What's behind the recent explosion of mergers and acquisitions in the accounting profession? The answer is self-evident.Mergers and acquisitions are the most efficient way to achieve a number of universal goals, including implementing an exit strategy; creating buy-in and buy-out opportunities; increasing the value of a practice through business development; increasing cash flow, economies of scale and profitability; gaining market share; adding new services and geographic markets; acquiring and attracting professional talent; and attracting superior clients.
An acquisition strategy
The first step in the merger or acquisition of a CPA firm is to determine the appropriate exit strategy, based on the partners' goals and objectives.
Sellers are in the driver's seat. They can structure transactions to meet each of their expectations. The following is a list of a few scenarios based on specific exit strategies.
1. Acquisition: Selling 100 percent of the equity, with an exit strategy targeted between three and five years.
2. Buy-in: Selling less than 100 percent equity interest (usually less than a majority) to a partner for long-term growth, with an eventual exit strategy of five to 10 years.
3. Buy-out: Selling out one or more of the retiring partners' interests while the others remain with the firm. The retiring partners' exit strategy is within one to two years.
4. Merger: Two firms joining resources, not necessarily exchanging any cash, and redistributing equity for long-term growth and market share. These transactions usually represent long-term exit strategies.
5. Smaller firms buying larger firms. When no junior partners exist (or qualify) to succeed the existing partners, having a smaller firm (with its own book of business) buy into a practice provides a long-term exit strategy, along with cash flow. This strategy allows the larger firm to maintain control over its practice while grooming a successor.
6. Larger firms buying smaller firms: In this instance, the larger firm almost always purchases 100 percent of the equity. A payout structure that includes sharing in the upside of any growth is usually part of the deal, with an exit strategy that can be either long- or short-term. In either instance, the selling partners are trading resources and an exit strategy for control over their firm.
It is common knowledge that CPA firms are valued at a multiple of their gross revenue. The method used to determine this multiple is the market approach. Key performance indicators and financial ratios are analyzed and ranked based on comparisons among firms of similar size, type and location.
These are also the variables that prospective buyers analyze in determining the compatibility and attractiveness of a merger/acquisition candidate:
Quality of clients: The probability of client retention based on an uninterrupted revenue stream and the ability to charge higher fees and offer more services.
Scope of services offered: The depth and breadth of the services offered by the firm. Firms require both a broad spectrum of services and niche markets.
Quality of staff: The expertise, experience, loyalty and client relationships, in addition to the quantity and quality of billable work performed by the staff.
Performance ratios: Productivity, realization and effective billing rates.
Profitability of firm: A trend analysis over five years compares revenue growth, fee structures, overhead costs, owners' compensation and benefits, staff expenses, and rent with similar firms and common size ratios.
If comparisons of local firms are not available, many industry studies are available based on surveys of CPA firms nationwide and actual accounting firm sales. In either case, the onus is on the seller to rate themselves in each of these areas to determine whether the overall value of their firm is at, or above, market value. Our experience over the past 10 years has yielded multiples ranging from one times gross revenue (minimum market value for a firm that is not in distress) to 1.5 times revenue, with an average of 1.2.
Sellers must present their practice in a clear, concise and concrete manner. This information should be organized into a practice profile and an executive summary. The profile defines and analyzes the seller's revenue by type of service as a percentage of total revenue, by type of tax return, by frequency of services, by fees per service (both hourly and fee-based), by niche markets, by clients (personal versus business) and by the overall breakdown between tax, accounting, consulting and financial services.
A practice profile should include the following: the location of business and clients; the firm's fee structure; computers; itemized services by revenue, and average income; the number of clients per service; annual revenue over the past five years; the number of employees, their compensation and billings; opportunities; and the sale terms.
Discreetly, these documents can be made available to pre-qualified candidates without revealing the company's identity.
Using multiple resources such as proprietary databases (lists that may be purchased), the Internet, newspapers, trade magazines and various national publications such as The Wall Street Journal, sellers can advertise their practices anonymously by preparing an anonymous executive summary (one page, with six paragraphs) that contains:
The firm mission: Your signature philosophy and objective;
Your scope of services;
Your client base: Highlights of individual and business clients (who they are, and of what size and type);
Your reputation: What you're known for in the community and among your peers;
Your history: The firm's inception and partnership evolution; and,
Your associates: Highlights of their credentials and expertise.
Economies of scale
Economies of scale are dollar savings realized when two businesses are combined by the elimination of duplicate expenses and the spreading of fixed costs over a larger revenue base. Mergers and acquisitions yield significant economies of scale, increasing profitability considerably. This is particularly evident when two or more locations are combined.
Yet even when an acquisition or merger does not result in the combination of locations, many economies of scale are realized. These savings are often large enough to cover the debt service required by either the seller or a lending institution. Expenses with the largest savings include rent, utilities, advertising, insurance, salaries and software subscriptions.
