As mergers and acquisitions in the accounting profession relentlessly pick up pace, firm leaders need to know how their firm's value is being determined — and how they can increase it.
The entry of private equity into the accounting profession five years ago — with major investments in firms like EisnerAmper in 2021 and Citrin Cooperman in 2022 — brought with it a major shift in how firms are valued, as well as a substantial increase across the board of firm valuations.
A firm's worth — or enterprise value — is calculated through an equation of EBITDA times the "multiple." Traditionally, firms were traded on the basis of gross revenue — effectively at a multiple of zero — but the entry of PE changed all that. At the beginning, what was considered an "outstanding" multiple was between 7-8X. Now, a "good" multiple hovers around 5-7X, a "very good" multiple around 7-8X, and an "outstanding" multiple around 9-10X, or even as much 11X. Since the advent of PE, multiples have increased essentially one point per year.
Doug Lewis, managing director at The Vis-ionary Group, compared firm transactions to the real estate market, in the sense that one's house is only worth what someone else is willing to pay.
"We might have conflicting viewpoints on what that number is," Lewis said. "If it's my house, I might think it's worth a little more than some of the buyers out there, but the buyers ultimately dictate what the market is for real estate, and it's very similar when we look at accounting firm transactions."
Raising your multiple
There are numerous factors a buyer considers when factoring the multiple: how strong is organic growth, profitability, potential to scale the business, leadership and next-generation talent, growth projection of the geographic markets the firm serves, and the competitiveness of the process — how many buyers the seller is talking to.
That said, the multiple is ultimately in the eye of the beholder. But there are still ways for firms to raise their value. For instance, Phil Whitman, CEO and president of Whitman Advisory, said firms with partners over the age of 60 need to have a clear succession plan. Older partners have shorter runways before cashing in on their equity, so choosing a successor makes the firm more attractive to buyers.
Firms can also increase their value through organic growth via business development, acquisitions of smaller firms, partnerships with complementary firms, and offshoring, Whitman said.
Lewis added that industry specializations can also help boost valuation. "The generalist catch-all and do-a-little-bit-of-everything firm will frankly not command the same value of a similar-sized firm if that other firm has a specific industry subset niche," he said, before noting a caveat: "There are some industries that are tough for other people to acquire, and then others will love it if they're already niched in that industry."
"There's lots of people out there who are saying, 'If you just focus on this area, your firm might be worth more,'" he continued. "It might be, but that's not a guarantee in the marketplace, because if you're working in an industry that is relatively taboo or not as sought-after as some of the other industries, that could impact your value one way or the other."
Firms don't have to do this alone: Whitman recommends engaging a CPA consulting firm or M&A advisor to focus on the highest-priority issues.
"The only thing absolute about that first offer is it's going to go up." said Allan Koltin, CEO of Koltin Consulting Group.
Just because a firm gets a low offer the first time doesn't mean they're being low-balled: "It just means they don't have, if you will, the gun to their head to raise the price," Koltin said. "We're asking, 'What do you think we're worth?' And they're giving us an honest answer. Later on, as they get feedback on their offer, other competing firms have to put a higher offer on the table."
But the devil is in the details, and the enterprise value doesn't tell the whole story, nor does the multiple. It's the fine print that really matters.
"When people go to the country club and pound their chest and brag that they got an X multiple or this enterprise value, I always say, 'I don't know what to say to you because I don't know the details,'" Koltin said. "There could be contingencies, there could be clawbacks, there could be earn-outs, there could be rights of offset."
"We call it the NFL headline offer," said Brannon Poe, founder of Poe Group Advisors. "In football, you see a headline in the newspaper: 'So-and-so signs a deal for $100 million.' But then you look at the fine print of that deal, and maybe he got $5 million at closing, and maybe there were all these conditions for the rest of the money to come."
The impact of private equity
Experts agree that private equity has had a radical effect on firm valuations and the profession at large — regardless of whether a firm takes outside investment or chooses to remain "radically independent."
For one, private equity has pushed the profession to a much more widely accepted valuation methodology among other industries, Lewis said. "The infusion of private equity has shifted the thought process of how a lot of these accounting firms are valued because they are essentially moving the whole market towards that valuation model, which is based on the multiple of EBITDA," he said.
"Even if you have no indication or interest of ever merging into or selling your practice to a private-equity platform, it's still impacting how all of these other firms compete as they choose to remain independent," Lewis continued.
Poe noted that private equity has also sped up the pace of transactions: "They quickly want to get you under LOI [letter of intent] and they want exclusivity. They want to lock out the competitors to the purchase, and we find that that's just not advantageous to sellers."
Like many others in the field, Poe remains cautiously skeptical about the long-term effects of private equity on the profession.
"I feel like there's a lot of lip service given to, 'It's a great cultural fit.' Maybe it is, maybe it isn't," he said. "Private equity firms are looking at this from a portfolio perspective. They're putting a puzzle together, and some of them are just trying to get pieces of puzzles on the board."
Marrying for love, marrying for money
At the end of the day, Koltin said it comes down to "marrying for love, or marrying for money."
"If you marry for money and that's all that matters, then you probably want to be a year or two away from retiring, and probably not care that much about your people, because if you're not happy, they're probably not going to be happy," he said. "The opposite of marrying for money is marrying for love. Love, in these deals, is what we call the cultural and strategic fit. So what do I always tell our clients? Marry for love and the money will follow."
Poe echoed the sentiment: "I think the times have changed, where people don't just want a business that's going to provide them with cash flow. They want a business that's going to allow them to have a good life, to build the business, to have balance."
With the increasing rate of change, firms need to be paying close attention if they want to remain competitive.
"We're having this conversation today. If we had a follow-up conversation about this exact topic three months from now, it could be worlds apart," Lewis said. "I think that firms who are just kind of sticking their heads in the sand and not at least exploring what the M&A market could look like for them, they might be missing out on what could be a golden opportunity."
"At least know what's out there," Koltin added. "Even if you're not going to do something, you might get a better idea of how to run your own firm. I think we all agree one thing that private equity has done is raise the bar. They've raised the bar in performance, they're producing more organic growth, they're producing more profit. What can we steal from that?"
