Fueled by the combination of aging partners who are sliding closer to retirement and the ongoing hunt for qualified staff, the accounting profession stands on the precipice of a major surge in mergers and acquisitions.According to Marc Rosenberg, CPA and president of The Rosenberg Associates, a consultancy in Wilmette, Ill., there has been a 30 percent reduction in accounting graduates from 1996 to 2000. "Although this has reversed somewhat, it has not improved to anywhere near the level that many think," he said. "In fact, statistics from the American Institute of CPAs' annual study of accounting firm graduates from 2001 through 2004 show that accounting graduates nationwide increased 8.9 percent. That's only 3 percent a year."
And all of this comes at a time when demand for CPA firm services has been as strong as it's ever been.
Clearly, said Rosenberg, there are thousands of firms, including sole practitioners, that have no exit strategy except to merge upwards into a larger firm. "These firms don't have the staff coming up the ranks who have the 'right stuff' to buy them out. Tens of thousands of young collegians who graduated from the mid-1990s through 2000 would have been up for partner or knocking at the door had they majored in accounting."
And all of this comes at a time when demand for CPA firm services has been as strong as it's ever been.
Clearly, said Rosenberg, there are thousands of firms, including sole practitioners, that have no exit strategy except to merge upwards into a larger firm. "These firms don't have the staff coming up the ranks who have the 'right stuff' to buy them out. Tens of thousands of young collegians who graduated from the mid-1990s through 2000 would have been up for partner or knocking at the door had they majored in accounting.".5 million and .5 million in annual revenue, you will see many of these firms merge during the next few years.
* Firms would like to maintain their position in the Top 100; however, with a difference of approximately million separating No. 76 from No. 100, it will be impossible for some of these firms to maintain their status with just organic growth. Therefore, many of these firms are identifying solid merger candidates as part of their expansion strategy.
Gallagher added, "I wouldn't be surprised if two large California firms don't merge to create an million firm in the next few years ... I would project two Top 25 firms will merge in 2007."IGNITE THE URGE TO MERGE
The Sarbanes-Oxley Act is one of the primary sparks igniting the surge in the demand for CPA industry services. Rosenberg pointed out that because SOX has essentially caused the Big Four and other top firms to focus on their huge public clients, these large firms in turn have ignored smaller clients. As a result, there's been a tremendous trickle-down effect of SOX in the CPA profession.
Allan Koltin, CPA, president and chief executive of Chicago-based consultancy PDI Global Inc., said that the Big Four have in essence migrated to become auditors of Fortune 500 companies, as well as specialists in SOX - and the entire balance of the food chain has moved downstream.
"This has caused an enormous transformation within our profession, as the Big Four have culled out their smaller clients and have passed them on to the mega-regional and middle-market nationals," he said. "In turn, the mega-regional and middle-market nationals have begun passing clients on to larger and midsized local firms, who now are passing some of their smaller clients to smaller local and sole practitioner firms."
Koltin believes that this transformation will continue to take place for the next two or three years, or until SOX diminishes in scope and the Big Four begin the process of retreating once again to the middle market. "Once they move into the middle market, it will set off a string of events that will once again transform the landscape of the profession for all the other firms," Koltin said.
WHAT'S THE MARKET?
Rosenberg feels that with the need for thousands of firms to look for upward mergers, sooner or later what has always been a seller's market will become a buyer's market. "We say seller's market because up until now, any firm that has been moderately successful without any skeletons in the closet, could, in a heartbeat, find a number of firms interested in merging them in. This situation primarily characterizes what has taken place in the top 50 or 100 cities in the country. In rural markets where buyers are few in number, obviously, finding a buyer is more difficult. And this problem, of course, becomes exceedingly tough the larger the seller is."
Today, Rosenberg said that if a firm in a top 100-population city announces that it is looking to merge in smaller firms, it's relatively difficult to do.
"Sellers know where to look but aren't particularly receptive to responding to overtures from large firms that they don't know," he continued. "But within the next five years, there will be so many firms looking to merge up that larger firms will have a field day getting the pick of the litter, so to speak."
Moreover, he added that firms that today would be snapped up in seconds, might find themselves fifth or even tenth on buyers' lists in the future. He added that obviously this has to lead to a reduction in the sale price that the smaller firms can command.
"Virtually every firm I work with these days is addressing succession planning and exit strategy," he said. "This compares to three years ago, when perhaps only 5 percent to 10 percent of my clients were addressing it."
PDI's Koltin said that in terms of M&A activity, he has never seen it running as fast as it is currently: "Over the past year, I have been involved in numerous discussions with Top 100 firms on the acquiring side, and these firms have been very aggressive in the mergers and acquisitions market. I believe we will continue to see this taking place for the next couple of years. Most firms today that are between $2 million and $10 million have a complicated choice to make, and that is whether they want to grow organically to get to the next level, or simply merge upstream and use someone else's playbook to achieve their goals."
