Small Firms: Think Big!

EXECUTIVE SUMMARY

THE SARBANES-OXLEY ACT HAS CREATED new requirements for public companies, spurring greater demand for professional services and for a range of engagements that offer opportunities to well-positioned smaller firms. ONE RESULT IS A CHAIN REACTION in which the big firms are going to focus on certain services and push the rest down to midsize firms. They in turn will push down work to smaller firms. SINCE THE ACT PREVENTS AUDITORS from helping their public-company clients with much of the compliance work, there is an opportunity for the “second CPA firm” to perform internal control testing and review internal control systems. In addition, there will be increased demand for business valuation and tax work. THE FIRMS BEST ABLE TO CAPITALIZE on these prospects are those in or with access to cities that are home to a number of public companies. They should determine which public companies are nearby and what services they might need, and which large audit firms in the area might be seeking second CPA firms—both midsize and smaller firms—to whom they can refer some projects. IN MANY CASES CPAs WILL HAVE only to reorient their practices or expand their knowledge and then create a marketing strategy to get some of this work. CPAs SHOULD BE AWARE that professionals in other fields are offering services such as internal audit engagements. Smaller firms planning to seek such engagements may have to invest in staff training and marketing.

ANITA DENNIS is a JofA contributing editor and freelance business writer.

or small firms there has never been a better time in the history of the profession to grow a practice,” says Richard Caturano, CPA, president of Vitale, Caturano & Co. in Boston, “because the Sarbanes-Oxley Act has created new requirements for public companies.” That has spurred demand for professional services mandated by the act and for a range of engagements that audit firms now either cannot or choose not to take on themselves for their own audit clients. Because of the volume and variety of work needed, a well-positioned smaller firm has an excellent chance to offer its own expertise in numerous areas and thus become what is being labeled a “second CPA firm.”

This article reviews what kinds of engagements smaller firms can pick up from larger firms (also see “ Section 404 Opens A Door, ” JofA , May04, page 55) and describes marketing strategies that can enable such firms to position themselves for growth.

Source: Survey of 136 CFOs and managing directors of U.S.-based multinational companies, PricewaterhouseCoopers’ Management Barometer, www.barometersurveys.com , July 2003.

A RANGE OF POSSIBILITIES
Section 404 of Sarbanes-Oxley focuses on companies’ internal controls and financial reporting procedures. Since auditors cannot help their clients with much of the compliance work the act requires, there is an obvious engagement opportunity for the second CPA firm to perform internal control testing and reviewing.

Not only does this present a new practice opportunity, but it also is a “way to balance your workload because this work can be done in nonpeak times,” says David Morgan, CPA, comanaging partner of Lattimore Black Morgan & Cain in Nashville. “Our audit staff is looking at a busier spring and summer than we’ve had in a long time.” Similarly, Caturano reports this year, for the first time in its history, his firm is fully booked for the summer.

While internal-control-related engagements might be best-suited for firms with 20 or more professionals, that’s not the end of the story. There are numerous other services auditors may not be allowed to offer because of the act’s restrictions or that large firms may choose to forgo.

Audit workpaper preparation. For their public-company clients, audit firms can no longer develop certain workpapers, such as cash reconciliations, intercompany account reconciliations or depreciation schedules, so smaller firms may be called upon to pitch in. “It really adds up to offering accounting assistance to companies because their auditors can’t help them in these areas anymore,” Morgan says.

Caturano reports his firm recently had an engagement in which it worked on a business’s intercompany account reconciliations. “In the past members of that company’s audit team might have spent two months doing these reconciliations because the client didn’t have the staff to do it,” he says. “Now the auditor can’t do it any longer and the company doesn’t want to hire a staff person to take it on,” so the second CPA firm can make a pitch for the work.

Business valuation. Many public companies will need valuations as a result of FASB Statements no. 141, Business Combinations, and no. 142, Goodwill and Other Intangible Assets. In other cases companies will need services involving intercompany transfer pricing for their international affiliates. Businesses also still require valuations for other reasons—for estate tax purposes or in litigation services engagements, for example. Again, under the act, the auditor can’t do any of this work. As a result smaller firms with valuation practices are in an excellent position to tap this market.

Tax. If companies decide they would prefer not to have their audit firms perform tax work for their executives, Morgan says, that will create an opportunity for any firm with a strong background in tax-return preparation and knowledge of taxation of stock options and related executive compensation issues.

“A lot of smaller firms have very strong individual tax practices and already work with executives on their personal tax returns,” Caturano says, which enables them to provide valuable expertise to companies seeking alternative providers.

Corporate tax accruals are another area of opportunity. Morgan’s firm has been engaged by large corporations to perform their tax accruals because their auditors are reluctant to take on this work due to uncertainties about the act’s intentions in this area. “A lot of the smaller public clients don’t have the capability to do this work in-house,” Caturano says, “and many smaller CPA firms have the expertise to perform it for them.”

Marketing Strategies: Two Firms’ Tips Take a closer look. When Vitale, Caturano & Co. decided to position itself to tap the market for engagements auditors could no longer offer, it began with a list of public companies in its area. Firm members set up meetings with two groups from the local offices of national firms: the managing partners and partners who had public-company clients. “We told them we were expanding our capabilities, described our skills and services and said we were hoping to take on some of the added work that would arise because of the changes Sarbanes-Oxley has made,” says Richard Caturano, firm president. The firm then followed up this effort with a direct-marketing campaign to company CEOs and CFOs. Key company contacts received a pair of binoculars imprinted with the firm’s logo. A cover letter introduced Vitale, Caturano and its services, and urged the recipient to “take a closer look at us. We got a tremendous response,” Caturano says. Educate existing and potential clients. David Morgan at Lattimore Black Morgan & Cain suggests scanning the firm’s client list to see whether there are CEOs or CFOs among its tax clients. “That makes it very easy to approach those companies” to offer expanded services, he says. His firm also sponsors seminars for CFOs and other financial professionals on how Sarbanes-Oxley might affect their companies. At the first one, “we expected 20 to 30 people, and 120 showed up.” Although most corporations now are familiar with the act, new accounting and PCAOB rules offer the firm ongoing chances to provide information updates, he says.

