How do you create significant firm value?
I’m often asked two questions by small and midsized CPA firms: How do we create significant firm value? And if we can get there, should we sell or stay independent?
The answers to these questions depend on a firm’s particular facts and circumstances and one size does not fit all. Nevertheless, a firm needs a number of ingredients to create significant value. Here are six of the most important ingredients:
1. A culture that breeds a firm-first mentality: Many firms put too much emphasis on the book of business and not enough emphasis on the idea that you are a team and, as a team, you are much more effective in the marketplace in attracting better clients and better laterals. To create significant value for your firm, you need to break down the barrier of the silo mentality and focus on the “firm first” mentality. That’s easy to say, but not easy to do, and most small and midsized CPA firms can’t get there.
2. Existing partners that have strong business development skills: Today, probably more than ever before, organic growth is difficult to come by. Work for a CPA firm isn’t just coming in the door the way it used to before the financial crisis. As a result, probably more than ever before, firms need about 25 percent of their partner group to have strong business development skills and knock the cover off the ball with new business each and every year. About 50 percent need to have some moderate business development success, and the remaining 25 percent have to support business development by writing articles in trade journals, for example.
3. Potential partners who have the “right stuff”: Too often, many firms make partners because of needs as opposed to qualifications. These admissions or promotions are referred to as “slot shots.” While I can understand why “slot shots” occur (partner retirements, organic growth, acquisitions, etc.), this practice truly undermines the value of a firm when it’s taken to an extreme because more than likely it doesn’t foster a strong succession plan. If your partner group has slipped into mediocrity and you wish your firm to be great again, start by raising the bar for your new partner admissions. Moving from senior manager or principal to non-equity partner (yes, I believe in two classes of partners with entry level being non-equity and the highest performers rising to equity) should be a consideration after functioning two or perhaps three years as a senior manager or director. Potential partners with the “right stuff” demonstrate your firm has a fairly good chance to enjoy a long runway — an ingredient that improves the value of a firm.
4. Skills and services beyond compliance: By now, it should be obvious that if your firm is only capable of providing plain vanilla compliance services, you probably won’t be in business much longer as the margin for that work has flatlined at best. To create significant value for your firm, you must begin to pivot away from a compliance shop into an advisory firm that provides consulting services such as international tax, transaction advisory, litigation support, estate and trust planning, state and local tax advisory and cybersecurity. This is where the future is. This is where the better margins are.
5. Several niches that give your firm market permission to do sophisticated work for marquee clients: If your firm’s attest and tax services aren’t distinctive in the marketplace, you are facing another red flag that doesn’t enhance market value. I strongly suggest your firm select three or four industry sectors and specialize in them. Examples include construction, real estate, professional services firms and hedge funds. As a by-product of the attest and tax services, offer a memorandum that summarizes your observations to improve EBITDA and working capital as a value-add that demonstrates your firm’s distinctiveness in the marketplace. The stronger your people get in an industry sector, and the “better looking” your client list becomes, the better your chances are of attracting better quality laterals and marquee clients who are recognizable names in the marketplace. This enhances value.
6. Critical mass or annual revenue base of $20 million to $25 million and at least 35 percent profits available to partners: Based upon years of M&A experience, I’ve found that firms that can achieve $20 million to $25 million in annual revenues with at least 35 percent in profits available to partners will get the attention of those Top 100 firms that want to be in that market or geography. That attention translates into value.
Let’s say you can get all of these components working for you and you can significantly enhance the value of your firm. Now comes the tough question — should you sell, or should you stay independent?
In my view, you should sell to a larger firm if you believe that a bigger brand and a more developed platform will provide your people the opportunity to grow professionally and to exponentially improve their earnings potential. On the other hand, you should stay independent if you have a huge runway with talent, age demographics and a history of steady organic growth. With that mix of positive factors, you probably can get larger and more profitable, and that translates into even greater value somewhere down the line.
It’s not easy to stay independent these days as organic growth is hard to come by and strong, quality partners are not easy to find and develop. Nevertheless, it can be done and, is in fact, being done by many of the Top 100 Firms today. Paying attention to the six factors above will help you create significant value for your firm. If you can achieve success with these factors and you have a huge runway ahead, my advice is to stay independent. If, on the other hand, you are a bit concerned about the future, even though you have created significant value for your firm, “Plan B”, or merging up, might be a very viable option for you.