EXECUTIVE
SUMMARY |
BUSINESS VALUATION (BV),
SUCCESSION PLANNING and
buy-sell agreements help CPAs prepare a
foundation for selling a practice, but the
final price of a firm will be affected
dramatically by the transaction terms.
TO SET A FINAL PRICE,
CPAs SHOULD review the
interrelationship of five key variables:
the down payment at closing; the length
of the payout period on the balance due;
the profitability of the deal; the
duration of the postclosing retention
period with adjustments for lost
clients; and the multiple (preferred
price based on a multiple of the gross
billings).
CLIENTS THAT OFFER
CROSS-SELLING opportunities,
that are growing and fertile referral
sources or that have young ownership
will add value to the practice. Aging,
slow-paying, underbilled clients will
hurt value—as will liability issues such
as exposure to malpractice claims.
A SUCCESSOR PERFORMING
DUE DILIGENCE prior to
acquiring a firm may examine not just
what services clients get, but also
those which they do not. If the seller
has a niche the buyer doesn’t have or
the successor firm has a niche the
seller didn’t offer, the framework to
develop additional revenues quickly may
be in place.
SOME FIRMS TRY TO OBTAIN
ACQUISITIONS that will get
them into new geographic territories.
Acquiring a practice is often the most
cost-effective way of creating another
office in a new location.
PRIOR TO CLOSING, BUYER
AND SELLER must focus on what
to do to make clients and staff
comfortable, what roles to take and what
message to send out to the public. The
best deals are those where everyone
prospers—sellers, buyers and clients.
| JOEL
SINKIN, president of J. Sinkin Consulting
in Hauppauge, New York,
www.jsinkinconsulting.com, which deals
exclusively with mergers and acquisitions
of accounting practices, has consulted on
650 accounting firm closings and
succession plans. Sinkin teaches
succession planning CPE for state and
national accounting associations,
including the AICPA, and has published
books and articles nationally. His e-mail
address is
joel@jsinkinconsulting.com .
|
ou’ve worked hard for many years to
build equity in your practice. Now you want to
sell. Business valuation (BV) and practice
succession procedures will help you prepare your
practice or share of it for acquisition, but
arriving at a final price for your equity will
depend, in part, on the art of the deal. Because
price differs from value ,
what your business is worth to a “willing buyer”
once the process of negotiation gets under way can
be affected dramatically by the transaction terms.
The factors include the amount of cash exchanged
at closing, the deal structure, the seller’s
financing and the presence of collateral and a
security agreement. If you’re a practitioner
thinking of selling a practice, here are important
points to consider when working out the details.
PRICING AN UNDER-$1-MILLION PRACTICE
The first step for
any CPA who wants to sell a practice is to obtain
a complete business valuation from an impartial,
qualified valuator such as a CPA/ABV. (For more
information see “ First, Get
Organized ,” and “ Have
a Fallback Plan, ” JofA , Sep.03,
page 57.) It’s equally important to look at the
sale from the buyer’s viewpoint.
Negotiating the price of a practice with less
than $1 million in annual revenues for an external
sale comes down to five critical variables, so
start the process by reviewing them. No one of
them dictates the final amount, but the
interrelationship of those important elements
ultimately will help determine the price.
First
, Get Organized
I f you’re preparing to
divest your practice, analyze its value
carefully. What is the firm’s reputation?
What types of services do you offer? Who
are your key employees? Will staff likely
stay with the practice through a
transition? Are noncompete agreements in
place? What are the practice’s
specialties, rates and write-downs,
profitability, location and lease terms?
Make a complete inventory of client
profiles to help negotiate a fair value.
John Eads, author of Practice
Continuation Agreements,
published by the AICPA in 1992,
also recommends CPAs compile, in
columnar schedule form, the following
information on each client:
Name, affiliates and
subsidiaries.
Description of business.
Client location.
Names and ages of
principals and their equity percentages.
Corporate structure and
vulnerability to loss of key executive.
Period of time as client.
How client was obtained.
Type and frequency of
services rendered.
