Staying independent while keeping an eye on an upward combination
Your firm was knocking the cover off the ball pre-financial crisis (circa 2007 and 2008) with a strategy of getting bigger with quality growth, stronger with quality talent, and more profitable, but it is increasingly obvious that it has become difficult competing in today’s mid-market space. The business environment is anemic and organic growth is hard to come by. Your challenge is exacerbated when you see an insufficient number of young superstars and rainmakers, and your senior partners—mostly baby boomers—don’t have an awful lot of “golf course” left to play.
It’s decision time. What do you need to do to go it alone and stay independent? What strategy will perpetuate the firm for the next generation and, in the distance, should you keep an eye on an upward combination?
There are no magic bullets. It takes hard work to remain independent and to grow your firm’s top and bottom lines. And how you go about it depends on how you answer a series of questions including the following:
- Are your partners on the same page strategically?
- Does your firm have a sound basic governance and economic model with an emphasis on firm growth, profitability and sufficient capital for future investment?
- Does your firm have the proper mix of client service partners and staff?
- Is there sufficient leadership and management talent at your firm?
- Do you have the right amount of partner accountability?
- Is there a sound performance management and compensation plan?
- Does the firm have the right number of superstars and rising stars?
- What is the plan to transition clients upon partner retirements? Are clients able to be transitioned? Will your firm need to go to the outside for talent to ensure smooth client service during transitions?
- Do your professionals have the right mix of technical, business and staff development skills?
- Does your firm have an adequate pipeline of internal candidates when it is time to change the managing partner and other leadership positions? Should your firm search externally?
- Do the roles and responsibilities of the managing partner and other leadership positions need to change as the firm evolves?
- Is there adequate capital to fund investments?
- Is the firm able to pivot from an accounting firm model (compliance services) to a professional services firm model (high-margin consulting and advisory services)?
- Will the firm be able to create brand permission and a message to the marketplace? Is there an appetite for dilution in the early years?
Once you begin to tackle these tough questions, you will also have to decide if you want to go big, go deep or pursue a taste of both options at the same time. No matter which path you take, don’t bite off more than you can chew.
Why go big? Because the marketplace places importance on size and brand awareness. Perception (and it's perception, but it’s also our reality) is that bigger is better. How big depends on your firm’s ability to digest and integrate. But the bigger you are, the odds are that your client list, your partners and your staff are more impressive. And an impressive client list with impressive partners and staff usually will help a firm attract and retain additional high quality clients and people. There is little doubt in our minds that the marketplace craves a “branded” firm that can consistently provide value added solutions and advice on how to grow EBITDA and working capital.
Why consider going deep? Because the marketplace cries out for a specialty firm with market distinction. Local and regional firms that are deep with industry expertise usually generate excellent livings for their partners. Industry specialization sells.
While you are working hard to going it alone, it’s very smart to become “educated” about an upward combination. An upward combination can catapult your firm with scale and talent.
A key consideration in an upward combination is the valuation of your practice. Today, we typically don’t see valuations of 100 percent of revenues as partner earnings are lagging in today’s environment and investments in talent and infrastructure need to be made. A practice payment in today’s economy is usually pegged at 75 to 80 percent of annual revenues plus net current assets. At some firms, there is a valuation cap equal to the amount that would be paid under a firm’s retirement policy. Other key components in a combination are compensation guarantees and capital funding methods. If you would like to understand about the value of an upward combination, retain a professional advisor who can help you identify viable candidates and help negotiate deal points.
I'm a big believers in a going alone strategy, particularly for small and midsize firms. We have seen many small and mid-sized firms prosper when they stick to their knitting and stay on a chosen strategic path. Unfortunately, however, we also find that many small and midsize firms lack the discipline to chart and stick to a strategic path. It is often said that leading a CPA firm is very much like herding cats (everyone going in different directions) because firms are very good at talking and planning about their future (it’s in their DNA) but are terrible at execution and implementation.
It’s a little like a shoemaker’s shoes. Partners get distracted with client service or low-hanging fruit and give up too quickly in creating change within their own firms. T. Boone Pickens, chairman of BP Capital Management, once said, “If you’re going to hunt elephants, don’t get off the trail for a rabbit.” That’s good advice for CPA firms!