners and co-owners are advised to seek legal and tax assistance when choosing a legal form.

Many co-owner topics in the questionnaire involved the following policy issues, which in most instances are covered in the corporate bylaws or partnership agreements.

* Whether proportionate ownership is required and what happens in the event of a major co-owner dispute.

* How salaries and profit sharing are determined and how disagreements in this area are resolved.

* What process is used for admitting new owners and how a buy-in price is determined.

* What happens in the event of a co-owner's death.

* What happens if a co-owner wishes to retire or otherwise leave the firm.

* What happens in the event of a permanent disability.

* Whether a noncompetition agreement is required of new co-owners upon entry into the firm.

* What co-owned assets, if any, are not available to a departing co-owner.

Several other considerations that may be covered in the corporate bylaws or partnership agreements are the errors and omissions insurance, the minimum number of work hours, and the long-term goals of the firm. It is important to note that ownership issues not covered in the corporate bylaws or partnership agreement will be handled according to state law if the co-owners are unable to resolve the issue. Thus, an incentive exists to anticipate as many problems as possible and to explicitly address these at the inception of the firm. Most legal authorities suggest that the corporate bylaws or partnership agreement by custom designed to meet individual needs.

The following items may need to be formalized that were not specifically addressed in the questionnaire.

* How transfers of ownership interests are to be handled.

* What dollar amount of liability can be incurred by any one co-owner acting alone.

* How much time is allowed for outside activities.

* Whether an agreement should be solicited from spouses agreeing to the particulars of the co-ownership agreement.

* When binding arbitration should be used to settle major disputes and what form the binding arbitration will assume.

* What events will cause the firm to dissolve.

* What events will allow for the expulsion of a co-owner.

* What would happen in the event of multiple co-owners wishing to leave the firm at the same time.

* Which expenses are reimbursable by the firm.

* How management of the firm is to be organized and financial records maintained.

* What vacation policy should be adopted.

An especially significant item that should be added to this list is a provision for updating the corporate bylaws or partnership agreement. Obviously, needs and circumstances change over time. Co-owners need to have the option to delete, add to, or change provisions of the existing agreement. Competent legal assistance is necessary when drafting the original agreement or amending an existing one.

The results of this study suggest that ownership is relatively common among designated members of the Appraisal Institute, although some members are content to work as employees. In addition, many appraisal owners within the Appraisal Institute are not interested in co-ownership, and thus are content to avoid the additional complexities and legal expenses associated with co-ownership.

On the other hand, there are many examples of successful co-owned appraisal firms. As emphasized by the questinnaire respondents, among the advantages of co-ownership is the ability to take time off from the business and still provide clients with service continuity. In addition, co-owned appraisal firms can offer greater efficiency; split responsibilities; a greater variety of assignments; and a sharing of workload, experience, and risk. While co-ownership is not without problems, proper planning along with competent legal assistance can increase the odds of creating a successful co-owned appraisal firm.

(1) A number presented in parentheses represents the total number of respondents who provided that particular answer to the question. Generally, the responses were not prompted.

Stanley R. Adamson, PhD, is assistant professor of finance and general business at Southwest Missouri State University in Springfield, Missouri. He received his MA and PhD from the Wharton School of Business, University of Pennsylvania, and his BBA and MBA from East Texas State University. He is a licensed real estate broker in Texas and was formerly president of Adamson-Barker Real Estate, Inc., in Greenville, Texas.

Robert W. Owens, MAI, PhD, is associate professor of finance and general business at Southwest Missouri State University. He received a PhD from the University of Washington. Mr. Owens was a fee appraiser for five years at Brooks, Lomax & Fletcher, Inc., in Albuquerque. New Mexico.
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Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Author:Adamson, Stanley R.; Owens, Robert W.
Publication:Appraisal Journal
Date:Apr 1, 1992
Words:3467
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