IN OUR OPINION, PERSPECTIVE #63 — July 22, 2018
(A Continuing Series for Leading CPA Firms)
HOW DO YOU CREATE SIGNIFICANT FIRM VALUE?
IF YOU CAN GET THERE, SHOULD YOU SELL
OR STAY INDEPENDENT?
“Willingness to change is a strength, even if it means plunging
part of the company into total confusion for a while.”
— Jack Welch
We are often asked two questions by small and midsized CPA firms:
- How do we create significant firm value?
- If we can get there, should we sell or stay independent?
The answers to these questions, of course, depend on a firm’s particular facts and circumstances and one size does not fit all. Nevertheless, we are happy to share our perspective based on best practices.
In Our Opinion, a firm needs a number of ingredients to create significant value. Presented below are arguably six of the most important:
- A culture that breeds a firm first mentality. Many firms put too much emphasis on the book of business and not enough emphasis that you are a team and, as a team, you aremuch 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. Easy to say but not easy to do and most small and mid-sized CPA firms can’t get there.
- Existing partners that have strong business development skills. Today, probably more than ever before, organic growth is difficult to come by as the middle market economy continues to lag with no immediate change in sight and work for a CPA firm isn’t just coming in the door the way it used to pre the financial crisis. As a result, probably more than ever before, firms need about 25% of their partner group with strong business development skills and knocking the cover off the ball with new business each and every year, about 50% has to have some moderate business development success and the remaining 25% has to be business development supportive by writing articles in trade journals, as an example.
- 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”. And while we understand why “slot shots” occur (partner retirements, organic growth, acquisitions, etc.), taken to an extreme, this practice truly undermines the value of a firm because more than likely it doesn’t breed for a strong succession plan. If your partner group has slipped into mediocrity and you wish that your firm was great again, start by raising the bar for your new partner admissions. Moving from senior manager or principal to non-equity partner (yes — we believe in two classes of partners — entry level is non-equity; highest performers rise to equity) should be a consideration after functioning two, perhaps, three years as a senior manager or director. Potential partners with the “right stuff” demonstrate that your firm has a fairly good chance to enjoy a long runway – an ingredient that improves the value of a firm.
- Skills and services beyond compliance. By now, it should be pretty 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 in that work is flat lined at best. To create significant value for your firm, you must begin to pivot from a compliance shop into an advisory firm that provides consulting services such as international tax, transaction advisory services, 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.
- 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. We strongly suggest that your firm select three or four industry sectors and specialize in them. Examples include construction, real estate, professional service firms and hedge funds. As a by-product of the attest and tax services, offering a memorandum that summarizes your observations to improve EBITDA and working capital, are value-adds that demonstrate a distinctiveness in the marketplace. And the stronger your people get in the industry sector, and the “better looking” your client list becomes, the better your chances are of attracting better quality laterals and marquee clients that are recognizable names in the marketplace. This enhances value.
- Critical mass or annual revenue base of $20 million to $25 million and at least 35% profits available to partners. Based upon years of M&A experience, it is our observations that in every market or geography, including the largest such as New York, Chicago and Los Angeles, we have found that firms that can achieve $20 million to $25 million in annual revenues with at least 35% 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?
It’s our view that 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, we believe 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 done the line.
It is 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 have you create significant value for your firm. If you can achieve success with these factors and you have a huge runway ahead, our best advice to you 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”, merging-up might be a very viable option for you.
Dom Esposito, CPA, is the CEO of ESPOSITO CEO2CEO, LLC — a boutique advisory firm consulting to leading CPA and other professional services firms on strategy, succession planning and mergers, acquisitions and integration. Dom, voted as one of the most influential people in the profession for two consecutive years by Accounting Today, authored a book, published by www.CPATrendlines.com., entitled “8 Steps to Great” which is a primer for CEOs, managing partners and other senior partners. In Our Opinion, is a continuing series of perspectives for leading CPA firms where Dom and his colleagues share insights, experiences and wisdom with firm leaders who want to “run with the big dogs” and develop their firms into sustainable brands. Dom welcomes questions and can be contacted at either firstname.lastname@example.org or 203.292.3277.