The only constant in the accounting profession over the past decade has been change.
Take the country’s Top 100 Firms as an example: That elite roster has been reshuffled and replaced over the past 10 years, largely as a result of the rampant volume of mergers and acquisitions.
Many familiar T100 names from the past are gone — either having merged into larger practices or been leap-frogged by a new fast-rising breed of dynamic practices cracking the revenue barrier for their place on the annual ranking. It’s estimated that in any given year there are between 300 and 600 mergers or sales of CPA practices — ranging from sole practitioners to super-regional behemoths — and that frenetic pace shows no signs of slowing down.
THE URGE TO MERGE
You could cite a number of factors, including a desire to penetrate new geographic markets. As an example, at our company, we’re getting an increased number of requests from clients for potential merger candidates in markets other than their own — such as a New York City practice that wants to expand its reach to South Florida or Atlanta or perhaps even cross-country to California. Advances in technology have helped made it exponentially easier to open satellite offices.
Another primary driver is the desire to expand a firm’s client service offerings — perhaps a tax-centric firm now wants to wade into financial planning or avail itself of such fast-growing niches as business valuations, state and local taxes, forensic accounting, or litigation support. Such a firm can either develop that service in house or look to affiliate with a practice that’s well established in that field and capitalize on the synergy of a merger. With an aging population, we’re also seeing client demand for such services as elder care, as well as significant growth in “green” accounting services.
But above all, and more important, firms are driven by the need to plan for succession — a strategy too often put off by practitioners until it’s too late.
While you can never begin formal succession planning too soon, a frightening reality within the profession is that many firm owners begin too late and have sadly put it on hold to the point where they’re faced with unfavorable options such as a hastily arranged merger, or, in a doomsday scenario, simply turning out the lights and locking the doors.
To put the problem in perspective, consider the sobering demographics from the American Institute of CPAs’ quadrennial PCPS Succession Survey, which found that 61 percent of current firm partners are over the age of 50, and 67 percent of the firms polled expected at least one partner to retire within five years. And more than half of the nearly 1,000 single and multi-partner firms who responded indicated that more than one partner would exit within that five-year frame.
And finally, consider this: Less than half of multi-owner firms in the PCPS poll said that they have a formal succession plan in place, and at firms with 15 full-time employees or less, less than 30 percent have a plan.
MAKING A MERGER HAPPEN
Ideally, the end goal of any succession plan is to smoothly transition client relationships to either an internal or external successor and monetize the value of your firm.
We recommend looking at your practice as you would a consulting engagement for a client. That means you first need to understand what your goals are both in the long- and short-term. For example, how many more years you want to work full-time before slowing down will dictate the timeline necessary to begin laying the framework for your succession plan.
If you are a partner in a larger firm, your existing partnership agreement should spell out exactly what happens in the event of death, disability or retirement. If not, your partnership agreement needs to be updated immediately.
For all sized firms, there are a couple of key issues that need to be addressed.
First, do you have the staff or a strong internal “bench” that can take over the practice from an expertise and/or capacity perspective? If the answer is no, then an upstream merger is probably your best solution for an exit scenario. Too often, smaller firm owners (and some larger ones as well) think that they’ll get lucky enough to land what we like to call the “Holy Grail” of the profession: a young CPA with a good book of business who has the ability to one day assume the reins of the practice.
Second, do you have unreasonable expectations? Today’s marketplace is far different from the over-priced valuations many firms received during the heyday of the consolidators like American Express Tax & Financial Services, H&R Block and the predecessor to what is now UHY Advisors, Centerprise.
The sobering reality is that valuations for practices have been dropping steadily over the past 10 years. Firms that once commanded multiples of 1.5 times revenue or even higher are lucky today to get 1.2 or, more commonly, even one time. And those are firms sited in major markets such as New York or Chicago, and rarely offer good will and expect longer payout periods than in the past. For secondary and tertiary cities, firms will be lucky to be offered multiples of .8 or .9.