Koltin added that, interestingly enough, more than 80 percent of the mergers that he has been involved with on a facilitating basis do not actually happen - usually, he noted, for the right reasons. "Those reasons typically are culture, financial terms, and then something as basic as firm name. However, I think we will continue to see more and more mergers taking place within our profession, and not just with the Top 100 firms, but also with firms that are between $10 and $20 million, who want to get to the next level and will become quite active in merging in firms with $2 million to $5 million in fees."
Koltin added that he is seeing fewer of the consolidator roll-ups (as in years past) but two - UHY Advisors and CBiz - continue to be extremely active in the M&A market. "Both are able to structure cash deals, which does give them a unique advantage in the marketplace. With the exception of those two firms, essentially all of the other Top 100 firms I work with are, for the most part, doing straight mergers with no cash exchanging hands at closing."
Gary Shamis, managing partner of Ohio-based SS&G Financial Services, remarked that in terms of what we are seeing in the marketplace, it's equal to or greater than the consolidation imprint of a few years ago. "Every firm seems to be entertaining a roll-up or merger of equals anywhere and at all levels. Pressure is coming from the inability of smaller firms to become competitive because of the breadth of services that clients are now demanding. Simply put, smaller firms need to offer more."
Shamis pointed out that there is an increased level of specialized tax service, such as with state and local taxes. "We are always running into issues that have some kind of state and local tax twists."
He feels that the international market is one area that is growing rapidly, affecting all sizes of firms, but as to financial planning services, he maintains that the smaller firms are more affected by the Baby Boomers. "Financial planning doesn't really apply to my firm, as 95 percent of our own business is on the corporate side. However, we do have a very thriving investment company."
Chris Frederiksen, CPA, a Mill Valley, Calif.-based consultant to CPA firms worldwide, said that global firms do not seem as active in the merger market as domestic practices. "There's a lot of activity among the regional firms - they are actively acquiring to get regional coverage and specialty coverage and to get scale. I have a particular interest in smaller firms and that's where I am seeing lots of activity," he said.
Frederiksen noted that the profession is aging, and it has been suggested that the average age of a CPA firm owner is over 50. "This would in turn suggest that there should be many practitioners coming up for retirement. To some extent, this is happening, although it appears that a lot of CPAs are opting to work longer. It has also been well-documented that there have been fewer young people entering the profession, and the No. 1 concern of firms is lack of 'quality staff.' With more owners reaching retirement age and fewer young people coming up in the profession, one might expect the number of sellers to exceed the number of buyers. The laws of economics would then dictate that prices should decline. But the opposite is happening. I am seeing smaller practices changing hands at up to 1.3 times retained fees, and sometimes more."
Several of the reasons for that higher valuation that Frederiksen noted include:
* Acquiring firms usually have adopted the latest technology (paperless, workflow, document management) and are highly efficient. They can bring that efficiency to bear immediately on an acquisition.
* Acquirers often have excess space, so a local acquisition can be accomplished without any appreciable increase in overhead.
* Many acquiring firms use outsourcing to get much of their more routine compliance work completed. Some of the outsourcing occurs locally to individuals working at home, some outsourcing is within the U.S. to employees who have relocated but whom the firm doesn't want to lose, but most goes overseas, with India being the primary destination.
A Acquirer firms have usually expanded their product offerings to include financial services and business coaching. These services can immediately be offered to many of the newly acquired clients, which have typically been underserved in the area of Type 2 services.
STARVED FOR BODIES
Of course, any discussion about what the market looks like now, or will look like in the future, has to rest somewhat on recruitment and retention.
Joel Sinkin, president of New York-based J. Sinkin Consulting and a partner in Accounting Transition Advisors, sees significant changes in the smaller regional firms. "Many of these firms have a talent shortage," he said. "This creates multiple problems. It is hard to continue to grow without the labor resources to handle the work. Also, they rarely can execute a 100 percent internal succession plan, and either need to add smaller, younger partners into their firm, along with everyone else, or merge up."
He added that the larger regional firms suddenly have multiple choices of firms to absorb, and where in the past the most important features of merging in a firm were the client base, fees, etc., along with the quality of the staff, now the staff itself may be the single most important aspect to many of these successor firms. "Bringing in young staff and partners is more appealing then bringing in a firm filled with retirement-minded partners and even good clients."
Rosenberg also pointed out that because the Big Four are starved for bodies, they're overworking their young talent, causing many to become disenchanted with public accounting.