Function and number of
employees needed to handle the account.
Description of client’s
accounting and management systems.
Average fees paid in the
past three to five years for regular and
special services.
Number of company and
personal tax returns prepared for
principals and others.
Potential for a fee
increase.
Direct costs of servicing
clients.
Adequacy of client
workpapers and records.
Method of setting fees.
Unusual service problems.
Staff problems with
clients, if any. A “practice is
worth no less than normalized cash
collected on clients for the 12 months
previous,” says Eads, who defines
“normalized” as ongoing and subtracts
nonrecurring business. Source:
Practice Continuation Agreements:
A Practice Survival Kit, by John
Eads, AICPA, 1992.
|
Down payment at closing.
The first variable is the size of
the down payment, if any. When there is cash up
front, the seller is financing only part of the
transaction and therefore assumes less risk,
making a lower price more appealing. However, not
all deals offer cash up front, and the amount of
cash is itself affected by many items. The
time of year tied into the short-term cash-flow
projections of the practice may have a significant
impact. Clearly a buyer acquiring a practice that
generates 75% or more of its income in the first
four months of the year will want to put less cash
down if the closing occurs in May than in
December. How you treat the accounts
receivable and work in process (WIP) also affects
this variable. If you’re selling a practice with a
significant amount of receivables and WIP and want
those funds from the first postclosing dollars
collected, you’re asking the buyer to invest
significant capital to pay the overhead and
operate the practice for months before starting to
participate in cash flow. The buyer therefore will
want to pay less up-front cash. In many
transactions, payout periods are worked out on the
receivables and WIP, thus creating more room for a
larger down payment to the seller.
Sometimes purchases are structured as a
collection or “earn-out” deal in which the
up-front money is treated as an advance against
future collections rather than as a down payment.
For example, a buyer may offer you an advance
against future collections plus 25% of all fees
collected from the original clients above the
advance over the next five years. A buyer may
offer a seller a $50,000 advance at closing but
request it be credited against the first dollars
due the seller; or $40,000 credited back over the
first two years; or $30,000 credited back over the
first three years. If the advance is credited
against the first dollars due, it likely will be
higher than if it is credited over the entire
payout period. Other factors may include assets
and liabilities that come with the deal.
In one satisfactory collection/earn-out sale of
a $500,000 compilation/tax-oriented practice, the
buyer paid the seller $50,000 at closing. The
balance due was based on 25% of collections
received by the buyer from the seller’s original
client base for the following six years, less the
first $25,000 the seller would have been entitled
to in years one and two. In addition, the deal was
structured to provide the successor firm a current
deduction, and it included all the nonpersonal
furniture, fixtures and equipment the practice
used and reasonable transitional assistance from
the seller (a personal introduction to the
clients, reasonable phone availability to the
buyer and former clients and an orientation to the
files).
The length of the payout period on the
balance due. This is a basic
cash-flow variable. If a buyer has a longer period
of time to pay off the purchase, the annual
payments will be lower, thus enhancing the buyer’s
cash flow. Some sellers allow payout periods as
long as 15 years, but some insist on being paid in
full at the time of closing. Most deals in the
under-$1 million size range have three- to
seven-year payout periods.
The profitability of the deal.
Some sources suggest it isn’t a
seller’s profitability that’s important in pricing
a practice but the successor’s profitability in
the deal. Take the following example: The owner of
a $200,000 CPA firm operates from home, handles
all the work personally and nets 80% of revenues.
A year later he moves into an office, hires staff
and nets 40%. At which time was the practice worth
more to a buyer? The answer lies in the
profitability of the deal for the buyer. If a
buyer is able to acquire a practice with little to
no incremental increase in overhead, he or she can
afford to pay a premium for the practice. If,
however, the acquisition requires retaining an
additional location and extra staff, the business
will be less profitable and the buyer will pay
less. Other factors may affect
profitability. A key concern is the tax treatment
of the payments from buyer to seller. If you (the
seller) want 100% goodwill in a deal and a payout
period of five years, the profit goes down
considerably for the buyer who must deduct those
payments over a 15-year period. Conversely, if you
accept all or some of the purchase price in a form
that provides the buyer a current deduction, the
profitability of the deal increases—and so does
the purchase price. Billing rates, how clients are
serviced, by which level staff, whether work is
mailed in or clients are visited are among the
other factors that affect profitability.
