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1 Joel Sinkin Joel Sinkin is the President of Accounting Transition Advisors, LLC a firm that exclusively consults on Mergers & Acquisitions for Public Accounting Firms. Mr. Sinkin is an expert in practice evaluation, succession planning and transaction structure. He has personally overseen 900+ transaction closings of accounting firms since He has worked with firms of all sizes from sole proprietors to large regional and international firms. He consults on internal and external succession planning and provides complete transaction support including valuations, alternative deal structures, documentation, due diligence and transitional issues regarding partners, staff and clients. MNCPA Footnote, The Asset, CPA Leadership Report, CPA Wealth Provider, Mergers And Acquisitions, The EA Journal, Best Practices in People Management (a Watson Wyatt publishing product). Joel co-authored BUYING AND MERGING CPA FIRMS published by PPC. Accounting Transition Advisors is dedicated to working exclusively with accounting firms nationwide to: Develop and execute strategies to expand through mergers and acquisitions Identify objectives and create unique methods to facilitate retirement and other transition of owners Build business plans and owner agreements to facilitate and manage internal succession Joel teaches CPE courses and lectures for the AICPA, many State Societies of CPAs, National Accounting Organizations and many other professional organizations. Mr. Sinkin is frequently quoted in trade magazines and has had articles authored by him or about him published in The Journal of Accountancy, Accounting Today, The CPA Journal, Insight, The Practicing CPA, The Practical Accountant, Inside Public Accounting, The New Jersey CPA, The Tax Pro Quarterly, The Sum News, The Diplomat, Florida CPA Today, The Business Journal, The jsinkin@transitionadvisors.com toll free (866) Mr. Sinkin is an editorial advisor to the AICPA s newsletter Small Firm Solutions. Recently Mr. Sinkin fulfilled a personal goal to create a new type of consulting firm that brings a fresh approach to the succession and growth needs of accounting firms and their owners nationally. In 2004, he joined forces with Terrence E. Putney, CPA to form Accounting Transition Advisors. MERGER AND TRANSITION ADVISORS EXCLUSIVELY SERVING THE NATIONAL ACCOUNTING COMMUNITY

2 Succession Planning For Accounting Firms In Today s Economy Joel Sinkin Accounting Transition Advisors Accounting Transition Advisors About the firm: Merger and transition advisors exclusively serving the accounting industry Customized solutions Over 950 transactions, over 18 years of experience Represent the buyer or seller Services include: Buyer-seller introductions Merger and acquisition transaction structure Document preparation/review, valuation and due diligence Post-transaction business planning General consulting and coaching

3 If there are 50 things you need to think about in a transaction. the smartest of us will think of only 35 Why is Activity So High? Competition Staffing Technology Niche Development Aging of the partners/staff The Economy

4 Three Ways to Grow One client at a time Develop marketable niches Merge or acquire another firm How will the Economy impact value Cash Upfront Retention Periods Treatment of A/R Buyers versus Sellers Marketplace Multiples

5 Starting the Transition Process When should we start? How many more tax seasons do you want to work? Client face time Investments including technology, leases, staff Start succession process during establishment of new firm and partnership agreements are in draft Is Your Successor Ready? Do you know. why the other firm wants to merge?... the staffing situation/excess capacity? their physical space requirements? current technology and equipment? financial strength to get through the recession Bigger is not always better!

6 How to Select a Successor Plan/client base to deal with Economy Professional/staffing strength Ethnic/language considerations Longevity of partners Employee track record What is the Seller Thinking? I am irreplaceable If I retire, I ll die! Clients NEED me I am MASTER of my own domain!

7 Sales Internal v. External Internal Sales Almost always go for less Often no retention period Death, disability and penalty buyouts Remaining partners making more Non multiple formulas on gross are more common Accounts Receivable & WIP External sales are more of a business deal and go for high dollars Sales Internal v. External Things to be wary of Multiple partners, leaving simultaneously Partners reducing time commitment, but not income or control Replace the role, not the body Cannot replace the administrator with a Rainmaker Must have excess capacity Partnership agreements (check them annually)

8 MERGERS FOR SUCCESSION Two Stage Deals Concept is remain whole in compensation, remain in control while commencing transition Structure Case Study Example Built in practice continuation agreements Do Practice Continuation Agreements work MERGERS FOR SUCCESSION Have agreed upon time tables for the role reductions of the retiring partners Cull out sale Have everything in place before you start: Terms Transition plan The capacity to takeover the retiring partners Space, staff, firm name

