Larger CPA firms have traditionally been interested in acquiring smaller firms, creating what might be termed a seller's market, and that situation still exists today.
But, according to Marc Rosenberg, CPA and president of the Rosenberg Associates, a management consulting firm based in Wilmette, Ill., for the first time in the history of the CPA profession, this could change to a buyer's market over the next five to 10 years. "It's all in the math," said Rosenberg. "Today, it's fairly difficult for a buyer to identify a serious, willing seller, for two reasons: Sellers realize that it's a seller's market and, as a result, either on their own or with the help of a consultant, can easily identify buyers when they are ready to sell or merge. Therefore, when buyers go shopping, the shelves are somewhat bare."
In addition, he pointed out that sellers are quite anxious about merging up. "They fear the worst about what their lives will be like in a bigger firm. Consequently, they put off pursuing an upward merger well beyond the time that they should have begun pursuing it. Accordingly, when buyers go shopping, they may see these sellers on the shelf, but they cannot access most of them because the sellers aren't in a talkative mood." Over that five-to-10-year time frame, Rosenberg opined that the larger accounting firms are going to find it easier and easier to find sellers, because so many of them will have reached the point where they don't have a choice.
"Assume a $7 million firm decides to search for a $1-million-to-$3-million firm to merge in," he suggested. "Let's further assume that in the $7 million firm's market, there are only 30 firms that meet the size criteria. Today, the reality may be that of the 30 firms, only three may be interested in merging up and only one actually takes action. This, obviously, is a seller's market and the seller has a strong negotiating position."
However, he noted that over the next decade, as the sellers continue to age, instead of only three candidates primed for the larger firm merger, perhaps 25 of the 30 may be looking to sell. "Now the pendulum swings the other way. The buyer can pick and choose which firm it deals with and has the upper hand in negotiations."
Another related nuance to the above scenario is this: If the total number of sellers is 10 times larger in five years than it is today, then there will be a limit as to how many of these firms can be absorbed by the buyers. It's entirely possible that, at the very least, the sellers will have to accept discounted prices. A worst-case scenario would be that the least-attractive sellers might not be able to find any willing buyers at all.
Robert Gallagher, CPA and president of RJ Gallagher & Associates, a Pittsburgh-based management, marketing and educational consulting firm, said that the merger arena would continue to be active as firms expand their geographic locations and critical mass. However, he cautions that firms are becoming more strategic with their acquisitions.
What's the market?
Gallagher believes that it is both a seller's and a buyer's market, as many CPA firms are looking at mergers and acquisitions as an opportunity to find talent, as well as to achieve their strategic growth goals.
"With today's shortage of professionals, mergers are a great way to find bench strength," he said. "On the other hand, many CPA firms realize the tremendous investment that will need to be made in order to improve their infrastructure, as well as to address critical succession issues. Therefore, they are interested in pursuing an upstream merger. The one point, which is very clear, at least to me, is that there will be a tremendous consolidation of firms over the next several years."
Allan Koltin, CPA, president and chief executive of Chicago-based PDI Global Inc., feels that it is neither an all-buyers' nor an all-sellers' market.
"I would have to say, unequivocally, that it is both," Koltin said, who pointed out, however, that between 2003 and 2005 some 84 percent of potential mergers failed to close. "The big landscape change continuing to evolve is that mergers, whether upstream, similar size or downstream, have proven highly successful as a business model for growth within the accounting profession. Firms continue to accelerate their search for mergers with firms of all sizes. If I had to pick and choose, I would say that the seller has the present advantage, simply because there are so many buyers in the market, although I would caution that clearly we are seeing many more mergers today, as opposed to outright sales."
Rosenberg pointed out that 50 percent of the partners at multi-partner firms of $20 million or less are 50 or older. "The Baby Boomer generation has reached its late 50s and early 60s and, therefore, is in what I term their 'pre-retirement years,' which is that period in their career when they have just a few years before retirement, and they should be actively planning their exit strategy."
He emphasized that today, when most firms under $20 million take a look at their younger partners and - worse yet - at their crop of experienced staff, they don't see them having the "right stuff" to keep the firms running after the current partners retire.