The duration of the postclosing
retention period and adjustments for lost
clients. This variable deals
with the time frame in which to adjust the balance
due for clients who leave the firm after it is
sold. Retention periods (or guarantee periods)
typically range from one year to the entire
duration of the payout, though some deals have no
retention period. If a deal is based on
collections or an earn-out arrangement, the
retention period typically is the payout period.
Several factors determine the length of the
retention period. If a practice has predominantly
annual clients, a one-year retention period may be
risky for the acquirer since it allows for only
one CPA visit to each client, barely enough for a
solid relationship to “take.” A two-year retention
period enables buyers to truly evaluate whether
they’ve kept the clients. Some sellers
fear long-term retention periods. Many deals I
have structured use a “stepped” retention period,
with an additional time frame that permits
purchase-price adjustments for clients lost not to
another local accountant but because the client no
longer needs a local accountant at all. That helps
protect buyers from paying for clients who die,
close or sell their businesses, or relocate.
You and the buyer also must understand what a
retention clause guarantees. Some retention
periods are based simply on clients’ staying with
the firm. However, most retention terms guarantee
the actual amounts to be collected from clients
over a specific time frame. In some deals a seller
participates in fee increases, at least for a
continuation of services that were provided in the
past. The parties must specify how fee increases
will be calculated during the retention period.
This is reassuring for sellers who make
collections deals since it is unfair to suggest
you participate only in losses and never in gains.
Some deals cap a seller’s participation in fee
increases.
Price/revenue multiple.
When asked what they think their
accounting practices are worth, most CPAs
typically expect to sell for a price based on a
multiple of the gross billings. For example, if
you have a practice that generates $500,000 in
billings, you may want a 1.25X multiple, or
$625,000. If a deal includes an adjustment
mechanism for gains or losses of clients or fees,
that figure may vary. A multiple is not an
appropriate target because it is the effect of the
first four variables. This is based on the
following formula: The lower the cash up front,
the longer the retention and payout period—and the
more profitably the deal is structured for the
buyer, the higher the multiple. (Of course, the
opposite is true, too.) To better illustrate this
point, here’s an example of a sale based on the
following assumptions:
The practice generates only $200,000
in revenues.
The acquirer can absorb this practice
into a current infrastructure without any
additional costs in labor, rent, staffing or other
overhead.
The seller participates in increases
in fees during the retention period. Given
those elements, if you were to ask for 17.5% of
collections from original clients for 10 years,
with no cash down, structured in a manner that
provides the buyer a current deduction, most
buyers would enthusiastically accept the deal
despite the fact that the multiple is 1.75X. The
current value of the practice has little to do
with the potential price if one premise is that
you (the seller) will participate in fee increases
(which may be more profitable than any interest
factor). Alternatively, if you want a
$40,000 down payment at closing, the balance in
five years, a locked purchase price after the
second year following the closing, payments
structured as 50% capital gains and 50% to provide
the buyer a current deduction, the purchase-price
multiple could drop to a range between 1.25X and
1.50X. If you insist on all cash at
closing, all capital gains and, obviously, no
retention or payout period, very few buyers would
even consider the deal at 1X. Those
examples aren’t exact, since an actual transaction
would involve additional information not described
here. The intent is to demonstrate how the most
attractive deal price may not be an absolute
multiple, but rather a package that makes sense
after you and a buyer review the interaction of
the variables. Other factors—such as types of
clients, billing rates, firm assets and
liabilities and qualities unique to your
practice—have a bearing on the end price, too. For
example, clients that offer cross-selling
opportunities, that are growing and fertile
referral sources or that have young ownership will
add value. Aging, slow-paying clients billed at
discounts will hurt value, as will liability
issues such as exposure to malpractice claims.