9 Supply and Demand Density of population of competitors cannot be ignored as a critical factor Overcoming via the satellite office Building an internal succession team Converting clients to less in person and more through technology may increase your buyer pool Building the brand versus the person Other Thoughts General chemistry between the parties Continuity of relationships will help retain clients A good deal is a fair deal Remember, it s the package, not the individual variables Staff merging

10 Documentation Restrictive covenants Other Thoughts Roles and responsibilities Hold Harmless Basic firm contact information Arbitration for disputes Divorce clauses, where appropriate Accountability of both parties Other Thoughts The Transition.. Client Communications Roles for new staff members Specialization

11 Transitioning Clients What are the clients fears: -Is the partner/owner I trust still there? -Is it going to cost me more money? -Do I have to travel far to meet with my new accounting firm? -Is the staff I am accustomed to working with part of the successor firm? CHANGE IS A DIRTY WORD THE EMPHASIS NEEDS TO BE ON CONTINUITY NOT THE LOSS OF, BUT THE GAIN OF For more information Please visit our website for resources including free reports, whitepapers and case studies. Joel Sinkin Jsinkin@transitionadvisors.com

12 SUCCESSION PLANNING/BUSINESS VALUATION When a firm changes hands, a satisfying deal for both buyer and seller is in the trade-off details. Price Equals Value Plus Terms REPRINTED WITH PERMISSION FROM THE JOURNAL OF ACCOUNTANCY DEC ISSUE BY JOEL SINKIN EXECUTIVE SUMMARY BUSINESS VALUATION (BV), SUCCESSION PLANNING and buy-sell agreements help CPAs prepare a foundation for selling a practice, but the final price of a firm will be affected dramatically by the transaction terms. TO SET A FINAL PRICE, CPAs SHOULD review the interrelationship of five key variables: the down payment at closing; the length of the payout period on the balance due; the profitability of the deal; the duration of the postclosing retention period with adjustments for lost clients; and the multiple (preferred price based on a multiple of the gross billings). CLIENTS THAT OFFER CROSS-SELLING opportunities, that are growing and fertile referral sources or that have young ownership will add value to the practice. Aging, slow-paying, underbilled clients will hurt value as will liability issues such as exposure to malpractice claims. A SUCCESSOR PERFORMING DUE DILIGENCE prior to acquiring a firm may examine not just what services clients get, but also those which they do not. If the seller has a niche the buyer doesn t have or the successor firm has a niche the seller didn t offer, the framework to develop additional revenues quickly may be in place. SOME FIRMS TRY TO OBTAIN ACQUISITIONS that will get them into new geographic territories. Acquiring a practice is often the most cost-effective way of

13 creating another office in a new location. PRIOR TO CLOSING, BUYER AND SELLER must focus on what to do to make clients and staff comfortable, what roles to take and what message to send out to the public. The best deals are those where everyone prospers sellers, buyers and clients. JOEL SINKIN, is a senior partner in Accounting Transition Advisors, LLC, The firm deals exclusively with mergers and acquisitions of accounting practices. Sinkin has consulted on 650 accounting firm closings and succession plans. He teaches succession planning CPE for state and national accounting associations, including the AICPA, and has published books and articles nationally. His address is jsinkin@transitionadvisors.com. ou ve worked hard for many years to build equity in your practice. Now you want to sell. Business valuation (BV) and practice succession procedures will help you prepare your practice or share of it for acquisition, but arriving at a final price for your equity will depend, in part, on the art of the deal. Because price differs from value, what your business is worth to a willing buyer once the process of negotiation gets under way can be affected dramatically by the transaction terms. The factors include the amount of cash exchanged at closing, the deal structure, the seller s financing and the presence of collateral and a security agreement. If you re a practitioner thinking of selling a practice, here are important points to consider when working out the details. PRICING AN UNDER-$1-MILLION PRACTICE The first step for any CPA who wants to sell a practice is to obtain a complete business valuation from an impartial, qualified valuator such as a CPA/ABV. (For more information see First, Get Organized, and Have a Fallback Plan, JofA, Sep.03, page 57.) It s equally important to look at the sale from the buyer s viewpoint. Negotiating the price of a practice with less than $1 million in annual revenues for an external sale comes down to five critical variables, so start the process by reviewing them. No one of them dictates the final amount, but the interrelationship of those important elements ultimately will help determine the price. Down payment at closing. The first variable is the size of the down payment, if any. When there is cash up front, the seller is financing only part of the transaction and therefore assumes less risk, making a lower price more appealing. However, not all deals offer cash up front, and the amount of cash is itself affected by many items. The time of year tied into the short-term cash-flow projections of the practice may have a significant impact. Clearly a buyer acquiring a practice that generates 75% or more of its income in the first four months of the year will want to put less cash down if the closing occurs in May than in December. How you treat the accounts receivable and work in process (WIP) also affects this variable. If you re

