Following a flurry of mergers throughout 2007, many top-drawer consultants in the accounting profession believe that this year will be just as active — and that foretells myriad changes for firms of all sizes.“I feel that [M&A activity is] hitting rapid proliferation moving forward,” said Gary Shamis, managing director of Ohio-based SS&G Financial Services. “And it’s going to become more significant in this year.”
Marc Rosenberg, founder of the Illinois-based Rosenberg Associates, said that the merger market will continue to heat up for several years to come. “The reason is simple: The Baby Boomer partners at CPA firms are reaching what I call the pre-retirement years — five or so years before they need to execute an exit strategy and get their money out of their firms.”
He noted that some fortunate firms will have younger partners and potential partners to turn the firm over to, but the vast majority of firms don’t have the people to buy them out.
Rosenberg pointed out that many firms will have no choice but to merge. However, there are problems associated with that climate of desperation. “First, for firms that must merge up because it’s the only alternative, their partners are having severe anxiety attacks,” he said. “They know they need to merge up, they know they should at least talk to a few firms to test the waters, but they can’t bring themselves to do it because deep down inside, they don’t want to merge in the worst way. They live in mortal fear of losing control. They are convinced that the good life, as they have known it, will cease and they will become just another small fish in a big pond. So, they’re frozen in time. They aren’t talking to firms about merging up. And they aren’t developing any successors internally.”
As a result, Rosenberg said that whether these firms are aware of it or not, they’re executing passive-aggressive strategies. “They’ve decided that dying in their chairs may be preferable to merging up, and if they sweep their succession-planning problems under the carpet, they will simply go away,” he said. “But sweeping things under the carpet only creates lumps, and there are tons of firms which have decided that, since they have no choice but to merge up, [they have to start] talking to potential buyers.”
Rosenberg also feels that because the merger market is so heated, the buying firms are absolutely swamped with merger opportunities. “However, they can’t handle them all. So, when this kind of market arises, the buyers can cherry pick the best firms and leave the average and below-averages to almost literally die on the vine.”
He added that many firms today think that they can always pull their trump card (calling a local firm to merge up) whenever they’re ready, but flagged that strategy as a mistake because the buying firms can literally have their pick of the litter.
WHOSE MARKET IS IT?
Bruce Clark, founder and chief executive of New Jersey-based consultancy New Clients Inc., watches the M&A activity from another road. He said that he has had an active year with both practice sales and accountants looking to grow their firms. “We have, however, been seeing a lot of accountants opting to build their practices internally, instead of trying to purchase a firm. We believe the reason behind this is simple: It’s much more cost-effective to acquire clients with a structured marketing plan than it is to purchase them. In fact, it costs up to 50 percent less to build through effective marketing than to buy.”
Clark noted that the other driving factor is supply and demand. “In most markets throughout the country, there are more buyers than sellers — in some cases as much as a 10:1 ratio. It’s difficult and time-consuming to find the right fit. When you factor in these elements, it makes good economic sense to learn how to catch your own fish, as opposed to paying market prices, so to speak. I believe we’ll see more practices up for sale due to the fact that many aging Baby Boomers are nearing retirement. A number of the sales we concluded in 2007 were clients of ours whom we had helped grow their practices. They then decided to retire or in some cases pursue a new career outside of the accounting profession.”
Allan Koltin, CPA, president and chief executive officer of Chicago-based consulting firm PDI Global Inc., said that, historically, advising firms about mergers and acquisitions used to occupy some 20 percent of his time. But in 2007, it rose to roughly 50 percent. “It just seems that everyone is in some form of merger discussion, independent of firm size.”
Koltin said that recently he went through the list of Accounting Today’s Top 100 Firms and saw that roughly 88 of them had either completed a merger, or were in some form of merger discussions. “This is even more amazing when you realize that four of the 12 firms not included were the Big Four. What I find fascinating (especially among the Top 50 firms) is the amount of time that the managing partner is now personally devoting to mergers and acquisitions.”
“The demand of buyers is much greater than the supply of sellers,” Koltin continued. “But I’ve always believed that buyers will have the upper hand, whether or not the number of sellers increases over the next decade. Buyers in the accounting profession, quite candidly, know how to cull through an abundance of sellers.”
“If you segment the market, the really large firms (such as the Big Four) will do a few tuck-ins, but there isn’t likely to be significant activity in this sector,” opined Chris Frederiksen, a Mill Valley, Calif.-based consultant to CPA firms. “These firms are enjoying substantial growth organically, particularly outside the U.S.”
Within the Top 100 Firms, Frederiksen expects to see substantial merger-based growth as these firms consolidate their strength regionally. “They’re doing this to get a larger presence in their home market, to get niche dominance (for example, not-for-profit or construction), to gain an expertise they don’t have or embellish what they’ve got, to gain staff, and to improve profits.”
According to Frederiksen, the profit improvement often comes about because of the ability to spread a relatively fixed overhead across more revenue and people. “In effect, they’re also doing deals just to get bigger, knowing that if they don’t, their competitors will overtake them. Since there are so many deals going down at the moment, the quality of what’s available will ultimately decline. This is where I see the greatest activity — in regional mergers, where firms want to dominate their entire patch and are filling in the gaps like a jigsaw puzzle.”
With regards to small and midsized firms, Frederiksen predicted that there will be more M&A activity because more senior partners are reaching their “sell by” date. “Many have delayed retirement (because it’s usually unfunded), but inevitably there’s a point where it has to happen,” he said, adding that he tells firms that it takes four active partners to pay out each retired partner. “Most firms are age-weighted towards the upper end, so you end up with a game of musical chairs.”
