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10 Steps to Success

Mergers & Acquisitions of CPA firms are highly specialized and require many areas of expertise in order to maximize value and minimize adverse legal and tax ramifications. The “10 Steps to Success” summarizes the entire transaction, along with checklists for each step. It details lists, forms, spreadsheets and legal documents that cover every aspect of the transaction from planning your exit strategy to ensuring a smooth transaction

Why a Merger or Acquisition?

What is behind the recent explosion of Mergers and Acquisitions in the accounting industry?  The answers are obvious.  Mergers and Acquisitions are the most efficient way to achieve the following universal goals:

  • A lucrative exit strategy either long or short-term
  • Create buy-in and buy-out opportunities for staff members
  • Increase the value of a practice for subsequent merger or sale
  • Increase cash flow, economies of scale and profitability
  • Gain market share quickly and efficiently
  • Add new services; financial planning, information technology, consulting, value niches, and investment advisory services
  • Acquire and attract professional talent and potential partners
  • Attract superior clients with greater resources

Ten Steps to Successful Mergers and Acquisitions of CPA Firms

Step 1) Choosing an Acquisition Strategy – You Can Have It All, Just Ask

The first step in the merger or acquisition of an accounting/CPA firm is the determination of an appropriate exit strategy, based on the partners’ goals and objectives. Sellers are in the driver’s seat. They can structure transactions to meet each of their expectations; all they have to do is ask. The following is a list of a few scenarios based on specific exit strategies. There are dozens more.

  1. Acquisition – Selling 100% of the equity with an exit strategy targeted between three and five years.
  2. Buy-In – Selling less than 100% equity interest (usually less than a majority) to a partner for long-term growth with an eventual exit strategy (5 to 10 years)
  3. Buy-Out – Selling out one, or more, of the retiring partners’ interests while the others remain with the firm.  Retiring partners’ exit strategy is within one to two years.
  4. Merger – Two firms joining resources, not necessarily exchanging any cash, and redistributing equity for long-term growth and market share. These transactions usually represent long-term exit strategies; more than 10 years.
  5. Smaller Firms buying Larger Firms –   When no junior partners exist (or qualify) to succeed the existing partners, having a smaller firm (with its own book of business) buy-in to a practice provides a long-term exit strategy, along with cash flow. This strategy allows the larger firm to maintain control over its practice while grooming a successor.
  6. Larger Firms buying Smaller Firms – In this instance, the larger firm almost always purchases 100% of the equity. A pay-out structure that includes sharing in the upside of any growth is usually part of the deal, with an exit strategy that can be either long, or short-term.  In either instance, the selling partners are trading resources and an exit strategy for control over their firm.

Step 2) Determining Value – ‘An Art not a Science’

One of SAFE’s Managing Partners is a prominent member of The National Association of Certified Valuation Analysts and is an Accredited Valuation Analyst (AVA); yet it is common knowledge that CPA firms are valued using a multiple of gross revenue (a rule of thumb).  Key performance indicators and financial ratios are analyzed and ranked based on comparisons among firms of similar size, type and location. This analysis yields a detailed comparison of staffing, services provided, fee structures, realization rates, business concentration, client mix and financial performance. Valuations are often used to implement business plans targeted at realigning administrative, financial and human resource policies to obtain the highest value upon divestiture.  They are also utilized for partnership agreements, mergers, divisions of assets and long term exist strategies.  Below are some of the key areas analyzed.

  • Quality of Clients – What is the probability of client retention and what are the opportunities, or lack thereof, offered by the client base.
  • Scope of Services Offered – What is the depth and breath of the services offered by the firm. Firms require both a broad spectrum of services in addition to niche markets.
  • Quality of Staff Members – The expertise, experience, loyalty and client relationships determine the value of a firm’s staff in addition to the quantity and quality of billable work performed by the staff.
  • Performance Ratios – Productivity, realization and effective billing rates.
  • Profitability of Firm – A trend analysis over five years compares revenue growth, fee structures, overheads costs,  owners’ compensation and benefits, staff expenses, and rent with similar firms and common size ratios.
  • Tangible Assets – These include furniture, fixtures and equipment in addition to receivables, work in process, cash, and net equity.

