ARE YOU READY
FOR A MERGER?
WHY ARE THERE SO MANY MORE MERGERS TODAY?
WHO REAPS THE BENEFITS OF THESE MERGERS?
DOES MERGER MAKES SENSE FOR YOU?
HOW DO YOU VALUE YOUR
ACCOUNTING PRACTICE?
ARE YOU READY
FOR A MERGER?
How can you have your cake and eat it too?
How can you work fewer hours and make more money?
How can you do more of the work you like and less of the work you dislike?
How can you assure yourself a secure payout and the option of part timer work on retirement?
For accountants across the
Mergers do everything except cure baldness. They are the classic Win-Win for the accounting profession.
This article summarizes the main benefits for mergerees, intelligent approaches to practice evaluation for mergers, successful alternative structures for mergers, and some of the more subtle aspects of this “Key to the Kingdom”.
WHY ARE THERE SO MANY MORE MERGERS TODAY AND WHO REAPS THE BENEFITS?
DIVISION
OF LABOR.
1. Do you do
audits? Not-For-Profits? Business Management?
SEC work? Investment Advisory Services? Financial Planning? Mass Market tax returns? Hi-net worth individuals? Foreign nationals? United States Citizens
working overseas? Foreign companies doing business in the
2. Are your actual hours limited Partner level work? some Senior Manager Level work? some Junior Work? Who empties the trash can and does the copying?
You make yourself (and the merged firm) the most money by doing what you know the best and let someone else take out the garbage and collate the 1040s. Merger provides the culture in which you can do that. Each of your staff can become more efficient and make more money for themselves as part of a well run merged practice. It does not take a genius to figure this out. But it may take a genius to put together the right people and on the right terms.
TECHNOLOGY
Selecting and using the best computer programs and the fastest easy to use equipment will allow you to maintain your fees but work so much more efficiently that your hourly rate will skyrocket. It can also make your staff produce so much more work product in a shorter time to that you can either save on labor cost or excise the dead wood from your staff, as the weakest employees truly become excess baggage.
The larger merged firm can afford IT personnel and the cash cost for acquiring and utilizing new technology and to have the in-house expertise to both manage your own technology and service your clients technology.
The larger merged firm should also provide the wider expertise you can use to bring in new business to replace some revenues which may be lost as the clients themselves pick up some of the drudge-work, traditional functions of an accountant which will ultimately disappear as clients use their own computers to ready their books and records for your review.
NICHE DEVELOPMENT
Accounting firms must develop niches. Quickbooks and cheap 1040 programs have eclipsed the typical accounting practice of 1963. Now, accountants sell expertise, not elbow grease. And the most profitable expertise is found in Niches. Niches can be anything from Focus Reports for Broker Dealers, to expertise in financial services arena, IT departments, Litigation Support and back office work for Not-for-Profits, or a myriad of other specialties.
Accounting firms can choose between training and certifying their own members in these fields or bringing in pre-trained new members through merger or acquisition.
FINDING AND
RETAINING COMPETENT STAFF.
It is easier to find competent staff now than it was 5 years
ago, when Arthur Anderson and the others were offering Rin-Tin-Tin
$45,000 a year right out of
SECURING YOUR SUCCESSION.
The truth is that there are FAR fewer competent 30-40 year old CPAs than there were 30 years ago. Why is that? It seems that most bright and articulate accountants told their children to go into law or finance and not work as hard as their parent. The result is a shortage of successors for accounting practices. The solution is technology and staff leverage though merger so that fewer competent partners will be able to handle the clients, sustain the practice and pay off the retiring “senior partners”. Those retirement age partners may also prefer to work part time, and be much appreciated for it. Using this strategy the “BABY BOOMERS” will get to realize the value they have built in their practices, in spite of the lack of established internal succession.
CONSOLIDATION
The other way to solve the problems above is to find “Big Brother” and sell to a Consolidator, like American Express, HRB, etc. For the moment the bloom has been off this rose, but sales to Consolidators may some day become an option again. In any case, Consolidators taught the accounting firms a valuable lesson about the power and influence they have with their clients. One of the major goals of the Consolidation movement was to establish cross-selling opportunities. Win-Win mergers capitalize on cross-selling lesson and enjoy its profits.
DOES MERGER MAKE
SENSE FOR YOU?
That depends. Check out the options below and see if you can find an application to your own situation:
Yes, there is definitely a merger for you. You are a person with high ability and ambition, a commodity in today’s market where competent professionals are in short supply. Many good quality firms will bring you in, so long as they have the resources to maintain your clients in case you change your mind. Often your comp can be supplemented with a long-term pre-retirement payout so that you can have your cake and eat it too.