"The result is a level of high anxiety among Baby Boomer partners as to what their exit strategy will actually be," Rosenberg said.
The problems, he explained, are two-fold: From 1995 to 2000, there was a stunning one-third drop in the number of students enrolled in Bachelor degree programs at U.S. universities. Put another way, 65,000 fewer students were enrolled as accounting majors in 2000 than in 1995. Many of those young men and women might have been knocking on the door of a partnership, if they existed in the first place.
Also, small and midsized CPA firms have never been good at succession planning. "And they still suck at it," said Rosenberg. "If you take a look at the top 25 firms in any major city from 20 years ago and compare them today, you will likely see that half, or more, of the firms from two decades ago no longer exist. The primary cause of these changes: Poor succession planning."
Gallagher emphasized that succession issues are becoming ever more crucial. "We are in a knowledge-based economy and it is extremely difficult to transfer knowledge. Continued success as an independent firm will be jeopardized unless there is a critical mass in each industry and service niche. Each partner needs to prepare an annual succession plan as part of the performance review, and knowledge transfer must be part of that plan. Firms in the $2.5 million to $5 million range would be vulnerable and look to merge in order to solve their succession issues. Those firms with business valuation, litigation and specialty service project work will find much difficulty in transferring such services to the next generation."
Gallagher noted that many accounting firms are now addressing their succession issues, and realize their vulnerability due to not having the necessary "bench strength." There is no question that the average age of many partner groups is a major concern. "The targeted average age for a partner team is between 45 and 48. Once the average age is in the mid-50s, time is running out to solve their succession issues, so an upstream merger is probably the best course."
Gallagher said that the opportunity for a true golden age of the profession is here, and firms will continue to acquire other firms for partners, staff and expertise in niches. "With the shortage of staff, many firms are looking at mergers as a vehicle to attract talent as well as clients."
Culture, of course, is key to a successful merger. He added that the problem is most firms don't devote the necessary time to determine if there is a proper culture fit. "You can slice economics but you can't slice culture. Larger firms are conducting 'culture audits,' utilizing internal or external industrial psychologists. Larger firms will continue to expand their critical mass in order to provide a myriad of services to their clients."
Koltin pointed out that it is the current scarcity of talent in the profession that dictates this condition. "Safe to say, the ideal merger for a top 100 firm today would be one that has 50 staff and no clients. While this may sound a bit silly, it highlights the desperate state that firms find themselves in, in terms of locating talent. As you know, many firms are essentially turning away business because they cannot build the labor force to effectively get the work done."
Rosenberg emphasized that partners today are very, very busy: "It's a good, albeit frustrating, time to be a CPA. Many firms simply cannot absorb more clients. So, if the seller cannot retain its partners and staff after the merger, this will create huge production bottlenecks at the buyer firms. Those firms will increasingly be unable to consider downward mergers if the union of the two entities puts too much stress on the surviving firm."
Who's doing what?
Koltin stated that the most aggressive firms he's seeing in the marketplace are the top 100 (other than the Big Four accounting firms). "Whether it is middle-markets, nationals, mega-regionals, large locals, or even smaller local firms, everybody has realized that M&A growth can be a wonderful way to expand the business, as well as the firm's talent pool."
"In terms of who's doing the selling, or merging upstream," he continued, "we are seeing more firms today suffering from those same succession planning issues, whereby they do not have a future generation of partners, or today's managers, to continue to lead the firm and essentially pay out the retiring partners' deferred compensation package. This should not come as a surprise, given that in 1990 just 2 percent of college graduates got their accounting degrees, and 10 years later, this percentage dropped to 1 percent. I believe we are just at the tip of the iceberg, as the next 10 to 15 years will prove to have an even bigger struggle for top talent than we've seen to date."
Rosenberg has his own sense of what's driving either side: "Firms become buyers to acquire talent because it's nearly impossible to recruit experienced personnel, to hire people to provide for their own exit strategy, and to increase their fee volume. Though many firms today report that they are holding back on marketing because they don't have enough people to get the work out, there is a sizeable minority of firms that are still struggling to attain a fee volume sufficient to enable their partners to earn decent levels of income."