NEGOTIATE A LARGE-FIRM PRICE
To determine an external sale price for
firms with more than $1 million in annual
revenues, the above variables play a role, as do
others such as
Types of clients and services.
Most large CPA firms today have
focused on adding consulting to the services they
traditionally provide. Certain clients by nature
are better prospects for cross-selling additional
services to generate new revenues for the firm.
Many times a successor practice performing due
diligence prior to acquiring a larger firm
examines not just what services clients get, but
also what they do not. If you have a niche the
buyer doesn’t have or the successor firm has a
niche you didn’t offer, the framework to quickly
develop additional revenues may be in place.
Understanding the client base may reveal a great
deal about how much in new receipts might be
possible.
Staff. Many larger firms
seek to acquire other practices to increase their
talent base. The trend toward fewer new accounting
graduates going into public practice has increased
the value of exceptional talent, sources say,
whether it’s to add a niche or grow the firm’s
depth.
New marketplaces. Some
larger firms seek acquisition partners to help
them branch into new geographic areas. Acquiring a
practice is often the most cost-effective way of
creating another office in a new location.
Absorptive capacity. It’s
a misconception of some CPAs that small firms are
worth lower multiples than large firms. For a $6
million practice the most likely buyer will be an
even larger firm, but few can absorb an entity of
such size without incurring significant
incremental increases in overhead (space, rent,
labor, insurance). Also, many larger firms net
less per client and struggle to maintain the
one-third operational ratio: one-third labor,
one-third overhead and one-third profit. A firm
netting 30% won’t be in a position to give up 25%
of collections for many years. Larger practices
typically sell for lower multiples with smaller
payouts over longer periods than small firms do,
although there always are exceptions.
RESOURCES
| AICPA
Resources |
Publications
AICPA Code of
Professional Conduct,
www.aicpa.org/about/code/index.htm
.
AICPA Statement
on Standards for Consulting
Services no. 1, Consulting
Services: Definitions and
Standards (# 055015JA).
Management of
an Accounting Practice
Handbook, loose-leaf
version (# 090407JA); e-MAP,
electronic version (#
MAP-XXJA).
Practice
Continuation Agreements: A
Practice Survival Kit
by John A. Eads (#
090210JA). For more
information, to make a
purchase or to register, go to
www.cpa2biz.com or call the
Institute at 888-777-7077.
| Web sites
http://bvfls.aicpa.org .
Business Valuation and Forensic
& Litigation Services Member
Section.
http://bvfls.aicpa.org/Community/Find+an+ABV.htm
. To find an Accredited in
Business Valuation holder.
| |
NEGOTIATE AN INTERNAL SALE
If you’re a retiring principal, your most
likely buyers are your existing partners, and the
price will generally be lower than in an external
sale. Still, the variables that influence an
external sale also apply, with a few additional
considerations. Many firms have capital accounts,
and how the payback of those accounts is
structured, along with accounts receivable and WIP
at the time a partner leaves, plays a significant
role in shaping final terms. In many cases the
partnership agreement provides a buyout framework.
Some agreements have vesting periods that pay more
the longer the partner is with the firm.
Pay attention to
Buyout agreements. We live
in a constantly changing business environment, and
terms worked out 10 years ago may not achieve the
win-win goal for all today. Make sure all
principals have reviewed and updated the
partnership-buyout agreement. This should be done
at least once a year (see “
Pass the Baton Without Missing a Beat, ”
JofA , Mar.02, page 43, and “ Make
the Most of Buy-Sell Agreements, ” JofA
, Oct.04, page 37). A good buyout deal
compensates you (the retiring partner) well for
your years of sweat equity while enabling
surviving partners to enjoy additional income.
Note: Every buyout agreement should
include disaster contingency language to protect
the practice’s cash flow and extend the payout
period in case of calamity (see “
The Best-Laid Plans ,” JofA ,
May04, page 46).
Pricing a partner’s equity.