If comparisons of local firms are not available, many industry studies are available based on surveys of CPA firms nationwide and actual CPA sales.  In either case, the onus is on the seller to rate themselves in each of these areas to determine whether the overall value of their firm is at, or above, market value.   Our experience over the past 10 years has yielded multiples ranging from one (1) times gross revenue (minimum market value for a firm that is not in distress) to one and a half (1.5) times revenue, with the average of 1.2.  

Step 3) Preparing the “Quintessential” Practice Profile

Sellers must present their practice in a clear, concise and concrete manner. This information should be organized into a Practice Profile and an Executive Summary.   The Profile defines and analyzes the seller’s revenue by type of service as a percentage of total revenue, by type of tax return, by frequency of services, by fees per service (both hourly and fee based), by niche markets, by clients (personal versus business) and by the overall breakdown between tax, accounting, consulting and financial services. A Practice Profile should include the following items;

  • A profile is created which represents a company’s highest value based on gross revenue, profitability, realization, business and client trends over a five year period.  
  • The Profile defines and analyzes the Seller’s revenue by type of service as a percentage of total revenue, by type of tax return, by frequency of services, by fees per service (both hourly and fee based), by niche markets, by clients (personal versus business) and by the overall breakdown between tax, accounting, consulting and financial services.
    • Detailed breakdown of the practice by accounting, tax, consulting, and other specific services
    • Number of monthly, quarterly and annual clients and services performed for each
    • Categories of accounting, tax, and consulting services with percentages of revenue generated
    • Length of services provided to clients and their location
    • Payroll, staffing, billable rates and hours worked by each staff member
    • Owner’s Income, Assets, and Details of the Transaction
    • Return on Investment, Transaction Cash Flow, and Debt Service
    • Specific Niche Services and Markets
  • Both collections and billings are compared, monthly and annually, over a five year period along with accounts receivable and work in process.
  • A determination of the market value of intangible and tangible assets is generated along with a detailed analysis of owners’ total compensation.
  • Financial statements are restated to reflect the true operating income (normalized earnings)  then industry standard financial ratios are applied.
  • A company’s employees are analyzed identifying their utilizations and realization rates as they relate to the firm’s profitability.

Discretely, these documents (Practice Profile and Executive Summary, see Chapter #3) can be made available to pre-qualified candidates without revealing the company’s identity.

Step 4) Qualifying Buyers – The Compatibility Key

Using multiple resources such as proprietary databases (lists that may be purchased), the Internet, newspapers, trade magazines and various national publications such as the Wall Street Journal, seller’s can advertise their practices anonymously by taking the following steps. These steps are designed to attract a buyer that is truly compatible with the seller’s practice. This synergy must then be supported by a thorough background check (items 2, 3, and 4 below).

  1. Preparing an anonymous Executive Summary  (one page, 6 paragraphs) which contains;
    – Mission – Your signature philosophy and objective
    – Scope of Services – Range of services and specialties
    – Client Base – Highlights of individual and business clients (who, size, type)
    – Reputation – What your known for in the community and among peers
    – History – Firm’s inception and partnership evolution
  2. Associates – Highlights of credentials and expertise
    Buyers signing a Confidentiality Agreement
  3. Buyers completing a Buyer Profile (same as Seller Profile).
  4. Buyers providing Financial Statements and Credit Reports
  5. Several meetings to evaluate Buyers’ compatibility with respect to their corporate culture, customers, services, fee structure, management style and long-term objectives

Step 5) Economies of Scale – A Pot of Gold

Economies of scale are dollar savings realized when two businesses are combined by 1) the elimination of duplicate expenses, and 2) the spreading of fixed costs over a larger revenue base. From years of experience, SAFE has developed a unique methodology of quantifying and accurately forecasting these savings when accounting practices are acquired or merged.  Significant economies of scale can be identified and achieved increasing profitability considerably. This is particularly evident when two or more locations are combined. Yet even when an Acquisition or Merger does not result in the combination of locations, many economies of scale are realized. These savings are often large enough to cover the debt-service required by either the Seller or a lending institution.

