By Tom Mishoe, CPA, CMA, MBA
CPA firm growth may occur either organically or through acquisition. Firms often choose to acquire other practices to (1) more quickly achieve desired client, revenue or profit growth, (2) fill existing or expected partner/employee, geographic or service capability deficits, (3) obtain higher quality or specialized talent, or (4) reduce fixed “infrastructure” costs. If you are considering an acquisition, proceed with caution. While acquisitions can be effective in meeting these firm objectives, they are not without significant challenges and risks.
There are key issues to thoroughly consider before, during and following a (potential) acquisition. An experienced mergers and acquisitions (M&A) advisor can provide further information about the topics discussed below and can be instrumental in helping to implement an efficient, effective and successful acquisition process. Experienced advisors will significantly reduce the acquirer’s potential risk by helping to develop an acquirer strategy, develop acquisition target attributes, provide due diligence, structure transactions, close transactions and, in some cases, implement post-acquisition procedures.
There are many CPA firms with partners at, or approaching, retirement age — but with no viable exit strategy. While this represents a significant opportunity for acquiring firms, these acquisitions must be pursued ONLY if the acquisition would otherwise fit within the strategy of the acquiring firm.
Develop a Type of Exit Strategy
Before you initiate the acquisition of another CPA firm, develop your own future exit strategy. There are not many companies, particularly smaller firms, who do this well. As a result, many CPAs and CPA firms leave “money on the table” in their own exits. Important items to consider include:
- When will we exit? Is the expected exit driven by a predetermined date, age of one or more key partners, an event or some other determining factor?
- To whom will we sell? The answer to this key question determines whether the exit plan will be internally or externally focused.
An internally focused approach requires a well-developed and implemented business succession plan. Key questions include: How long will key partners continue to lead the organization? Are there identified successor(s) and do they have the skills to continue to effectively lead the firm? If not, are there viable plans to ensure the successors will be adequately prepared for leadership roles? Are the identified successors fully committed? Is there an agreed-approach to firm valuation and transaction structuring, pricing and funding? Can the successors make agreed-upon payments?
An externally focused approach requires significant thought about the buyer(s) who might best be able and/or willing to purchase your firm at the desired exit point. Key determinants important to a potential buyer include selling firm attributes such as size, geographical footprint, client list, particular areas of service focus, capabilities of the partners/employees, culture and general reputation.
Whether preparing for an internally or externally focused exit strategy, it is critical for the firm to ensure its own long-term financial health while moving toward its own exit plan. In addition to an exit strategy, this includes appropriate compensation plans to recruit, retain and reward key employees to serve the firm’s current and future clients. Additionally, the owner must have appropriate succession plans. Statistics indicate only 30 percent of firms have buy-sell agreements, and of those, only 30 percent are adequately funded. This means less than 10 percent of firms have an identified and properly funded succession plan.
So what happens to the firm if an owner or key employee has one of the following events: disability, death, divorce, bankruptcy or the owner becomes hostage to the business because of the lack of a meaningful exit strategy? Asked another way: how would you like to be in business with your former partner’s wife’s new husband’s lawyer? Appropriate succession strategies with adequate funding mechanisms are critical to ensure the firm’s long-term survival. Without appropriate plans in place, an event like one described above will significantly decrease (if not totally destroy) the value of the CPA firm. Properly structured plans and funding mechanisms can prevent forced firm liquidation, buy time for a firm to replace a “key man” who has died or become disabled, provide collateral to support a loan or provide an alternative source to meet borrowing needs. These plans, agreements and funding mechanisms should be reviewed on a periodic basis to ensure adequate protection to the firm in the case of unforeseen events.
What Do You Want to Be When You Grow Up?
To find and acquire the appropriate firms, you must determine “what you want to be when you grow up.” In other words, you must develop and clearly enunciate your firm strategy, which is critical to determining and identifying the parameters for an acquisition. This strategy must be proactive and developed PRIOR to beginning the acquisition process. Examples of firm attributes with strategic implications to an acquisition include:
- Clients served: Do you serve particular industries or companies of a particular size or business mode (profit, nonprofit, governmental, etc.)? Do you intend to continue in your existing industry/market niches, expand into peripheral industries/markets or engage with new industries/market?
- Services provided: What services do you currently provide to your clients? Do you intend to maintain these current services or expand your client service offerings? Does the desire to expand services simply reflect a desire to enter into a potentially lucrative new market(s) or is this expansion critical to your ability to retain existing clients who have entered new industries, become more “complicated” or simply “demand” other services? What is the ability of your existing employee base to meet current and anticipated client needs?
- Geographical footprint: What is the geographical footprint you currently serve? What additional geographical area(s) present viable opportunities AND can be managed by existing and potential acquired personnel?