II. “I AM 1-6 YEARS AWAY FROM EVEN REDUCING MY ROLE.”
You are the hot commodity. In today’s accounting world, many top quality accountants have risen to the top of their firms and maintain the loyalty of their existing clients. However, many never developed “business getting” ability. If you possess the ability to bring in business, then you provide what most firms lack. The merged firm will reward your ability and also give you generous payouts and compensation for full and part time work as you train their personnel to transition your clients. Often the senior partners have rainmaking skills, but the next generation within the firm does not. As a result, your clients will help the firm expand the practices of this generation. That is why a present-time merger prior to retirement facilitates the smooth transition. It takes time to acclimate clients to your successors. Since accounting practice sales always factor in retention, it is essential to plan for client transition. Starting this process sooner than later makes everybody money.
III. LARGER FIRMS CAN BE MORE PROFITABLE AND
MORE SECURE.
If you have staff at all levels, you can have juniors grind out the grunt work and Managers perform the high end work. Then you can charge the big bucks. When the high hourly rated staff do the photocopying, you end up with write-downs. You can also handle more clients with fewer partners when you have the competent staff to leverage the Partner’s billable time. You can afford to hire better staff and your firm will be appealing to staff when you are that large. The larger firm can also afford the infrastructure and offer the profitable services available to maximize the profits for client work. Once you have a sufficient client and staff base, litigation support and business advisory services can add immensely to the bottom line.
Your payout security is increased because the large, profitable firm can afford to buy out its retiring partners and has the next generation built in to take over. Adding niches, increasing the talent pool, creating additional back up and support are some of the obvious advantages of merging to create a larger firm. Others include spreading the risk of lost clients and potentially opening another geographic marketplace by retaining additional offices derived from mergers. Size is no barrier to personal service. That always depends upon the partner in charge, whether at a large or a small firm.
IV. HOW DO I KNOW WHEN I
FIND THE RIGHT FIRM?
First, you will calculate the increased profit. Next, you will evaluate the synergies. It will be easy to compute the overhead reduction you will enjoy as a result of erasing cost redundancies.
But for once, you will ultimately relax and trust your gut. The final test is the “Personal Chemistry Test.” Do you look forward to going to lunch with these partners? Would you like to use their professional experience as you wrestle with a tax or accounting matter, or solve a practice management issue?
Once you have determined that the economics are a “No-Brainer”, put your calculator aside and go to your gut. Ultimately, your question is CHEMISTRY. If you are satisfied, you will also satisfy your staff and clients.
HOW DO YOU VALUE YOUR
ACCOUNTING PRACTICE?
The Wise Guy answer is “You don’t value a practice. The Market does.”
The Cop-out answer is to use a “Rule of Thumb” (like a 1X multiple). Let others hang by their thumbs. You can use your brain.
The real answer takes some real thinking. Your Practice is worth the profits your buyer can make from it.
Ironically, it is NOT your profits that determine your practice’s value. It is the profits of your successor. This is true for strangers or for internal successors. Your payout will be a portion of those profits.
For example, the typical practice with the highest value per dollar or revenue is also the smallest practice. It is a $50,000 tax practice run by a “tax preparer” from his basement, using the cheapest software, and selling to a replica practitioner, who also runs his practice from his basement. In such case the Seller nets 90% of his gross. The buyer will net 98% of the added gross because the buyer’s labor, rent, software etc. will remain the same. He will pay out a few more dollars for stamps, phone calls, and ink. This buyer can pay you a 2.0X multiple over 4 years and still realize a whopping 50% profit on your practice while doing so.
The lowest valued practice in one for which you perform at the highest level of expertise and then sell to a successor who must hire your replacement at a price equal to your own compensation. Then there will be nothing left over to pay you.
SIZE MATTERS Typically a larger firm pays a lower the multiple than a smaller one, because it has non-partner overhead that reduces how much is “left over” from any dollar that is received. However, 2 other factors give the larger firm a greater ability to pay: (1) It can pay over a longer period of time since its size gives it longer term credibility so that even if it will pay a smaller annual percentage, it may make that up by paying for more years. Typically, larger firm payouts continue for longer periods than smaller firms. (2) Some larger firms can add clients so efficiently that the additional cost for such clients is nil. For example, it may add high end tax work to an existing infrastructure of expertise and software so that the profit on the additional work is enormous. On the other hand, it the firm adds a $100,000 audit, it may need to devote $70,000 in “time” to complete the work. Before you go to step 2 with a firm, you must make sure you are not “putting a square peg in a round hole.” The economics must work before you start with the Chemistry.