14 selling a practice with a significant amount of receivables and WIP and want those funds from the first postclosing dollars collected, you re asking the buyer to invest significant capital to pay the overhead and operate the practice for months before starting to participate in cash flow. The buyer therefore will want to pay less up-front cash. In many transactions, payout periods are worked out on the receivables and WIP, thus creating more room for a larger down payment to the seller. Sometimes purchases are structured as a collection or earn-out deal in which the up-front money is treated as an advance against future collections rather than as a down payment. For example, a buyer may offer you an advance against future collections plus 25% of all fees collected from the original clients above the advance over the next five years. A buyer may offer a seller a $50,000 advance at closing but request it be credited against the first dollars due the seller; or $40,000 credited back over the first two years; or $30,000 credited back over the first three years. If the advance is credited against the first dollars due, it likely will be higher than if it is credited over the entire payout period. Other factors may include assets and liabilities that come with the deal. In one satisfactory collection/earn-out sale of a $500,000 compilation/tax-oriented practice, the buyer paid the seller $50,000 at closing. The balance due was based on 25% of collections received by the buyer from the seller s original client base for the following six years, less the first $25,000 the seller would have been entitled to in years one and two. In addition, the deal was structured to provide the successor firm a current deduction, and it included all the nonpersonal furniture, fixtures and equipment the practice used and reasonable transitional assistance from the seller (a personal introduction to the clients, reasonable phone availability to the buyer and former clients and an orientation to the files). The length of the payout period on the balance due. This is a basic cash-flow variable. If a buyer has a longer period of time to pay off the purchase, the annual payments will be lower, thus enhancing the buyer s cash flow. Some sellers allow payout periods as long as 15 years, but some insist on being paid in full at the time of closing. Most deals in the under-$1 million size range have three- to sevenyear payout periods. The profitability of the deal. Some sources suggest it isn t a seller s profitability that s important in pricing a practice but the successor s profitability in the deal. Take the following example: The owner of a $200,000 CPA firm operates from home, handles all the work personally and nets 80% of revenues. A year later he moves into an office, hires staff and nets 40%. At which time was the practice worth more to a buyer? The answer lies in the profitability of the deal for the buyer. If a buyer is able to acquire a practice with little to no incremental increase in overhead, he or she can afford to pay a premium for the practice. If, however, the acquisition requires retaining an additional location and extra staff, the business will be less profitable and the buyer will pay less. Other factors may affect profitability. A key concern is the tax treatment of the payments from buyer to seller. If you (the seller) want 100% goodwill in a deal and a payout period of five years, the profit goes down considerably for the buyer who must deduct those payments over a 15-year period. Conversely, if you accept all or some of the purchase price in a form that provides the buyer a current deduction, the profitability of the deal increases and so does the purchase price. Billing rates, how

15 clients are serviced, by which level staff, whether work is mailed in or clients are visited are among the other factors that affect profitability. The duration of the postclosing retention period and adjustments for lost clients. This variable deals with the time frame in which to adjust the balance due for clients who leave the firm after it is sold. Retention periods (or guarantee periods) typically range from one year to the entire duration of the payout, though some deals have no retention period. If a deal is based on collections or an earn-out arrangement, the retention period typically is the payout period. Several factors determine the length of the retention period. If a practice has predominantly annual clients, a one-year retention period may be risky for the acquirer since it allows for only one CPA visit to each client, barely enough for a solid relationship to take. A two-year retention period enables buyers to truly evaluate whether they ve kept the clients. Some sellers fear long-term retention periods. Many deals I have structured use a stepped retention period, with an additional time frame that permits purchase-price adjustments for clients lost not to another local accountant but because the client no longer needs a local accountant at all. That helps protect buyers from paying for clients who die, close or sell their businesses, or relocate. You and the buyer also must understand what a retention clause guarantees. Some retention periods are based simply on clients staying with the firm. However, most retention terms guarantee the actual amounts to be collected from clients over a specific time frame. In some deals a seller participates in fee increases, at least for a continuation of services that were provided in the past. The parties must specify how fee increases will be calculated during the retention period. This is reassuring for sellers who make collections deals since it is unfair to suggest you participate only in losses and never in gains. Some deals cap a seller s participation in fee increases. Price/revenue multiple. When asked what they think their accounting practices are worth, most CPAs typically expect to sell for a price based on a multiple of the gross billings. For example, if you have a practice that generates $500,000 in billings, you may want a 1.25X multiple, or $625,000. If a deal includes an adjustment mechanism for gains or losses of clients or fees, that figure may vary. A multiple is not an appropriate target because it is the effect of the first four variables. This is based on the following formula: The lower the cash up front, the longer the retention and payout period and the more profitably the deal is structured for the buyer, the higher the multiple. (Of course, the opposite is true, too.) To better illustrate this point, here s an example of a sale based on the following assumptions: The practice generates only $200,000 in revenues. The acquirer can absorb this practice into a current infrastructure without any additional costs in labor, rent, staffing or other overhead. The seller participates in increases in fees during the retention period. Given those elements, if you were to ask for 17.5% of collections from original clients for 10 years,