Shamis concurred. "Clearly, the Big Four have migrated to working with the Fortune 1000, while everyone else has moved up the food chain," he said. "I see a huge change in that, years ago, we used to feed from the Big Four. Not any more. When people depart a Big Four firm, they usually leave the public practice arena altogether. They've been burned out and are more willing to look at other opportunities. We simply can't attract them any more. The quality-of-life issue has become vitally important to these people. So, we try to convince them that we can offer the difference between what they have previously experienced and what they can find with us."
Hugh Duffy, co-founder of Build Your Firm Inc. in Madison, Conn., said that hiring full-time staff is a challenge in key markets for the small accounting firm. "As a workaround solution, many small firms have been targeting part-timers and positioning themselves as providing a better work environment, such as closer to home, flexible hours and being family-friendly. In the future, small firms will need to become savvy about recruitment, retention and compensation."
THE SMALLER GUY
Duffy's daily interaction is with small-business accountants that are generating annual fees of up to $3 million. As a result, he said that he doesn't really get exposure to the Big-Four-versus-the-regional-firms dynamics. However, he has noticed a number of trends.
For one, there is the declining productivity of "cold call" telemarketing for lead generation: "By all means, it still works for those that are skilled at it, but the returns are declining as this medium has been overused by many industries."
Also, he has seen a decline of traditional write-ups because of QuickBooks. "While I can't quantify this, more and more accounting firms have acknowledged the decline of write-ups due to the adoption of QuickBooks. In fact, the QuickBooks Pro Advisor program continues to grow in size each year, thus reflecting increased acceptance by accountants. For the most part, this evolution is driven by the business owner, not the accountants who are recommending QuickBooks per se," he said. Of course, in that regard, he notes that smaller firms still struggle with how to capitalize on QuickBooks. "With the small- business owner or staff managing their own bookkeeping, many firms wrestle with how to price and manage this new type of client."
By the same token, he does not feel that small-business owners really know how to use a P&L as a tool to monitor business performance. "Small-business accountants simply don't know how to overcome this paradigm. And because many small-business owners now manage the bookkeeping to cut checks and manage cash flow, what role does the accountant now play? So, is this now a threat or an opportunity?"
Duffy does feel that small accounting firms are adopting technology to improve productivity. "This ranges from paperless offices to Internet marketing to online accounting options to remote access programs and file transfer. They know how to Google and now understand terms like URL, ISP, FTP and the like. The technologies that the small market lags behind are with the BlackBerry, online accounting services, spam control, etc."
He also sees firms running away from Yellow Pages advertising and more towards Internet marketing. "With the proliferation of Yellow Page books, combined with more people using the Internet to find things, Yellow Page renewals are dropping like a rock."
Bruce Clark, founder and chief executive of New Jersey-based New Clients Inc., said that he deals mostly with smaller firms that are being bought and sold. These firms range from as little as $50,000 in annual billings to upwards of $750,000, with the average size firm being around $300,000. "In this market, there has been a noticeable increase in activity over the past year, and more recently in the past few months. We expect this trend to continue with many accountants reaching or nearing retirement age. I think another aspect that is fueling this is the availability of financing from several sources that specialize in practice acquisitions."
Duffy reflects on the fact that there are basic concerns about who will purchase a practice five to 15 years from now. "Due to demographic factors, small accounting firms are concerned about declining valuations as they near retirement."
And as a cap on this, Sinkin noted that the real small firms in densely populated areas seem to be the least changed.
LOOKING AHEAD
Rosenberg said that one has to remember that the return on investment in "buying" a small firm at roughly one times fees is about 200 percent, and he terms that valuation a "super investment." He believes that there are still a lot of firms that like small mergers for this reason alone.
"I see a widening growth gap and profit gap between the more successful firms and the less successful ones," he said. "There are a lot more firms around these days that are managed very well and are confident in their ability to take a marginal small firm and convert it into a profitable one in a couple of years. They feel they can do this because of the know-how they have developed in firm management, marketing and recruiting."
"I recently did some work with a three-partner firm in a major city of a mid-population state," he noted. "Their profitability was well below national norms and they were very frustrated with their inability to recruit staff. They got a merger offer from a large firm in their state that wanted to enter the big-city market. I recently saw the managing partner of the smaller firm at a MAP conference and she was absolutely delighted at how the merger had gone. She said that the recruiting know-how and brand name of the larger firm had produced five new staff members. Boy, was she happy!"
As to how the larger firms see the market for merging in smaller firms, Rosenberg said that because the organic growth is so easy to get, the driving force for the bigger firms, especially the really big firms (say, over $10 million, but especially the Top 100) is the desperate hunt for bodies.
"So, one could surmise that a small firm with partners who want to stop working soon and have little talent to add, then these type of firms will not be very attractive merger candidates," he said. "And when the merger market turns from a seller's to a buyer's market, no one may want them at all."