- Size considerations: How large are you? How large do you want to become? What ability do you have to adequately absorb an acquisition?
- Culture: What is the firm’s culture? While this can be difficult to define, think about the following types of questions: What is truly important to the firm? How are clients and employees treated? How does the firm work to achieve its objectives? What are the personalities of key partners, employees and clients?
Identify and Locate Potential Acquisitions
An experienced M&A advisor will provide invaluable assistance in identifying and locating potential acquisition candidates. Based upon the firm’s strategy, “best attributes” for an acquisition can be identified. Subsequently, specific acquisition targets can be identified and contacted to determine interest in a potential transaction. This may best be performed by the M&A advisor, who can make discreet contact with acquisition targets, determine the potential interest of these targets and maintain confidentiality of the acquiring firm until serious interest has been established.
The due diligence process is critical to verify information provided by the acquisition target, identify areas that require additional information and/or analysis and recognize areas of potential risk or value. While the list of items deserving some level of due diligence attention can be quite long, examples of important items include:
- Financial results: An acquirer should fully understand all aspects of the financial status of the acquisition target. This provides for the opportunity to identify areas of opportunity as well as plan for corrective action where financial results are lacking. Leases, contracts, insurance policies, etc. should be thoroughly reviewed.
- Clients: While respecting the confidentiality of client information, important aspects of a prospective client base to understand include: services provided to each client, fee structure, client revenue and profitability by component services, client longevity by component services, identification of existing or potential firm liabilities and/or litigation related to client issues, identification of potential future projects, identification of other services desired by clients, length of time client has been served by current engagement teams and planned client transitions.
- Partners & employees: Important information related to a prospective group of partners and employees include: partnership and employment agreements, desired timing of transitions and exits, salary, benefits, bonuses and other compensation, longevity, current and planned education and certifications, status of continuing professional education requirements, summary performance reviews, identification of individual performance issues, areas of existing or contemplated specialization and identification of clients served and length of time and dates served on specific client engagements.
- Service capabilities: The respective service capabilities of the buyer and the seller should be compared and contrasted to determine overlap of service capabilities as well as potential new service capabilities available to the acquiring firm.
- Culture: See above for brief discussion of culture. The importance of compatibility of the respective organizational cultures cannot be overstated.
Transaction structuring reflects the negotiation between the parties. There is certainly some truth to the old M&A saying of “a deal where both parties are not (at least somewhat) irritated is a deal that will not close.” All parties will have certain issues that are highly important and, if not effectively resolved, will likely destroy a deal. In other cases, it is possible for contentious issues to not preclude a closing but, because the issues were not resolved in an appropriate manner for both parties, the result will be significant post-acquisition challenges. While all parties want to “get a good deal,” both parties must realize that appropriate compromise and agreement on significant issues may not only determine whether a deal closes but the future success of the acquisition.
While many items may be negotiated, issues typically critical to the structuring process include: acquisition price, payment schedule, fixed versus variable acquisition pricing, client retention, partner transitions, post-acquisition compensation for all employees, firm management and ownership and post-acquisition firm leadership.
The two most significant assets in a CPA firm sale are clients and employees. Acquiring firms must remember that acquired employees have the ability to move their employment (potentially to direct competitors) and that clients, if unhappy with their post-acquisition engagement teams, can “require” team changes, follow key engagement team members to a new firm or seek bids from other firms. While this does not mean an acquiring firm should give a selling firm “everything they want,” it does mean the acquirer should think long and hard about the consequences of certain negotiating positions and decisions to the ability to close a desired transaction and effectively integrate and manage the acquisition.
Both parties in an M&A transaction often fail to move expeditiously toward closing. While I am not suggesting taking transaction shortcuts or failing to “dot each ‘i’ and cross each ‘t,’” I believe one should be diligent in completing transaction-related activities as quickly as possible and moving forward to the next transaction activity. Things can rapidly change — buyers or sellers can become distracted with their own internal issues and challenges or see what appears to be a “better deal.”
Additionally, this approach will limit time being wasted on a transaction that will never close. If you are going to get to “NO,” it is to the benefit of all parties to get to “NO” as soon as possible. Good M&A advisors will continually drive the transaction toward closing. Both buyer and seller should have a dedicated deal team to ensure tasks are quickly completed and issues are identified and solved.
After the Closing
Post-closing efforts should be focused on implementing the plans that were developed prior to closing. If you are developing post-acquisition plans following closing, it is highly likely you will end up with a failed, or at least much less successful, acquisition.
Finally, exhibit the utmost integrity, both legally and morally, in all deal activities and decisions. Fulfill your promises, exactly. Word quickly gets around the professional and business communities. You may want to acquire another firm in the future!
Tom Mishoe is the founder and president of FinOpStrat Advisors, LLC, in Richmond, providing financial, operational and strategic advisory services. Email him here.