16 with no cash down, structured in a manner that provides the buyer a current deduction, most buyers would enthusiastically accept the deal despite the fact that the multiple is 1.75X. The current value of the practice has little to do with the potential price if one premise is that you (the seller) will participate in fee increases (which may be more profitable than any interest factor). Alternatively, if you want a $40,000 down payment at closing, the balance in five years, a locked purchase price after the second year following the closing, payments structured as 50% capital gains and 50% to provide the buyer a current deduction, the purchase-price multiple could drop to a range between 1.25X and 1.50X. If you insist on all cash at closing, all capital gains and, obviously, no retention or payout period, very few buyers would even consider the deal at 1X. Those examples aren t exact, since an actual transaction would involve additional information not described here. The intent is to demonstrate how the most attractive deal price may not be an absolute multiple, but rather a package that makes sense after you and a buyer review the interaction of the variables. Other factors such as types of clients, billing rates, firm assets and liabilities and qualities unique to your practice have a bearing on the end price, too. For example, clients that offer crossselling opportunities, that are growing and fertile referral sources or that have young ownership will add value. Aging, slow-paying clients billed at discounts will hurt value, as will liability issues such as exposure to malpractice claims. NEGOTIATE A LARGE-FIRM PRICE To determine an external sale price for firms with more than $1 million in annual revenues, the above variables play a role, as do others such as Types of clients and services. Most large CPA firms today have focused on adding consulting to the services they traditionally provide. Certain clients by nature are better prospects for cross-selling additional services to generate new revenues for the firm. Many times a successor practice performing due diligence prior to acquiring a larger firm examines not just what services clients get, but also what they do not. If you have a niche the buyer doesn t have or the successor firm has a niche you didn t offer, the framework to quickly develop additional revenues may be in place. Understanding the client base may reveal a great deal about how much in new receipts might be possible. Staff. Many larger firms seek to acquire other practices to increase their talent base. The trend toward fewer new accounting graduates going into public practice has increased the value of exceptional talent, sources say, whether it s to add a niche or grow the firm s depth. New marketplaces. Some larger firms seek acquisition partners to help them branch into new geographic areas. Acquiring a practice is often the most cost-effective way of creating another office in a new location. Absorptive capacity. It s a misconception of some CPAs that small firms are worth lower multiples than large firms. For a $6 million practice the most likely buyer will be an even larger firm, but few can absorb an entity of such size without incurring significant incremental increases in overhead (space, rent, labor, insurance). Also, many larger firms net less per client and struggle to maintain the