INTERNAL SALES are intrinsically different from external sales and are priced generally lower. 1. Gone are some of the uncertainties which cause discounts. The Seller takes less of risk and will usually ask a lower price because of it. The buyer takes a smaller risk and therefore will usually “lock” the price earlier. As a result, many internal sales are not even based on a multiple of billings but based on the retiring partners past compensation, which often is the historical net, net profit.
As in external sales, the internal successor always asks the question: “What profit will I make from bukying/succeeding to this practice.” If the successor can increase his net while paying out the retiring partner, then the deal works. At a minimum, the cost of replacing the labor of the retiring partner plus his retirement payout must be less than what the retiring partner makes. A growing problem we have seen today are younger partners of firms calling to complain they must abandon the firm that groomed them as successors because the buyouts for the senior partners are so excessive that the successor partners are compelled to take pay cuts to make the payments.
EXTERNAL SALES for practices are typically discussed as a multiple of billings. But there is absolutely NO magic to a “multiple” The multiple varies from deal to deal. Why? Because the multiple is only the effect of the calculation of profits. Price and terms are best analyzed in terms of 5 variables which are always present and a few which are often a consideration.
Cash Upfront. 75% of accounting transactions have cash advanced at closing. Once in a blue moon, Sellers will take a huge discount for an all cash deal, but most buyers will run like wind when a seller will take a 50% discount for cash. They figure the practice must be truly bogus to take a 50% hit day one.
Retention Period. Most practices are priced at a percentage of collections and the longer the payout, the higher price they get for the practice. Buying accountants prize certainty. Most are willing to pay a high price for a practice as long as they pay out of profits. They are risk averse in the true sense, but are generous with profits. Retention deals guarantee their safety.
Profitability. Price is determined by the net profit a successor will realize. Profitability is often reflected by billing rates and it will be critical to determine which personnel in the successor firm will do the work, the type of work, the growth potential, and tax ramifications of payouts.
Duration of the Payout Period is the fourth critical variable. For example, most firms would prefer to pay 20% of collections for 7 years, rather than them the much lower “Multiple” of 33 1/3 % for 3 years.
Multiple is the 5th element and has psychological as wells as economic import, but can only be measured in the context of the 4 other variables. The Multiple will be higher with (1) a longer the payout period; (2) a longer retention period; (3) greater profitability; and (4) the less cash upfront. There are no hard and fast methods of saying “if a firm does $X volume and nets $Y, what is it worth?” How these 5 critical variables interact will ultimately determine your value.
Compensation for Continuing Service from Selling Partner. To the extent that a partner in an external sale or merger continue to work and draw compensation, it takes on characteristics of a merger. To the extent a merger covers payouts, it takes on characteristics of a sale.
Many other Facets Staffing, assets, leases, cross selling opportunities and many others items will be contributing factors to the valuation process as well.
1. Straight Collections: The seller receives a percentage of collections from the buyer over a number of years from the original clients transferred.
2. Fixed Price Based upon Short Retention Period: Purchase Price is fixed based upon collections from retained clients during a finite initial period.
3. Fixed Purchase Prices: (Rare as Hen’s teeth). Paid in one lump sum or over time. It requires a great discount from the Seller and why should he give it? Most often seen in an internal deal where the senior partner is bought out by a staff which is 100% dependent upon his largess.
MERGER STRUCTURE:
1. Mergers include all aspects of the sale, including buy out provisions for retirement, death, disability, and ear termination.
2. Equity Issues. There are no hard and fast rules. Often it makes little economic difference since compensation, retirement, and control are often treated without respect to equity. Most commonly, each partner’s equity is calculated based on his book of business. Only when the profit distribution, decision making and buyout compensation is based on equity is equity critical.
3. Merger Issues: equity and what it means, profit distribution, compensation for partners, roles, titles, names of firm, staff impact, the treatment of accounts receivable and WIP, type of entity used, partnership or other entity agreement covering the key issues and defining disability (permanent and temporary), expulsion, retirement, death, decision making, and de-merger. Many firms plan heavily and attempt to cover every facet of a merger based on it working and invest little to no time for a contingency if it fails. Having a prenuptial agreement or de-merger method is an important consideration.
IN SUMMARY: This article identifies some important details of accounting mergers. There are no easy GAAP regs, rules of thumb or simple formulas. Each firm is unique and your terms will also need to be sculpted to your situation and goals. What to review in due diligence, the proper transition, treatment of staff, when to start the process, documentation of the deal are more questions you will answer as you enter the process.