Financing the transaction
CPA acquisitions are easy to finance. Banks love lending to CPA firms, as long as a personal guarantee is provided, even up to 100 percent. Nonetheless, the majority of transactions include a down-payment, some or all seller financing, or some or all bank financing.
In the case of bank financing, the onus is on the seller to demonstrate that they have a viable business with excess cash flow to support the new debt. The buyer must demonstrate that they are creditworthy and experienced.
The following documents quantify and document the deal's efficacy:
* The combined financial statements of the two practices, deducting the cost savings from realizing the economies of scale;
* Monthly cash flow projections for the following 12 months based on the combined financial statements and economies of scale;
* A schedule of assets and liabilities itemizing the collateral available for use in obtaining financing;
* An acquisition analysis documenting the return on investment; and,
* A cash flow analysis determining the viability of the debt service and the remaining "cash-throw-off."
Letter of intent issues
A critical component of the transaction is a non-binding letter of intent outlining the offer and detailing the core aspects of the entire transaction. The most important issues are negotiated in the letter of intent. This process culminates with a deposit held in escrow establishing the buyer's commitment prior to due diligence.
The purchase and sale agreement is the legal interpretation and detail that support this agreement. The following items are negotiated: the purchase price; assets to be sold; the down-payment; the adjustment period; the liabilities assumed; terms and interest rates; adjustments to the purchase price; non-compete agreements; due diligence; employment; allocation of the purchase price; and any specific agreements.
Preparing for due diligence
Due diligence is a vital step in the transaction process. In addition to verifying income and expenses, every service, client (and their files), employee and tax return must be quantified, analyzed and verified.
This process usually takes anywhere from one to five days. The best advice here is to perform a "mock" due diligence analysis before proceeding with any buyers. Skeletons need to be flushed out by the seller, not the buyer. Specific items to be reviewed include client lists and billings; client files and workpapers; work in process and accounts receivable; deposits and bank statements; employee salaries, benefits and agreements; financial statements and tax filings; revenue by service, by month and by year; overhead and profit; and the owners' income and perks.
Legal agreements and documents
Depending upon the type of transaction, the following is a list of some of the important legal documents required in an M&A transaction:
Confidentiality agreements: These define information that is confidential and specifies an agreement between the parties on how this information is to be used and disclosed.
Asset purchase agreements (or stock purchase agreements): These describe and convey the intangible and tangible assets being sold with the necessary warranties and representations specific to the sale of the assets of an accounting practice.
Partnership, operating or shareholders' agreements: These describe the duties and responsibilities of the partners/shareholders and how the partnership/corporation/LLC is to be operated and managed.
Buy-sell agreements: These describe how possible future events relating to buy-sell, death and disability issues will be handled procedurally, legally and financially.
Restrictive covenants: These are agreements whereby the seller agrees not to compete with the buyers for a specified period of time, in a specific geographic location, or for specific types of services.
Exhibits: These schedules detail the clients, revenues, assets, liabilities, accounts receivable, work in process and any other equity items that may or may not be part of the deal.
Each transaction is different, and requires specific contracts, agreements and documentation that must be carefully orchestrated. This means not relying exclusively on attorneys. The parties to the transaction must stay proactively involved in each step of the process.
The following documents are typical, but tailored, to each transaction: the purchase and sale agreement; the settlement statement; UCC filings; an employment agreement; non-compete agreements; promissory notes; work in progress/receivables; a corporate resolution; the bill of sale; pro-rations; exhibits; and lease assignments.
This is one of the most important aspects of the transaction, yet it is often overlooked until after the closing - when it is too late. Critical issues regarding each party's responsibilities on a day-to-day basis, in addition to the dozens of logistical changes that are required after a merger or acquisition, must be addressed.
Often, the success of a transaction hinges on the successful planning and execution of transition issues. Among the issues to be considered are:
* Office, legal, licensure and employee logistics;
* Methods for assuring maximum client retention;
* The seller's compensation and job description;
* Who's the boss?
* Referral fees;
* Client introductions;
* A letter introducing the new owners;
* Conflict resolution; and,
* Technology issues.
Cindy Ragan and Larry Wald are the co-owners of Strategic Alliance Funding & Equity, a Fort Lauderdale, Fla.-based management-consulting firm that specializes in mergers and acquisitions of CPA firms. Jay N. Nisberg Ph.D., is president of Ridgefield, Conn.-based Jay Nisberg & Associates Ltd. and a leading consultant to the accounting profession.
Letters may be sent to: Editor, Accounting Today, 1 State Street Plaza, New York, N.Y. 10004, or by e-mail to AcToday@sourcemedia.com. Accounting Today reserves the right to edit all submissions.
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