  • Advertising and promotion
  • Automobile
  • Bank service charges
  • Computer maintenance and supplies
  • Education and professional development
  • Health insurance
  • Licenses
  • Malpractice insurance
  • Owner’s salaries and benefits
  • Payroll processing fees
  • Postage and supplies
  • Property & Casualty insurance
  • Property taxes
  • Rent
  • Repairs and maintenance
  • Salaries and wages
  • Software subscriptions and maintenance
  • Telephone
  • Utilities
  • Workers compensation insurance

Step 6) Financing the Transaction – A Piece of Cake

CPA acquisitions are easy to finance. Banks love lending to CPA firms as long as a personal guarantee is provided, even up to 100%.  Nonetheless, the majority of transactions include a down payment, some or all Seller financing, and/or some or all bank financing.  In the case of bank financing the onus is on the Seller to demonstrate that he/she has a viable business with excess cash flow to support the new debt. The Buyer must demonstrate that they are creditworthy and experienced.  The following documents quantify and document the deal’s efficacy:

  • Combined financial statements of the two practices deducting the cost savings from realizing the economies of scale.
  • Monthly cash flow projections for the following twelve months based on the combined financial statements and economies of scale
  • A Schedule of Assets and Liabilities itemizing the collateral available for use in obtaining financing.
  • An Acquisition Analysis documenting the return on investment
  • A cash flow analysis determining the viability of the debt service and the remaining “cash-throw-off”.

Step 7) Letter of Intent Issues – Where the Peddle Hits the Metal

A critical component of the transaction is a non-binding Letter of Intent outlining the offer and detailing the core aspects of the entire transaction.  The most important issues are negotiated in the Letter of Intent. This process culminates with a deposit held in escrow establishing the Buyer’s commitment prior to due diligence.  The Purchase and Sale Agreement is the legal interpretation and detail that support this Agreement.  The following items are negotiated:

Purchase Price
Assets to be Sold
Down Payment
Adjustment Period
Liabilities Assumed
Terms and Interest Rate

Adjustments to Purchase Price
Due Diligence
Allocation of Purchase Price
Specific Agreements

Step 8) Preparing for Due Diligence – Do or Die

Due diligence is a vital step in the transaction process.  In addition to verifying income and expenses, every service, client (and their files), employee, and tax return must be quantified, analyzed and verified. This process usually takes anywhere from one to five days. The best advice here is to perform a “mock” due diligence analysis before proceeding with any buyers.  Skeletons need to be flushed out by the seller, not the buyer. Specific items reviewed include:

  • Client Lists and Billings
  • Client Files and Work Papers
  • Work in Process and Accounts Receivable
  • Deposits and Bank Statements
  • Employee Salaries, Benefits and Agreements
  • Financial Statements and Tax Filings
  • Revenue by Service, by Month, and by Year
  • Overhead and Profit
  • Owners Income and Perks

Step 9) Legal Agreements and Documents – No Mystery

Depending upon the type of transaction, the following is a list of some of the important legal documents required in an M&A transaction.

  • Confidentiality Agreements – Defines information that is confidential and specifies an agreement between the parties on how this information is to be used and disclosed.
  • Asset Purchase Agreements (or Stock Purchase Agreement) – Describes and conveys the intangible and tangible assets (or Stock) being sold with the necessary warranties and representations specific to the sale of the assets of an accounting practice.
  • Partnership, Operating and/or Shareholders’ Agreements – Describes the duties and responsibilities of the partners/shareholders and how the partnership/corporation/LLC is to be operated and managed.
  • Buy-Sell Agreements – Describes how possible future events relating to buy-sell, death and disability issues will be handled procedurally, legally and financially.
  • Restrictive Covenants – An agreement whereby the Seller agrees not to compete with the buyers for a specified period of time, geographic location, and types of services.
  • Exhibits – Schedules that detail the clients, revenues, assets, liabilities, accounts receivable, work in process and any other equity items that may or may not be part of the transaction.

10) Closing Documents & Transition – Details, Details, Details

Each transaction is different and requires specific contracts, agreements and documentation that must be carefully orchestrated.  This means not relying exclusively on attorneys. The parties to the transaction must stay proactively involved in each step of the process, including legal documents. The following documents are typical, but tailored, to each transaction.


From Blog

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Get The Complete Guide To Mergers & Acquisitions of CPA Firms
* Acquisition Strategies
* Valuation of CPA & Accounting Firms
* Practice Presentation
* Compatibility & Risk
* Economies Of Scale & Financing
* Letters Of Intent
* Due Diligence
* Legal Documents
* Closing Requirements
* A Smooth Transition