You and your partners should review
the total compensation you take from the firm,
inclusive of all payments for draw, profits, perks
and benefits. From this sum the firm should
subtract the costs of replacing you. The
difference, if everything else remains stable, is
the additional cash flow available to the firm
upon your retirement. This should provide a
starting point for calculating a price, since the
parties will need to agree on what percentage of
the additional cash flow will go to each party and
for how long.
Formulas. Many partnership
agreements pay retiring partners based on a
multiple of billings of the firm multiplied by the
retiring person’s equity. Another method becoming
popular bases retirement dollars on recent income.
Firms take an average of the retiring partner’s
last three years of income, apply a multiple such
as 2X and pay it over a period of seven years, for
example.
Penalty buyouts. More and
more practices include multiple buyout formulas in
partnership agreements. Retiring partners who are
vested, provide ample notice and assist in the
transition get the maximum price; those who don’t
are penalized with lower prices or longer
retention guarantees to protect the firm’s
survival.
Retention period. Many
internal-sale agreements specify a short client
retention period—or none at all—because the firm
expects to go on with minimal change. However,
when the retiring partner provides little notice
or is the main or only contact for certain
clients, keeping those clients isn’t a given. If
you allow ample time for a careful transition, a
retention period may be less critical. An orderly
retirement transition may require as much as 10
years, some sources say.
Insurance buyouts. Most
firms’ partnership agreements include buyout
formulas that address partners’ potential death or
permanent disability, usually through insurance.
Many firms now have partners take out personal
insurance policies and compensate them to offset
the cost and lower the buyout, which results in a
more favorable tax treatment all around.
Company-paid insurance policies traditionally
either become the buyout vehicle or are credited
toward it. If the latter, payments due a former
partner’s estate may need to be deferred to give
the firm time to get back on a strong footing as
it recovers from the loss. Partners should check
insurance policy terms yearly to ensure they keep
up with current equity value. |
PRACTICAL TIPS TO
REMEMBER
| |
CPAs should look at
the sale of their practices from
the buyer’s viewpoint, too.
A buyer acquiring
a practice that generates 75%
or more of its income in the
first four months of the year
should put less cash down in
May than in December.
Pay attention to
the successor’s profitability
in the deal, which is more
important in determining a
price than the seller’s
profitability.
Selling CPAs
should give buyers a longer
period of time to pay the
balance so annual payments can
be lower, thus enhancing the
buyer’s cash flow.
Sellers that tie
payment terms to client
collections should participate
in gains as well as losses.
CPAs should make
sure all principals review and
update a partnership-buyout
agreement at least once a
year.
A buyout
agreement should have disaster
contingency language so that
if a calamity befalls the
practice, cash flow is
protected and the payout
period is extended while the
firm recovers.
| |
VALUE IS WHERE YOU FIND IT
There’s an unproven theory that audits and
general business work are worth more than tax
work. In truth, though, while individual tax
clients are more transient in nature than business
clients, they often are superior from hourly
billing rate, profitability, liability and
collection-headache perspectives. With a two-year
minimum retention period guarantee, there’s no
reason why a tax practice should be less valuable
than an audit practice. In fact, firms that offer
financial services view individual tax clients as
a fertile market for niche services and covet them
over audit clients. Low interest rates
have encouraged many recent buyers to borrow the
money to make a large down payment and thereby
reduce the practice price. There are arguments on
both sides of this issue, but if a buyer can lower
the price while retaining the clients, the
profitability of the acquisition may rise.
In valuing a firm, remember that assets can
include space at a great value, name recognition
and—a growing consideration—Web sites and
databases. Technology may add value, too. For
example, a recent merger between two large firms
was partially based on the fact that one lagged in
its technology. With several partners nearing
retirement, the chance to get a return on their
investment by upgrading was limited. The firm
chose to merge with a larger one that was already
there from a technology standpoint. And
finally, prior to closing on the sale of an
accounting practice, seller and buyer must focus
on what they need to do to make clients and staff
comfortable, what roles they need to take and what
message to send out to the public. The best deals
are those in which all parties—sellers, buyers and
clients—prosper. |