The Complete Framework
10 Steps to Success
Mergers & Acquisitions of CPA firms are highly specialized. These ten steps summarize the entire transaction — from exit strategy to smooth transition.
We Wrote the Book
The Complete Guide to M&A of CPA Firms
By Cindy Ragan
CVA, Economist
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.
01
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.
- Acquisition — Selling 100% of the equity with an exit strategy targeted between three and five years.
- 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).
- 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.
- 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.
- Smaller Firms buying Larger Firms — When no junior partners exist 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.
- 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.
02
Determining Value
'An Art not a Science'
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.
- Quality of Clients — What is the probability of client retention and what are the opportunities offered by the client base.
- Scope of Services Offered — What is the depth and breadth of services offered by the firm.
- Quality of Staff Members — Expertise, experience, loyalty and client relationships determine the value of a firm's staff.
- Performance Ratios — Productivity, realization and effective billing rates.
- Profitability of Firm — A trend analysis over five years compares revenue growth, fee structures, overhead costs, owners' compensation and benefits.
- Tangible Assets — Furniture, fixtures and equipment in addition to receivables, work in process, cash, and net equity.
03
Preparing the "Quintessential" Practice Profile
Present the practice clearly, concisely and concretely.
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, 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
04
Qualifying Buyers
The Compatibility Key
Using multiple resources such as proprietary databases, the Internet, newspapers, trade magazines and various national publications, sellers 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.
- Preparing an anonymous Executive Summary — Mission, Scope, Client Base, Reputation, History
- Associates — Highlights of credentials and expertise
- Buyers signing a Confidentiality Agreement
- Buyers completing a Buyer Profile
- Buyers providing Financial Statements and Credit Reports
- Several meetings to evaluate Buyers' compatibility with respect to corporate culture, customers, services, fee structure, management style and long-term objectives
05
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, we have developed a unique methodology of quantifying and accurately forecasting these savings when accounting practices are acquired or merged.
- Advertising and promotion
- Computer maintenance and supplies
- Education and professional development
- Health insurance, Malpractice insurance, Property & Casualty insurance
- Owner's salaries and benefits
- Payroll processing fees, Postage and supplies
- Rent, Utilities, Telephone
- Software subscriptions and maintenance
- Salaries and wages
06
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.
- Combined financial statements of the two practices deducting the cost savings from economies of scale.
- Monthly cash flow projections for the following twelve months based on combined financial statements.
- A Schedule of Assets and Liabilities itemizing the collateral available for 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.
07
Letter of Intent Issues
Where the Pedal 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.
- Purchase Price
- Assets to be Sold
- Down Payment
- Adjustment Period
- Liabilities Assumed
- Terms and Interest Rate
- Adjustments to Purchase Price
- Non-Competes
- Due Diligence
- Employment
- Allocation of Purchase Price
- Specific Agreements
08
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.
- 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
09
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 confidential information and how it is to be used.
- Asset Purchase Agreements (or Stock Purchase Agreement) — Conveys the intangible and tangible assets with required warranties.
- Partnership, Operating and/or Shareholders' Agreements — Describes duties and how the entity is to be operated.
- Buy-Sell Agreements — Handles future buy-sell, death and disability events.
- Restrictive Covenants — Agreement not to compete for a specified period, geography, and types of services.
- Exhibits — Schedules detailing clients, revenues, assets, liabilities, AR, WIP and other equity items.
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.
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All ten steps in detail — with checklists, forms and legal templates — are in the book.