THE CHAIN REACTION
In addition to creating more opportunities in specialized areas for smaller CPA firms, Sarbanes-Oxley also has generated greater demand for services overall. Because the act added new layers of audit and reporting requirements for public companies, the auditor’s work has expanded. That development combined with consolidation among the larger firms means those national practices may no longer be able to or may choose not to serve some existing clients.

“The national firms realize they have to do a lot more work on public-company audits than they had in the past,” Morgan notes. “Next year, for example, they will have to report on their systems of internal controls. The act also has moved up the reporting deadlines, so they have to get more work done in a shorter period. If they are using all their resources on these tasks for public-company clients, they may decide they are not able to service nonpublic clients.” (The full text of the act along with a summary of its provisions and other resources are available at the AICPA’s Sarbanes-Oxley Act/PCAOB Implementation Central at http://cpcaf.aicpa.org/Resources/Sarbanes+Oxley/The+Changing
+Regulatory+Landscape.htm .)

That’s good news for smaller firms. “The work is moving downstream at a tremendous rate,” Caturano says. But will middle-market firms be the only beneficiaries if national firms shed some clients? Caturano doesn’t think so. “The big firms are going to focus on services that will make money for them and push the rest down to midsize firms. They in turn will push down work that is not essential to them to smaller firms.” A midsize firm might, for example, give up hundreds of individual tax or small business clients because the partners decide they need to pay more attention to their larger corporate clients. “The small firms can really benefit if they have the right expertise,” he says.

CREATING A MARKETING STRATEGY
Caturano and Morgan agree that the firms best able to capitalize on these prospects are those in or near cities that are home to a number of public companies. How can these firms position themselves to take advantage of these opportunities? The first step would be a two-pronged research project to determine

Which public companies are nearby and what services they may need that their audit firms no longer will provide.

Which large audit firms in the area may be seeking other CPA firms to whom they can refer some projects.

Armed with a better sense of the market, the potential second CPA firm will decide what to focus on—whether that means services directly mandated by the act, engagements auditors can no longer offer or services for smaller clients larger firms may be shedding. The firm then must assess whether it has adequate expertise and resources to take on the new engagements (see “ Tips for the Sarbanes-Oxley Learning Curve ”). If not, it may be necessary to add more staff, as Caturano’s firm has done, taking on nine former national firm partners. Similarly, Morgan’s firm brought in auditors who could address internal audit issues to complement its existing staff, whose experience with audits was more financial-statement-oriented.

“When you hire new experts, they create marketing opportunities,” says Caturano. “We brought in a specialist on transfer pricing from a larger firm. We already had an existing business valuation practice, but having this specialist has given us added credibility in that area.”

In many cases CPAs will have only to reorient their practices or expand their knowledge. For example, “many small firms do business valuation engagements that involve obtaining a value for an entire company,” Morgan says. “Now they may be asked to value intangibles only” under the new FASB standards. In that case practitioners will need to acquire an understanding of the standards and their implementation in order to enter this new market but won’t need to add personnel.

Finally, in forming a marketing strategy, CPAs should be aware that professionals in other fields are offering services geared to complying with the act’s provisions. “This market is not exclusive to CPAs,” Morgan says. For example, he notes, the staffing service Robert Half places temporary workers with companies to complete specific projects related to Sarbanes-Oxley requirements, while Robert Half’s Protiviti subsidiary and Jefferson Wells both offer internal-audit-outsourcing services.

PRACTICAL TIPS TO REMEMBER

These new practice opportunities will be a way to balance a firm’s workload because they can be done during nonpeak times. Small firms with strong form 1040 practices should scan their individual client list to discover public-company CEOs and CFOs who might want to use the firm’s services in other areas. In forming a marketing strategy, CPAs should be aware that professionals in other fields will compete with them to offer services to public companies.

SOMETHING FOR EVERYONE
“Sarbanes-Oxley has created practice opportunities that are available to every firm that is in a major market,” Caturano says. To take advantage of them, however, firms likely will have to make an investment—either in people, office tools, software, training and marketing or some or all of these, Morgan says. Such an investment does pay off, say Morgan and Caturano, who report their practices have grown sharply in the past year due to their efforts to capitalize on opportunities created by the act (see “ Marketing Strategies: Two Firms’ Tips ”).

“Both companies and their auditors have work they need done. It’s just a matter of educating the people in your market about your own capabilities,” says Morgan. “There’s potentially something in this for everybody.”

RESOURCES

Publications
Financial Reporting Alert, Internal Control Reporting—Implementing Sarbanes-Oxley Section 404 (# 029200JA).

The Team Approach to Tax, Financial & Estate Planning by Lance Wallach (# 017235JA).

Conference
National Advanced Accounting and Auditing Technical Symposium (NAAATS)
July 21–23
Hilton La Jolla Torrey Pines
La Jolla, California

For more information, to place an order or to register, go to www.cpa2biz.com or call the Institute at 888-777-7077.