Robert Gallagher, founder and head of R.J. Gallagher Associates in Pittsburgh, also projects a number of acquisitions of smaller firms. “With the eight new auditing standards, Circular 230 requirements, and international standards coming faster than I thought, I’m sure that many smaller firms are considering merging upstream. We’ll see how this plays out in a few years, but I already see a few mega-mergers happening this year,” he said.
THE SINGLE PRACTITIONER
Rosenberg said that he has never understood why a solo firm would want to remain a solo. “If bigger firms can’t find staff, what chance does a solo have? But there always seems to be a demand by small businesses and 1040 clients to hire solos. The vast majority of the country’s 30,000 single practitioners earn a small fraction of the $320,000 earned by the average partner in a $2-million-to-$10-million firm.”
SS&G’s Shamis said that it’s important to segregate single practitioners into markets. “For those single practitioners in smaller towns, their roles won’t vary. They have no competition. However, for the smaller practitioners in larger areas, the competition is becoming more sophisticated, thereby creating an even wider gap.” He explained that sole practitioners will have to be very focused on establishing a service or industry niche, and most important, they will have to recognize that they can’t be good at everything.
Frederiksen noted that there have periodically been predictions about the demise of the sole practitioner, and the flood of practices that will come to market as practitioners reach retirement age. But he pointed out that that’s not happening because many sole practitioners are profitable, especially those who have embraced new technologies such as document management, workflow, portals, multiple monitors and outsourcing. Moreover, he added that the Internet has leveled the playing field, and sole practitioners can be just as efficient as bigger players.
“Through a modest investment in a Web site, [sole practitioners] can be as attractive in a marketing sense as larger firms, because people are working longer,” he said. “As accountants reflect the longevity and improved health of the rest of the nation, there’s no longer an accepted retirement age. Most of the small practitioners I talk to just want to keep working as long as they can, albeit at a reduced level. Many practitioners have not funded their retirement sufficiently, and therefore retirement does not seem attractive. The accepted pricing of small firms at 1 to 1.5 times fees is not attractive to many solos. They say to me, ‘I’ll just work an extra two years and I’ll be in the same place economically. And I’ll still have my practice to sell!’”
Clark of New Clients noted that sole practitioners as a whole appear to be doing well, given the economic climate this past year. He pointed out that 2008 may bring some surprises if the economy continues to worsen, with the housing slump and stock market gyrations. “We’ve been telling our clients not to worry, because during a recession the small business market actually expands as a result of large companies laying people off. How so? Many of them go out with help from a severance package and start that business they have always dreamed about. The way to make this work to the accountant’s advantage is to push forward and not pull back. Become proactive with effective marketing targeted at small-to-midsized business clients. Eighty percent of all money spent for accounting services stems from the SMB segment of the marketplace. The question then becomes, are you getting your share of that abundant market?”
Also, a number of sole practitioners have developed wealth management practices, which are largely devoid of stress and deadlines, and often more lucrative than traditional accounting or tax work.
Gallagher emphasized that as firms address what issues will follow in mergers, they will have to consider specific positions that will bear a considerable investment. These include directors of human resources, recruiting, technology, marketing, administration, learning, and the controller. “Because of the need for these investments, I would predict that firms between $2 million and $5 million will rethink their current situation and many would merge up.”
In addition, Gallagher feels that firms without the bench strength and an entrepreneurial culture will eventually be looking to merge, and unfortunately, it will be too late for many of them to maximize their value. “First generation is entrepreneurial; second generation is generally much less entrepreneurial; and therefore, their succession plan could be in jeopardy — especially for firms in the $2.5-million-to-$5-million range. An additional key factor is transferring knowledge and relationships, which is much more difficult today and adds another component to the succession saga.”
Merger or no, it’s become increasingly difficult for small and midsized firms to find adequate and necessary people.
“The bigger firms are getting better at putting strategies in place to improve,” said SS&G’s Shamis. “The difference between the ‘haves’ and the ‘have-nots’ is growing increasingly more apparent, and the gap is getting wider. The larger players have the knowledge and know-how, and the smaller players don’t have the ability to get, let alone keep, people.”
Rosenberg said that for most buyers today, when they’re contacted by a seller or a consultant representing a seller, the first question they ask is: Does the firm have any talent? “They’re interested in partners who are young enough to stay around for many years. And most of all, do they have young staff? The booming market for CPA services has enabled CPA firms to grow with minimal marketing and practice development efforts. The problem is they can’t hire enough staff to service the demand. Increasingly, buyers aren’t willing to be the sellers’ exit strategy.”
2008 AND BEYOND
According to Joel Sinkin and Terrence Putney, principals in Accounting Transition Advisors LLC, of New York and Overland Park, Kan., the trends clearly point to the pace of deals accelerating.
“Midsized firms (generally those with three to 10 partners) appear to be the most impacted by the current changes in the market,” said Sinkin. “Many of these firms have several partners who will be seeking role reduction and succession over the next several years. We often see firms with five or six partners all between the ages of 55 and 65. In addition, many of these firms are experiencing great difficulty recruiting and developing the staff necessary to create an internal solution for partner succession. As a result, a number of these firms are finding it necessary to merge upstream in order to keep the firm viable and to create retirement value for their partners.”
Putney added that in most markets, the number of accounting firms that can absorb a midsized firm are few. “Therefore, the larger firms that are in a position to grow through merger often now have several choices and have become much more selective. For much of the profession, the seller’s market of the past few years is moving to a buyer’s market.”
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