17 one-third operational ratio: one-third labor, one-third overhead and one-third profit. A firm netting 30% won t be in a position to give up 25% of collections for many years. Larger practices typically sell for lower multiples with smaller payouts over longer periods than small firms do, although there always are exceptions. NEGOTIATE AN INTERNAL SALE If you re a retiring principal, your most likely buyers are your existing partners, and the price will generally be lower than in an external sale. Still, the variables that influence an external sale also apply, with a few additional considerations. Many firms have capital accounts, and how the payback of those accounts is structured, along with accounts receivable and WIP at the time a partner leaves, plays a significant role in shaping final terms. In many cases the partnership agreement provides a buyout framework. Some agreements have vesting periods that pay more the longer the partner is with the firm. Pay attention to Buyout agreements. We live in a constantly changing business environment, and terms worked out 10 years ago may not achieve the win-win goal for all today. Make sure all principals have reviewed and updated the partnership-buyout agreement. This should be done at least once a year (see Pass the Baton Without Missing a Beat, JofA, Mar.02, page 43, and Make the Most of Buy-Sell Agreements, JofA, Oct.04, page 37). A good buyout deal compensates you (the retiring partner) well for your years of sweat equity while enabling surviving partners to enjoy additional income. Note: Every buyout agreement should include disaster contingency language to protect the practice s cash flow and extend the payout period in case of calamity (see The Best-Laid Plans, JofA, May04, page 46). Pricing a partner s equity. You and your partners should review the total compensation you take from the firm, inclusive of all payments for draw, profits, perks and benefits. From this sum the firm should subtract the costs of replacing you. The difference, if everything else remains stable, is the additional cash flow available to the firm upon your retirement. This should provide a starting point for calculating a price, since the parties will need to agree on what percentage of the additional cash flow will go to each party and for how long. Formulas. Many partnership agreements pay retiring partners based on a multiple of billings of the firm multiplied by the retiring person s equity. Another method becoming popular bases retirement dollars on recent income. Firms take an average of the retiring partner s last three years of income, apply a multiple such as 2X and pay it over a period of seven years, for example. Penalty buyouts. More and more practices include multiple buyout formulas in partnership agreements. Retiring partners who are vested, provide ample notice and assist in the transition get the maximum price; those who don t are penalized with lower prices or longer retention guarantees to protect the firm s survival. Retention period. Many internal-sale agreements specify a short client retention period or none at all because the firm expects to go on with minimal change. However, when the retiring partner provides little notice or is the main or only contact for certain clients, keeping those clients isn t a

18 given. If you allow ample time for a careful transition, a retention period may be less critical. An orderly retirement transition may require as much as 10 years, some sources say. Insurance buyouts. Most firms partnership agreements include buyout formulas that address partners potential death or permanent disability, usually through insurance. Many firms now have partners take out personal insurance policies and compensate them to offset the cost and lower the buyout, which results in a more favorable tax treatment all around. Company-paid insurance policies traditionally either become the buyout vehicle or are credited toward it. If the latter, payments due a former partner s estate may need to be deferred to give the firm time to get back on a strong footing as it recovers from the loss. Partners should check insurance policy terms yearly to ensure they keep up with current equity value. PRACTICAL TIPS TO REMEMBER CPAs should look at the sale of their practices from the buyer s viewpoint, too. A buyer acquiring a practice that generates 75% or more of its income in the first four months of the year should put less cash down in May than in December. Pay attention to the successor s profitability in the deal, which is more important in determining a price than the seller s profitability. Selling CPAs should give buyers a longer period of time to pay the balance so annual payments can be lower, thus enhancing the buyer s cash flow. Sellers that tie payment terms to client collections should participate in gains as well as losses. CPAs should make sure all principals review and update a partnership-buyout agreement at least once a year. A buyout agreement should have disaster contingency language so that if a calamity befalls the practice, cash flow is protected and the payout period is extended while the firm recovers. VALUE IS WHERE YOU FIND IT There s an unproven theory that audits and general business work are worth more than tax work. In truth, though, while individual tax clients are more transient in nature than business clients, they often are superior from hourly billing rate, profitability, liability and collection-headache perspectives. With a two-year minimum retention period guarantee, there s no reason why a tax practice should be less valuable than an audit practice. In fact, firms that offer financial services view individual tax clients as a fertile market for niche services and covet them over audit clients. Low interest rates have encouraged many recent buyers to borrow the money to make a large down

19 payment and thereby reduce the practice price. There are arguments on both sides of this issue, but if a buyer can lower the price while retaining the clients, the profitability of the acquisition may rise. In valuing a firm, remember that assets can include space at a great value, name recognition and a growing consideration Web sites and databases. Technology may add value, too. For example, a recent merger between two large firms was partially based on the fact that one lagged in its technology. With several partners nearing retirement, the chance to get a return on their investment by upgrading was limited. The firm chose to merge with a larger one that was already there from a technology standpoint. And finally, prior to closing on the sale of an accounting practice, seller and buyer must focus on what they need to do to make clients and staff comfortable, what roles they need to take and what message to send out to the public. The best deals are those in which all parties sellers, buyers and clients prosper. REPRINTED WITH PERMISSION FROM THE JOURNAL OF ACCOUNTANCY Click here for a link to a Letter to the Editor regarding this article and the response the author provided, both of which are online with the AICPA:

