Common Misconceptions about Selling an Accounting Firm
A decade or so ago, when private home prices were going through the roof, I was struck by the ideas that average home owners had as to the market value of their homes.
They were very much aware of the rising values of real estate, although in most cases they had an inflated idea of the value of their own home. Is the same true of accountants when they enter the market to sell their practice?
“If it’s your property, there’s some tendency to over-inflate its value,” said Tom Jones, a shareholder/partner and chair of the Atlanta Corporate Team at Chamberlain Hrdlicka.
Selling an accounting practice is a once-in-a-lifetime experience for most practice owners. There is much time, energy and money invested in an accounting practice, so finding the right buyer is crucial. Since it is such a rare event, sellers should be educated about some of the key misconceptions about the process.
Although many owners have a misconception about the value of their business, the usual value is a multiple of gross revenue, according to Jones, who has structured many accounting practice sales and mergers.
“If it’s a true sale as opposed to a merger of equals, the pricing that’s discussed is usually 1 to 1.2 times gross revenues,” he said. “That’s not always true, however. You might have two firms of approximately equal size that decide to combine operations. In that case there may not be any money changing hands at all. The more disparity of size, the more there will be an exchange of value in the transaction.”
Another misconception is in the area of noncompete agreements, observed Jones. An important point to consider is how to hold together an organization, he noted. “How do you maintain the personnel that have come into the buyer organization, and how do you make sure that they don’t decide to take their files and go home and do something else?” he asked. “The misconception is that noncompete agreements are not enforceable and therefore not necessarily appropriate or effective in the context of these transactions.”
“The reality is that noncompete agreements are enforceable,” he said. “Many states have enacted statutes that make them more enforceable than they have been historically, so they are tools that can be used in buying an accounting practice or any other service business where there is a need to preserve the value of what is being purchased. Basically, the buyer is purchasing client relationships with the seller that they are trying to incorporate into the buyer’s practice. They’re really buying the people and hopefully the right and the opportunity to service their clients. One way to deal with that is though a noncompete agreement that ensures that workers that leave won’t be competing or taking away clients for some time after the transaction.”
In the past, an overly broad noncompete agreement might be struck down in its entirety by the courts. However, a number of states will now “blue pencil” an agreement to make it enforceable.
“It used to be that if you got greedy and made an over-expansive noncompete agreement, the court would throw it out and you would get no protection at all,” said Jones. “Now, in many states the court will reduce the covenant’s scope to a reasonable’ level and enforce it.”
For example, he said, the noncompete agreement might say that an accountant who leaves cannot practice in the Southeast for a period of 10 years. Rather than throw out the agreement, the court might reduce it to a few states or counties, for a period of two or three years.
Another misconception is that you don’t need a “de-merger” clause when questions arise about how a deal will work, Jones noted. “On the front end of a merger, how things will work out with personalities, compatibility of systems, and other things that might cause problems is unknown,” he said. “What if you get six months into a deal and it becomes apparent that the transaction was a mistake? In some instances the contract will have a clause to de-merge. But how do you unravel the transaction? The misconception is that you don’t need a de-merger clause, and the parties think they can unilaterally elect to de-merge.
One more misconception is the idea that a lawyer isn’t necessary in a sale or merger of accounting practices, Jones said.
“In any business sales transaction there are traps for the unwary,” he said. “The bulk of the transaction agreement constitutes representations and warranties and related indemnification provisions. These go on for page after page, and tend to take up a large portion of the acquisition agreement. Generally, the seller is making a long list of representations regarding the practice, including warranties regarding financial and legal status, employment law aspects, and tax compliance issues, to name a few. Every component and facet of the seller’s business is portrayed in the form of representations and warranties in the agreement. “
“Perhaps the most critical of the warranties are the financial warranties,” he said. “You tell me what your assets and liabilities are, your historical income and expense, and that paints a financial picture of the practice. So if you say you average $2 million in revenue over the past five years, but it’s really only $1.5 million, you have misrepresented the financial condition, and the buyer will have certain rights and remedies. A lawyer can help in determining what are the appropriate warranties, how the buyer keeps from breaching one or more of the warranties, and how you make a warranty that won’t result in having to refund a part of the purchase price later on.”