There are many conversations about what a firm is worth. Even firms that have or had no desire to sell or merge upward are looking at the question of value right now simply because of the calls from private equity or another firm looking to expand. Even though you may not be actively looking, it is hard not to open that door and take the call to see what they are offering.
Who can say accounting is "boring"? Let's complicate the entire accounting profession with the question of what is a firm worth? We have been getting that question for the last decade, but in the last few years as we weaved through COVID, pushed hard into outsourcing, and then had private equity enter the mix, this question has become much more complex. It can be confusing to many owners of accounting firms.
Let's add a few other factors: Implementing artificial intelligence, boosting recruiting, adding advisory, and establishing outsourcing are expensive and time-consuming. Does your firm have the ability to manage those pieces? Those are different skills and responsibilities from running an accounting practice. Yes, firms have technology and people today, but it is getting much more complex and further from the core business of accounting, tax and assurance.
A major factor in the merger and acquisition sector is the private equity element. It is having a much deeper impact on the accounting profession than just the decision to accept a capital investment for a firm. It is changing the landscape of traditional M&A deals as well. Firms are questioning which direction to go. Should they go PE or look for a traditional deal? If they try to be the acquirer, can they afford to make a deal because the cost of an acquisition has gone up if they are talking to certain M&A targets? We will explain this in more detail a little later in this article.
Two other twists to the private equity element are whether PE will be the right step for the rest of the people in the firm, and whether PE will last. Is it the right step? It depends on the firm. The one thing to do is to separate the emotional from the logical in your assessment. If your conversation starts with, 'This is not the right direction for the accounting profession,' you have already eliminated any logical assessment of PE being right for your firm. Will PE last? No one knows the answer to how long PE will stay interested in accounting, or whether values will fall or increase.
What's PE's plan? They acquire an initial firm and then several others to create a larger firm of $100 million or more. They acquire X% of a firm's equity at price $Y. The price is dependent on many variables, including the firm's current size, performance, location, etc. The acquired firms will work collectively to increase their adjusted EBITDA (how that will be done is a completely different article). PE will then seek a buyer for their newly formed, larger firm with the refined, higher adjusted EBITDA and at a multiple of Z instead of Y. The Z multiple could be 10 times to 14 times or whatever the market will bear. Right now, Z is an unknown.
What firms are in demand? Every call we get starts with, "We are looking for targets of $10 million on up." When it boils down, this is a short list of firms who have been worked over for the last three-plus years. The under $10 million to $5 million group have all been called and there is interest, but it is hard for a PE company to build a platform firm in a new city on a $5 million firm. Those targets are more likely to be tuck-in to a city where a firm or the PE company already has a presence and existing leadership.
Some market confusion is occurring due to the sweeping infusion of private equity firms. The industry tracks the Top 500 firms, with the smallest firm on that list in the $5 million range. A fun side note is it seems as if there are 500 private equity companies trying to enter this market. We receive calls from a new PE company almost every week looking at how to get in, but each of these PE companies has differences in their stories. As they share their story or offer with a firm, it confuses the firm even more.
A few core elements in private equity or any M&A deal are the adjusted EBITDA, multiple, cash upfront, cash over time, percentage of the firm being acquired, working capital, the earn-out target, and the working period commitment by the partners. Now, layer in terms such as preferred dividends and management fees. It is easy to offer a multiplier of 10 if you lower the adjusted EBITDA, add in other fees, or set hard-to-achieve targets.
In deals we have consulted on, we have seen varying structures and terms. A favorite was when the acquirer wanted to keep the partners working capital accounts for 10 years with no interest. That might be plausible if there was no working capital required, but that was also in the deal terms.
Finally, is the highest price the best deal? The stories on values can be very diverse. Most transactions decline to share the details of the deal, so the stories that circulate are shared verbally and pieces of the story start to change as it gets passed on. Then there is the rumor mill version of the story when the multiple on the deal grew from an actual of seven to 10 or 11. Like the fishing story, where the eight-inch fish somehow becomes 16 inches.
This is what is going on in the world of accounting firm mergers and acquisitions. Dollars are being offered, but it is not just the money that is driving the interest. Firms are trying to balance what's right for their team and in some cases, what is right is taking the capital infusion. It can remove unfunded deferred compensation liability and provide cash for future investments. While this might seem counterintuitive, it can create an opportunity for younger staff to move up the ranks quicker and make more money in the process.
What is your firm worth? The economic basics of supply and demand still rule the day. Your firm is worth what a buyer will pay. The decision to sell is still up to the seller, but in today's market, some sellers have other obligations or factors to consider. These may force a firm to conduct a transition to protect the interests of the firm and/or to take advantage of a market opportunity that may not last.