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21 SMALL FIRM SOLUTIONS WINNING STRATEGIES FOR PROFITABLE FIRMS VOL. 3 ISSUE 1 PAGE 1 PRACTICE MANAGEMENT/M&A WHAT WILL A BAD ECONOMY MEAN FOR CPA FIRM M&A? Every news story reinforces the idea that we are in economically challenging times. How will these turbulent times affect the mergers and acquisitions market among CPA firms? What other practice management considerations could it raise? While no one knows with certainty what will happen down the road, a look at the past sometimes can give you a sneak peek into the future. Learning from the Past In early 1990s, a tough economy made it difficult for most of my clients (accounting firms in the New York metropolitan area) to collect their own fees, let alone grow. Client attrition was hurting gross volume at a pace that ran well ahead of new client development. An ad in the New York Times for a junior accountant brought letters from hundreds of seniors applying for the junior s job. The reason was a steep decline in the real estate market, in new construction and in retail sales, especially in garments and textiles. There are clearly some comparisons to our own situation today. So what did we see during that time that we may see again? Until very recently, CPA firms were having a great deal of trouble finding staff. In recent months, though, the top 10 accounting firms have laid off a lot of employees, as have many financial service and other companies. My regional firm clients have suddenly begun filling positions that have been tough to fill for the last two years. While this windfall has not trickled down to the small practitioners yet, there is reason to believe that staffing issues may improve soon. While this is a good thing for many accounting firms, we do have to wonder if we will need the labor if demand for services shrinks. Over the past few years, the value of accounting firms has dropped in most parts of the country. This has been primarily due to three factors: The aging of the baby boomers, which increases the supply of firms on the market. The shrinking labor force, leaving fewer firms with excess capacity to buy, which lowers the supply of buyers. The good economy, which has made it possible for so many firms to grow organically that there was less interest in acquisitions and therefore lower demand. Anticipating Near-term Change How will this change in a recession, if at all? One possibility may be a return of what I saw in the early 90s: A huge demand for accounting firm acquisitions. Acquisition was one of the few ways to grow and offset the loss of business from clients in financial trouble. If acquisitions do become popular again, the economic climate will likely work against all-cash sales of firms. I have never been a proponent of any cash/no retention deal for an accounting firm, and uncertainty about client retention during a recession will likely mean that most sales within the profession will be based on future collections and client retention. This protects the buyer against client losses. The seller, too, may benefit from a higher value. That s because buyers will be anxious about buying a firm and losing clients that go out of business and less likely to engage in fixedcash deals. Add in the challenge of finding financing for an all-cash deal, and you can see that the attraction- and value- of these deals will probably decline. But there s better news for the seller who is willing to share the risk. This seller offers the buyer an opportunity for an immediate influx of clients and the chance to pay only for those who are retained. As a result, don t be surprised if the seller who wants little to no retention period has a hard time finding a buyer or a good value, while the seller who makes a deal based on retention is well rewarded for his or her years of sweat equity. Niches Become Popular Another notable development in the early 1990s was the addition of niches at CPA firms. How many readers have added a new service area (financial services, information technology consulting, business valuation, general consulting, etc.) that you never had before the early 1990s? This is partially a practice development strategy when demand for traditional services declines. In recent years, many firms may have been reluctant to venture into a new niche or may not have felt it was necessary. Will that change? Are we about to see an influx of new niches catering to individual and business needs that reflect the current economy? For example, consulting on bankruptcy and debt problems may become lucrative niches. It s easy to imagine them adding significantly to a firm s bottom line.

22 SMALL FIRM SOLUTIONS WINNING STRATEGIES FOR PROFITABLE FIRMS VOL. 3 ISSUE 1 PAGE 2 Mergers for Overhead In the early 1990s, many firms decided it would be a great idea to reduce rent, software, labor and other costs by merging. One valuable lesson to be learned from that period: Don t merge for this reason! Many of us spend more waking time with our partners than with our significant others. Being a partner is about more than sharing space. There are many good reasons to merge, including but not limited to adding depth of talent, niches, services, succession, marketplace, cross selling and more. However, if the only point of merging is overhead dumping, live together (share space), but don t get married! What to Expect How will the CPA firm M&A market change? While no one knows for sure, expect to see values stop sliding and even potential increases in price for sellers of smaller firms in densely populated areas of the country who are open to appropriate retention periods that adjust the balance the seller is owed from the buyer based on future client retention. New niches will become popular and some old ones, such as bankruptcy consulting, will strengthen in the current economy. The staffing shortage will ease as more people are let go. Mergers will remain a powerful solution for mitigating client losses, adding niches, cross selling and, when coupled with these benefits, reducing overhead for both parties. Joel Sinkin (jsinkin@transitionadvisors.com) is the President of Accounting Transition Advisors, LLC, which consults exclusively on the merger & acquisition of accounting practices nationally. He teaches CPE for state and national accounting associations and has consulted on over 900 accounting firm closings and succession plans and published books and articles nationally. He is an editorial advisor for the AICPA s Small Firm Solutions. He can be reached at or at