As to sellers, he said that firms move in that direction because partners are nearing retirement age, or are at retirement age, and they need an exit strategy. Then, there are partners who are still five to 10 years away from retirement and they have a strong need to secure their buyout. They figure that merging sooner rather than later is the best way to go. Oft times, smaller firms are devastated by their inability to attract staff. "This state may be further exacerbated with other frustrations of operating as a small firm, such as lack of service diversity and cost of technology."
Allan Boress, CPA, CFE and head of Florida-based Allan S. Boress & Associates, which provides coaching, training and consulting, maintains the seller's market theory. "There is desperation out there, because every year we get older and realize that we have to seize opportunities to build up the business by acquiring firms."
He cited resources as the No. 1 problem. "The Big Four sees this as they are overwhelmed with work. People are acquiring competitors today, thereby getting market share and resources."
He added that there are good accounting firms are out there, but the number is getting smaller and smaller. "It's dwindling. Many firms want to be acquired and are trying to boost the bottom line." Boress noted that the same people, as before, are involved. "They want to dominate the market. It's all a matter of resources. Sellers are looking to get premium prices for their firms."
Moreover, according to Boress, larger firms sometimes are waiting for panic to set in, especially for the smaller firms that need to be acquired. "It's not that different than what is taking place in real estate today. People are getting older and want to get out or need to boost revenue, and they want to do this when they sense the market is high. Firms that are planning to stay and not be bought out can only effectively remain in business by consolidating with other firms or buying other experienced people."
Gallagher said that the profession has yet to experience the real effect of the litigation trend and problems with the Big Four leading to an eventual break up. "There will be another Enron, and it is impossible for the Big Four to continue their imbalanced leverage issue without severe repercussions. We experienced the break up of AT&T and I believe that during the next 10 years, we will experience the break up of the Big Four into many regional firms. In other words, there will be at least four top 25 firms that will merge during the next few years."
"Today, if a smaller firm wishes to merge into a larger firm, this can be easily and swiftly executed, assuming there are no skeletons in the seller's closet," said Rosenberg. "But over the next five to 10 years, this storm is going to turn into a Category 5 hurricane. Many sellers who put off a merger for too long may find a market that is not very receptive to them."
PDI's Koltin concurred that during the next five years we'll see a mass of consolidation: "I have already been privy to discussions in which locally based firms are talking about creating regional practices and regional firms are talking about essentially becoming mega-regional firms. The economics make sense, and if the cultures are compatible, I see no reason why we won't see many more of these mergers."
Analyzing the marketplace
They believe that when analyzing today's marketplace, it is necessary to break it down into categories:
1. For smaller firms under $1 million in large metropolitan areas, it remains a seller's marketplace.
2. For smaller firms in less populated areas of the country, it is a buyer's marketplace.
3. For midsized to large firms, especially in the $3-million-to $8 million range, it is a buyer's marketplace regardless of location.
4. In larger metropolitan areas of the country, there are many firms seeking to grow that have excess capacity.
Sinkin said that when a practitioner indicates, "I have $500,000 in billings, I am ready to give up," there are many firms seeking to add those billings to their firm.
"Generally, there are many more buyers for $500,000 firms than sellers," he said. "Not only is there a plethora of small-firm buyers in larger metropolitan areas, but also in many cases the buyer firm can absorb the seller with little to no incremental increases in overhead, and can afford to pay the seller a premium for the practice and still generate a profit. Based on these and other market conditions, it has been, and will likely remain for some time, a seller's marketplace."
According to Putney, in areas where there are fewer buyers, the lack of competition for the seller firm among several buyer candidates causes the supply/demand curve to be very different. As a result of the limited audience that a seller has, the value of the practice suffers and it becomes a buyer's market.
