IMGCAP(1)]In 2015, by some accounts there were just over 100 CPA firm mergers and acquisitions—a large number of which were consummated by the 2015 Accounting Today Top 100 Firms.
In January 2016 alone, there already have been announcements of 22 mergers and acquisitions, including 13 of the 2015 Accounting Today Top 100 Firms as summarized below:
• BDO (#7) (Chicago) merges in Feeley & Driscoll (Boston)
• CBIZ (#9) (Cleveland) merges in Millimaki Eggert (San Diego)
• CliftonLarsonAllen (#10) (Minneapolis) merges in:
o Four Point Partners (Edina)
o Guthoff Mehall Allen (Bloomington)
o Komisar Brady (Milwaukee)
o Galanti (Dunwoody)
• Dixon Hughes Goodman (#17) (Charlotte) merges in Stegman (Baltimore)
• Friedman (#44) (New York) merges in Shectman Marks Devor (Philadelphia)
• O’Connor Davies (#30) (New York) merges in Flackman, Goodman & Potter (Ridgewood)
• Warren Averett (#27) (Birmingham) merges in Jinks + Moody (Panama City)
• Wipfli (#21) (Milwaukee) merges in Steinberg Advisors (Northbrook)
• WithumSmith+Brown (#32) (Princeton) merges in:
o Averett Warmus Durkee (Orlando)
o The Mironov Group (Edison)
If this pace continues, we can expect to see over 260 CPA firm mergers and acquisitions in 2016 with about 150 with Top 100 firms. That’s more than twice 2015!
Based on our personal interactions, more than one out of every two CPA firms of any significant size is either discussing a merger combination, acquisition or sale or is planning to do so in the near future.
Let’s take a hard look at why “merger fever” is at a frenzied pace and the Top 100 firms continue to get bigger, stronger and more profitable. Consider the following:
• The economy is not robust. Clients aren’t growing. They aren’t in need of CPA services beyond compliance services. Net profits per partner are not as healthy as they were in circa 2006-2007. Average collected rate per hour at many firms is down 10 to 15 percent because of the mix of services and predatory pricing. Makes for a difficult challenge when it comes to monetizing the value of the firm and paying out distributions of deferred compensation/retirement plans.
• Partner demographics are an inverse pyramid; top heavy with baby boomers and lean with “under 40” partners.
• Firms do not have enough rainmakers and business people.
• Partner level talent, particularly tax talent, is nearly impossible to find and marquee clients are demanding higher quality services.
So here is the question we ask you to ask yourself and your partners: Is it time for your firm to carefully evaluate an alternative path to a go it alone strategy? If your answer to this question is yes, in our opinion, take a hard look at an upward merger, particularly if you aspire to become a mid-market sustainable brand. Here is a brief overview of what you need to know.
To be clear, an acquisition is buying a client list from retiring partners. This happens when a small CPA firm has the capacity to handle more clients but has not been able to grow organically. Thus, acquiring a practice from retiring partners makes a lot of business sense. Acquisitions also occur if a CPA firm is seeking to add advisory or consulting skills and credentials. There are many boutique consulting firms that want to bolt onto a mid-market sustainable brand to accelerate their growth and monetize, at least in part, the asset they created by getting acquired.
On the other hand, a merger combination is as much the addition of accounting/tax talent as it is the addition of clients. A merger combination makes sense when the combined firm potentially becomes stronger in talent bench strength, marquee clients and revenue base. The two typical valuation components in most CPA firm merger combinations are capital and goodwill.
Capital is straightforward: it is the firm’s accrual-based capital adjusted for the fair market value of fixed assets, work in process, receivable reserves and other liabilities. It is generally paid as cash or a note (in some cases the note bears interest) over a relatively short term—usually upon retirement.
The second component is goodwill. Goodwill values have trended downward since the financial crisis of 2007. Goodwill is almost always expressed as a multiple of revenues; the generally accepted value of goodwill in the “old” days (circa 2001 to 2007) was one times revenue. The bad news is that current CPA firm valuations now average about 80 percent of revenue plus accrual-based capital. For firms with less than $20 million in revenue, goodwill value is often below 80 percent of revenue. Clearly, one times revenue is gone. Some of the Next Six have a valuation cap (3½ times average partner compensation over the last two or three years).
There are many other considerations, including compensation guarantees, vesting schedules for age and years of service, death and disability provisions, mandatory retirement ages, post-retirement employment, and retirement payment caps (generally 8 to 10 percent) to protect the CPA firm.
That’s a quick overview. A word of caution, however: we implore you—no matter how tempting it may be—don’t do a merger combination if 1 + 1 doesn’t at least equal 3. Accretion to your partners usually takes place in the third year post-merger—maybe two if things fall into place quickly. If you don’t sense that this will be the case with the transaction you are exploring, pass on the opportunity. It isn’t right for your firm. There will be others.
So if now isn’t the time for your firm to consider an alternate path to a go it alone strategy, when is? Don’t wait until the last inning when your key partners are nearing retirement. As long as the economy stays anemic and your clients aren’t demanding an awful lot of advisory or consulting services from you, valuations aren’t going to get better in the immediate future. When you are ready, we suggest retaining an advisor who can run an auction on your behalf. It is a valuable technique for advice and guidelines on firm identification, deal point negotiations and process.
Dom Esposito, CPA, is the CEO of ESPOSITO CEO2CEO, LLC. Dom, voted as one of the most influential people in the profession for two consecutive years by Accounting Today, authored a book, published by