23 SUCCESSION PLANNIN G/M&As Two-Stage Deals A sequenced transition can smooth a firm s ownership transfer. by Joel Sinkin and Terrence Putney EXECUTIVE SUMMARY Although it s not the only way to go about succession planning, a two-stage deal offers a transitioning CPA an opportunity to imbed a practice into a successor firm s infrastructure while maintaining a considerable amount of autonomy for an agreed-on period of time. Both firms negotiate the eventual transaction contract just as in an immediate sale. The firms agree to the latest date when the sellers will reduce their time commitment to the firm and final payments will commence, usually within one to five years. Clients are served under the buyer s brand, and the buyer hires any new employees. The transition looks just like a traditional merger to outside constituents. The buyer s payments are mostly or completely deferred until the contractual back-end date or a triggering event occurs. Transitioning owners earn similar income as before if they dedicate comparable time and effort to the practice and fees remain steady. They also can avoid costly late-stage reinvestment in infrastructure. Most accounting practice sales have contract contingencies that adjust the purchase price based on client retention. It is in both parties interests to give clients and the successor an opportunity to get acclimated to each other before a trusted partner retires. Two-stage deals bring successor firms the benefits of both a straight acquisition and a traditional merger. Buyers delay investment in the acquisition until they assume complete control. Joel Sinkin has been involved in succession planning for accounting firms for more than 15 years. Terrence Putney, CPA, has been involved in many acquisitions of accounting and consulting firms as national M&A director with RSM McGladrey. Sinkin and Putney are the senior partners of Accounting Transition Advisors LLC and together have handled in excess of 700 mergers and acquisitions of accounting firms. Their addresses are jsinkin@transitionadvisors.com and tputney@transitionadvisors.com, respectively.

24 ow can you have your cake and eat it too? You aren t quite ready to retire, but you know you need to find a successor for your practice. You wonder how much accountability an owner firm will impose if you decide to merge. You worry about a change in culture, loss of identity and what your role in the new firm will be prior to your eventual exit. You want this settled. Consider a two-stage deal primarily designed for the small accounting practice of one to three partners who want to reduce their time commitment over a one- to five-year period. It creates a flexible way to affiliate with a successor firm when internal succession is not an option. Retiring partners get to start the process, achieve some long-term goals and maintain some independence until they retire, while the successor firm benefits more than from a straight purchase or standard merger. Retiring partners get to start the process, achieve some long-term goals and maintain a measure of independence until they retire, while the successor firm benefits more than from a straight purchase or standard merger. Step Out in Style A two-stage deal handles succession in increments rather than all at once. Stage one is a contractual period during which a seller continues to work at the firm, retaining income and a level of autonomy. Stage two, which is activated by an agreed-on date or by a triggering event, is the buyout. HOW DOES IT WORK? Flexibility is the key to this type of transition strategy, and the parties to a two-stage deal can customize it to fit their goals. The idea is to imbed a transitioning firm s practice into the successor firm but allow exiting owners considerable autonomy for an agreed-on time period. In stage one, a seller typically relocates into the buyer s office the seller s practice becomes an infrastructure within the buyer s. The seller continues running his or her practice with no change in income or schedule. However, during this time clients gradually get to meet the new owner. That helps stabilize client retention and gives the buyer potential cross-selling opportunities while the seller reduces his or her role. Payments are deferred during stage one even though equity is transferred on the effective date of the deal. Stage two is the buyout when the payments commence. The sequence of a typical two-stage deal is as follows: The firms work out all the terms in advance, just as in an immediate sale. Both parties put everything in writing and have a clear understanding of the purchase terms and the business plan.

