“The worst thing you can possibly do in a deal is seem desperate to make it. That makes the other guy smell blood, and then you’re dead “. — Donald J. Trump
The last several years have experienced a “merger
frenzy” with small and mid-sized CPA firms (with annual revenues
between $10M and $24M) getting acquired by larger CPA firms that
have a strong brand and a track record of average to above average equity
partner profitability. Further, while it cannot be characterized as a “merger
frenzy”, there certainly is considerable “consolidation” among
firms with annual revenues between $25M and $100+M.
Opinion, the “merger frenzy” and “consolidation”
have occurred and willcontinue (at least in the near future)
because of some combination of the following challenges:
Post the 2008 financial crisis, a decline in equity
partner profitability because of slow organic growth.
The inability to find experienced, professional
An ageing “baby boomer” population; senior partners
(significant generators of new business) are retiring at a significant pace.
The concern about significant technology and HR
investments and their drain on profitability.
The transformation (occurring as firms pursue higher
margin lines of business) from the traditional CPA firm model to a professional
services firm model that requires significant investment for talent and
The need to shore up partner talent, credentials and
the ability to compete for larger clients.
Leadership succession issues.
As a result, there is a very good chance that your CPA
firm, either as an acquirer or as an acquiree, will entertain a strategic
transaction or “deal” in the near future. The purpose of this newsletter is to further
a reader’s understanding of two important aspects when pursuing the “art
of the deal”:
The prices paid for accounting firms sold over the
last two years with a particular focus on:
with annual revenues below $25M.
Firms with annual
revenues between $25M and $100M.
A synopsis of the terms and deal points for the above
The practice payment (i.e., the price
paid) for CPA firms with annual revenues between $10M and $100+M is based on a
multiple of annual revenues (usually ranging between 75% to 100% although there
are exceptions both below and above this range). The multiple varies and
depends on the bottom-line profitability percentage distributed to the equity
partners. Presented below are typical illustrations:
For smaller firms with annual revenues below $25M, experience has demonstrated that many of these firms
face serious succession issues and usually require some upgrade in partner
talent, audit/tax quality, size and profitability of clients, IT systems,
marketing, etc. The expectation is that a firm’s bottom line profitability
percentage (distributed to the equity partners) usually ranges between 37% to 50+%
(although there are exceptions both below and above this range) as the
partners, on average, have between 1,500 and 1,800 annual billable hours.
Presented below is typically found in the marketplace:
If a $20M firm with 40% equity partner profitability
is acquired, the practice payment would be about $20M.
If a $20M firm with 60% equity partner profitability
is acquired, the practice payment would be about $24M.
For firms with annual revenues up to $100M, experience has demonstrated that many of these firms
want to be associated with a larger brand to shore up partner talent and client
credentials and to enhance their ability to compete for larger clients.
Succession issues are also a concern but usually to a lesser extent than what
found with firms with
annual revenues below $25M. The expectation is that a firm’s bottom line
profitability percentage (distributed to the equity partners) usually ranges
between 32% to 37%
(although there are exceptions both below and above this range) as the partners,
on average, have between 1,200 and 1,500 annual billable hours. Presented below
is typically found in the marketplace:
If a $80M firm with 37% equity partner profitability
is acquired, the practice payment would be about $80M.
If a $80M firm with 60% equity partner profitability
is acquired, the practice payment would be about $96M.
of the Terms and Deal Points for the Above Transactions:
The CPA firm “merger frenzy” and “consolidation”
have occurred and willcontinue (at least in the near
future) also because acquirers, who usually have (or are) effectively
addressing the challenges facing sellers, need talent and critical mass to fund
investments and compete in the marketplace.
The above “deals” or transactions are usually
structured as asset purchases. Presented below are the typical terms and
significant deal points:
Generally, acquired firm partners will join acquiring firm
as either equity or non-equity partners with the rights and obligations set
forth in the acquiring firm’s Partnership Agreement, except as expressly
amended in their respective
Supplement. The Partnership Agreement
contains customary restrictive covenants as to clients and employees after a
partner leaves the firm.
Individuals admitted as equity partners will make
varying amounts of capital contributions (risk capital) per the terms of the acquiring
firm’s Partnership Agreement (usually about $100K upon admission and up to
$350K over time with annual contributions after the initial $100K at six to ten
percent of compensation, along with the right to prepay up to $350K at any
time). The proceeds from the purchase of
the acquired firm’s fixed assets (below) can be credited toward capital
contributions. Interest is paid on
capital contributions at about ten percent per annum.
Aggregate compensation to acquired firm partners
during the two years after closing (the “guarantee years”) will be guaranteed
at not less than their aggregate compensation for the year prior to closing,
provided overall acquired firm revenues and profit are maintained at the same
level as for the year prior to closing.
Compensation would be reduced pro rata in the event of a decrease in
revenues and/or profitability. Acquired firm partners will be considered for
should revenues and/or profitability increase.
Compensation would be allocated among the acquired firm partners in such
manner as acquired firm
representatives determine, subject to the acquiring firm’s right of reasonable
Compensation would be paid per the terms of the acquiring
firm’s Partnership Agreement and the Compensation Plan, with the anticipation,
however, that during the guarantee years, no newly admitted partner would
receive after tax cash flow at any point during the year (assuming target
revenues and profitability are met) less than after tax cash flow received
during the year prior to closing
Acquired firm partners will receive a practice
payment that would be allocated among the acquired firm partners prior
to closing in such manner as acquired firm representatives determine, subject
to an acquiring firm’s right of reasonable review. Each acquired firm partner
would be entitled to receive his/her benefit upon withdrawal from acquiring firm
(provided the partner has remained with the firm a minimum of four years), paid
over ten years from the date of withdrawal.
acquired firm partners would be eligible for consideration for vesting
into the acquiring firm retirement plan (in lieu to the practice payment provided
for above) based upon future performance.
Purchase and Other Business Combination Issues:
Acquiring firm will purchase the
fixed assets of acquired firm required for the ongoing operation of its
business at book value, payment to be made at closing.
Acquired firm will transfer to acquiring
firm its AR and WIP existing at time of closing. The amount of the AR and WIP
collected by acquiring firm, less any acquired firm debt assumed by acquiring firm,
will be added to the practice payment. AR and WIP collections will be credited to acquired
firm partners for
purposes of determining
compensation during the Guaranty Years (and whether revenue and/or
profitability targets have been met).
Acquired firm will assign, and acquiring
firm will assume, the acquired firm office leases and operating agreements.
Acquiring firm will offer employment
to all acquired firm employees.
Acquired firm will purchase tail
insurance at the same level as insurance is currently maintained to cover
against post-closing claims and acquired firm partners will indemnify acquiring
firm against claims arising out of acquired firm pre-closing activity.
The “art of the deal” is a sensitive
negotiation between buyers and sellers. The best “deals” are cut when there
is both an educated consumer as a buyer and an educated
consumer as the seller and that there is an
understanding that there has to be reasonable give and take. A deep
understanding of the prices paid and the important terms and deal
points will create efficiencies in the
transaction process which usually is filled with starts and stops and can take
months before closure is attained.
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 shares 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 email@example.com