DETERMINING THE BEST FIT’
Myriad factors go into determining why some mergers work and others end up looking like an ugly divorce battle.
Many times it has as much to do with firm culture as it does the basic mechanics of the deal. Client retention is always an ongoing work in progress even under normal conditions. In fact, a recent study from the AICPA found that fully one third of the client base in over 600 firms surveyed are thinking of switching CPA firms, citing a lack of personal service as the No. 1 reason. Unfortunately, that’s an unintended consequence of enhanced technology as firms may communicate regularly with clients via e-mail and the phone, but rarely see them in person except for tax season.
However, client fears are magnified in a merger. They wonder if the partners they have come to know and trust will remain, or if their fees will suddenly increase. Do they now have to travel longer to get to their CPAs’ offices? The last thing you want in a merger is to trigger client panic, which more than likely will result in a mass exodus.
Obviously, a transition will go more smoothly if two firms share similar cultures and chemistry. If the standard “uniform” for one firm is a polo shirt and jeans, and a potential merger partner mandates a jacket and tie to be worn at all times, that most likely will indicate a clash of cultures. Or take vacation and perks: What do you do in the case where one firm offers four weeks of paid vacation, while a merger partner only offers two or three?
While we understand that having a mandatory retirement age is a vital tool to attract young talent who could potentially rise to become an equity owner or even run the firm, we find it head-scratching at times that firms push out their most experienced people simply because of the date on their birth certificate. Some firms have been proactive in recognizing this tremendous waste of experience and are keeping older partners around in non-equity roles and deferring their purchase prices. Their expertise can then serve as an invaluable mentoring tool for younger staff.
A PROVEN SOLUTION
One of the most common types of external succession strategies we help facilitate is what is known as the “two-stage deal.” Under a two-stage deal, the seller firm works alongside and as a part of their successor firm for a specified period of time — “stage one.” The seller continues managing their book of business in their usual manner, but the successor firm assumes most, if not all, of the back office operations and overhead.
This structure has been effective for owners seeking succession because they retain reasonable control over their autonomy and income, and the successor firm enjoys the synergies. Clients can become accustomed to and, most important, comfortable with the newly combined practice. The successor firm can take the time necessary to become familiar with the newly acquired client base while you are still working full-time and remaining visible to your clients.
The seller’s compensation is most often based on historic profit margin applied to the collections from their client base — as long as the staff and resources necessary to provide services to the clients don’t increase. If the need for those resources does increase, an adjustment would be made in compensation.
When the transitioning practitioner reaches the agreed-upon date for “stage two,” the buyout payments begin. The terms are usually determined in a similar fashion as if the deal had been structured as a sale at the beginning of the first stage.
But by now, the clients have grown accustomed to the successor firm once the buyout begins and retention is no longer the concern it once was. The key to the two-stage deal lies in positioning it to the seller’s client base. The seller firm needs to showcase it as the gain of the successor firm, not the loss of their firm!
It is important to note that mergers can be for growth, not just succession. Having a larger platform of services, access to additional niches and talents, and marketplaces to attract more staff and clients are just some of the reasons that accounting firms seek mergers for growth solutions as well as succession. Many firms approaching the marketplace are seeking both; senior partners seek a near-term or long-term succession plan while younger partners seek professional and financial growth.
As we stated, the current pace of mergers isn’t about to brake anytime soon. Unfortunately for many practitioners, neither will the number of firms that continue to procrastinate with regard to drafting a formal succession plan.
With 77 million Baby Boomers expected to retire in the coming years and one person turning 65 every eight seconds in the U.S., that signals the potential for a talent void in the profession roughly the size of the Grand Canyon. So you can expect to see not only merger mania continue among the smaller practices, but we’re far from done with unions of those in and around the Top 100, and there will no doubt be some surprises ahead.
Joel Sinkin is president and Bill Carlino is managing director at Transition Advisors, a national consulting firm specializing in ownership succession and transition strategies for CPA firms. Reach them at (866) 279-8550.