The primary complaint of most C.P.A. firm owners that are ready to retire and monetize their practices is that there are few, if any, next generation successor partners to inherit their practice. Consequently, in today's market, many owners must resort to selling or merging their practices. The truth is that many owners of small to medium-sized C.P.A. firms have not adequately prepared their firms for sale or merger. In most cases, a successful sale or merger cannot be accomplished in a hasty fashion; it requires a sufficient ramp-up time for shaping the practice into one that a buyer will desire and be willing to pay market, or even a premium price.
How CPA Firms Are Sold
Most sales of C.P.A. firms are structured as retention-based sales. There are many variations, but a typical deal usually involves a contingent sales price based upon a percentage of collected billings for a fixed period of time. The percentage and time-period metrics will reflect a percentage of a year's billing as the total selling price. For example, if a practice will sell for 1x annual billings, the percentage of collected billings would be 20% over a 5-year period. In a retention-based sale, the risk is shared by both the buyer and the seller.
Some deals require a cash down payment, but the amount of cash is usually a small percentage of the overall selling price, usually no more than 10 to 20%. Some sales are structured as a multiple of the owners' pay or distributions. For example, 3x an owner's annual pay or distributions is a common multiple.
Current Market Pricing
Today, it is uncommon that a firm will sell for greater than 1x annual billings. Firms are selling for 85% to 95% of annual billings, depending upon the quality of the clients and employees. Internal sales to employees typically sell for a lesser multiple, usually around 70% to 75% of annual billings.
Client Quality Is Key
For a successful exit, the existing clients at the time of sale need to remain clients of the successor firm. If not, the buyer forfeits the revenue, and the seller forfeits the sales price — it is that simple. An attractive practice will consist of quality clients. For this purpose, “quality” consists of billings at market rates, loyal clients, clients that pay their bills timely, and clients that are either business clients or high-net worth individuals.
A practice that consists of a large volume of individual tax returns at low or discounted prices will not be as attractive to a buyer, unless the buyer is a high volume 1040 practice that merely wants to add to the top line.
The Importance of Market-Rate Billing
For a practice that consists of a good mix of business and individual clients, it is critical that the rates charged reflect current market rates. Clients that are undercharged will undoubtedly experience an unexpected increase in rates when the buyer assumes control. These clients are at great risk to leave.
Too often a mature practice will contain billings for legacy clients that have not kept pace with market billing rates. Many owners are reluctant to raise fees on clients that were clients when the firm first began, or clients that are relatives and friends. The hourly billing rates should reflect the difficulty of the work and increased costs and risks of operating a C.P.A. practice in today's marketplace.
Employee Retention
Experienced, and quality employees seem to be in short supply today. Many buyers are not only looking to expand their client base and revenue, but are also looking for quality employees. Employee retention will also be key in attracting qualified buyers.
A Readiness Plan
1. Enough Lead Time
The ideal time-frame for preparing for a sale requires at least three years lead time — five would be better. Some firms have succession plans that extend 10 to 20 years out, but the majority of small firms start to think about an exit plan much too late — in some cases merely a year before retirement. The lead time is necessary to have enough ramp-up space to increase fees to market rates, and to cull out clients that are poor payers and inordinately consume valuable production time.
2. The Tough Part: Increase Fees
Increasing fees to bring the firm into market value is the most critical component:
Eliminate as much as possible those clients that are charged very discounted rates or are done for free. This is obviously difficult where friends and relatives are involved, but necessary.
Review billing rates of owners and employees. Where necessary, institute a planned three-year incremental increase in hourly rates.
Review the billings for every client for the last three years. Institute a program to raise fees by at least 10% each year per client; more if possible.
Identify premium work and bill at premium rates that are higher than the standard rates. For example, estate and trust and international work could be billed at premium rates.
Implement a minimum 1040 fee for new clients — and stick to it. New clients that are not willing to pay the minimum should look elsewhere.
Identify why there are write-offs and poor realization. Decide whether the work is profitable and whether it should be continued or performed more efficiently.
Set as a goal to increase the top line by at least 10% to 20% each year.
Strive to have a bottom line margin that is no lower than 35%, and ideally at least 50%, before owner’s salary or distribution.
3. Continuous Review
- A plan is only as good as the implementation. Periodic reviews during the year should be scheduled.
- The reviews should consist of analyzing client billings for write-downs, realization, potential for fee increases, account receivable aging, and profitability.
4. Employee Retention
- It is often said that a firm's greatest assets are its employees. Review employee benefits, understand current salary requirements and trends, encourage mentoring and coaching, and provide continuous training and education.
- If the sale is an internal sale to one or more employees, it may be necessary to provide compensation incentives to these employees to provide them resources to fund a buy-out.
The above discussion is meant to be a guideline or a good place to start if you are contemplating a sale of your firm in the foreseeable future. Planning for a sale requires careful thought, a sufficient lead time for preparation, and the ability to make difficult decisions regarding fee increases and employee retention. The goals are twofold: to attract buyers, and to command the highest price possible.