"For larger firms, the overall shortage of talented, younger, experienced CPAs, combined with the aging of the industry, has caused many firms to have succession problems," he said. "There are a great number of firms who lack the second tier of partner-level professionals within their practice who professionally and financially can buy out the senior partners and maintain or grow the firm. The larger practices seek such firms not because they want to acquire practices owned by retirement-minded practitioners, but in order to add young talent to their firm. The clients of midsized firms tend to be more demanding of a larger array of services, as well. This leads to many midsized firms seeking upstream mergers. The lack of motivated buyers for retirement-minded partners of $3 million to $8 million firms makes this segment of the market a buyer's market."
"However," Putney continued, "for midsized firms that have partners and near partners looking for a long-term affiliation with a larger firm, especially if they have young partners and near partners, it is a seller's market."
Range of areas
Putney emphasized that buyers of smaller practices in the more densely populated parts of the country fall into a wide array of categories. "They include professionals who left public accounting and now wish to return in the role of an owner or in a manager-level professional position - those who want to be 'Master of Their Own Domain.' The majority of buyer firms continue to be the many one-to-four partner firms who make up the bulk of the public accounting industry. These firms see acquiring a practice as the best method of growing their firm, and more expedient than adding one client at a time."
Sinkin noted that the midsized to large firms remain attractive to other large local and regional firms due to their desire to meet several objectives. "The firms seeking to absorb practices primarily do so for all or some of the following reasons: to add billings, to add talent, to add new locations in existing or target marketplaces, to add a niche, and to increase the opportunity of cross-selling additional services that the larger firm offers to a new client base."
He adds that a midsized to large firm with insufficient professional talent to produce the work and retain the client relationships, especially if partners are retiring coinciding with the affiliation, is a practice that is frequently not as attractive to larger firms, since they often are already short of quality staff and have little excess capacity to replace retiring partners.
"For the 16 years that we have been helping firms merge, acquire and plan for their succession, we have heard about the demise of the small practice, especially the sole practitioner," he said. "It has never come to be and we don't see it happening in the future. The large firms are rarely geared up to handle the small, closely held businesses that continue to prefer dealing with small accounting firms. There are a tremendous number of smaller firms in existence, and new ones are cropping up each day. As long as the number of small firms seeking to grow exceeds the ones seeking succession, which has been the case for the last 16 years, we don't see the marketplace changing to the detriment of the smaller firm."
Putney noted that the pressure on succession issues for midsized to large firms would likely continue. "It appears the labor crunch will persist as the Baby Boomers age. The value of these firms may decrease and the buyers will become more selective about whom they are willing to acquire. Industry statistics of accounting school graduates over the last 15 years indicates that it will be at least another decade before the pressure on the amount of available labor eases, especially at the level of staff that provides internal succession solutions."
Also, they said, the emphasis on cross-selling will continue, and fields such as information technology, elder care, financial services, and estate and trust work will become more prevalent. "In response to this, you will also see smaller firms elect to specialize as a means to compete with the one-stop-shop approach offered by larger firms. Both strategies are well served by mergers and acquisitions, and as a result, that activity will remain robust."
(Reach Sinkin and Putney at firstname.lastname@example.org and email@example.com.)
Why mergers do and don't happen
* Of 50 potential mergers, 42 never made it to the altar, eight got married, and one got divorced.
* 84 percent of potential mergers didn't happen.
* 16 percent of potential mergers did happen.
* 12.5 percent of mergers that happened, failed.
What are the top 10 reasons why potential mergers didn't happen?
1. Disagreement over firm name.
5. Too many people can say "no."
6. The "myths" are stronger than the "reality."
7. Worried about perceived risk.
8. Compensation programs too dissimilar.
9. Other firm did a better job of "selling their franchise."
10. Financial terms.
Why do firms merge? "Often times there are multiple reasons, some of which are hidden," noted Koltin. These include:
* Fixing a problem;
* Expanding into new markets;
* Geographic expansion of services;
* Improving profitability;
* Expanding upon an existing specialty;
* Servicing larger clients;
* Unfunded retirement obligations;
* Succession-planning issues;
* No longer having "fun;"
* Better service for clients;
* Offering clients more products and services; and,
* Cashing out.
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