25 The firms agree to the latest date (the back-end date) when the seller(s) will reduce their time commitment to the firm and buyout payments will commence. This is normally in the range of one to five years. Typically an agreement lets a seller accelerate the retirement date through triggers such as working fewer hours than a certain quota, giving notice, permanent disability or death, which triggers buyout payments to heirs. The firms consummate their affiliation at the beginning of stage one. To outside constituents the transition looks just like a traditional merger. Clients are served under the buyer s brand, and the buyer hires new employees. During stage one, selling owners manage their book of business much as they did before. Their income stays substantially the same if they put comparable time and effort into the practice and fees remain steady. The buyer defers making most or all purchase payments for the equity until stage two, which is the earlier of a trigger or the contractual back-end date. To make this type of arrangement successful, several considerations are important. For instance, because clients normally choose their accounting firm based on their comfort level with key members, personalities are important. Don t do a deal with someone you don t enjoy having lunch with. Location and fees are important, too, so choose a firm that will maintain a comparable experience for your clients. Agree on the roles of the individuals and the brand names that will be used never agree to agree later. BENEFITS FOR THE TRANSITIONING PRACTITIONER The two-stage deal allows a CPA to find a successor and start the exit process before it becomes a necessity. The specific benefits of this approach for retiring owner(s) are They can maintain their income level as long as their time commitment to the practice and the revenues from their clients remain steady. It creates a safety net in the event of death, disability or the loss of key staff. All details of the future transition are resolved for clients and staff. Sellers can avoid costly late-stage reinvestment in infrastructure. They can focus on client service instead of day-to-day firm management. They can reduce the time spent working in the practice at a more flexible pace without jeopardizing the value of their business. Because sellers now have back-up resources and can devote less time to administrative duties, they can focus on increasing the value of the practice.

26 Client retention is enhanced because the seller is still actively involved during the transition and higher retention equals higher value. BENEFITS FOR THE SUCCESSOR FIRM Successor firms using two-stage deals get the benefit of both a straight acquisition and a traditional merger that is They do not make an investment in the acquisition until they assume complete control of the client list and the seller s compensation has been significantly reduced or eliminated. The transition of client relationships to the buyer s care is enhanced by the seller s active involvement over an extended period, which provides a proper, supportive transition. They get new revenue opportunities and additional profits from reduced overhead one office suite, one technology infrastructure and one malpractice policy, for instance. They don t have to replace the selling practitioner s production capacity immediately, which can be the acquired practice s largest resource. They can begin to tap the seller s referral network, which often is extensive and therefore ripe with opportunity at this mature stage. They gain the opportunity to cross-sell services to the seller s client list. The date for the transition of control of the practice is already established. MASTER OF YOUR DOMAIN: A POTENTIAL CLASH IN CULTURES Fear of loss of autonomy and income are the primary reasons retirement-minded practitioners in small firms often procrastinate until they are ready to retire for good. Although they know they need to address succession issues soon and that clients and employees would benefit from their active involvement in the process they are reluctant to give up being master of their domain. They are set in their approach to managing, accustomed to working on their own schedule, and unwilling to embrace a dramatically different role. In a typical merger, they would be right the successor firm would expect all partners to adhere to its policies. That s exactly why a twostage deal can work better. Another area of concern for transitioning practitioners is that a traditional acquisition structured to create a return on investment for the buyer can result in reduced income even if the hours worked remain the same. But a two-stage deal enables the successor firm to defer most or all of its investment in the acquisition, so it doesn t have to demand an immediate return.

27 THE CASE FOR NOW RATHER THAN LATER Retiring practitioners also recognize the need to properly transition the client base. Most clients don t have a yardstick by which to measure their accountant s level of competency or skill. They remain loyal out of affection and trust. That trust must be transferred from the seller to the buyer, and the seller plays a critical role in making that happen. Trust is earned through a track record of experience, and transferring it is a process that can take months or even years. Small firms meet personally with clients remarkably infrequently. Business clients may mail in or drop off work and sit down with the partners only at tax season that once-a-year meeting is not uncommon. So when partners are five years from retiring from the firm or reducing their time commitment, that may turn out to be only five visits with some clients. A two-stage deal takes full advantage of those five encounters. Most accounting practice sales have contract contingencies that adjust the purchase price based on client retention after closing. It is clearly in both parties interests to give clients and the successor the opportunity to become acclimated to each other before a trusted partner retires. That way the seller is still available to assist in completing the transition. The risks and challenges of accounting practice combinations are unique, so consider hiring a professional who has experience with acquisitions and mergers. TWO-STAGE EXAMPLES ABC, a two-partner firm generating $1.2 million in annual fees, recently sought assistance in developing a succession plan. The partners were each three years from retirement and were devoting 2,200 hours per year to the practice. One was about 70% chargeable, and the other was 55% chargeable, owing to a greater practice management role. Including all perks, benefits, salary and profit distribution, the partners were netting 36% of their gross. They were introduced to several potential buyers. ABC narrowed the choice based on the chemistry between it and firm XYZ s similarities in fee structure, service approach and location. Under the negotiated deal, ABC moved into XYZ s offices, but the retiring partners maintained their existing entity, into which their compensation was paid and in which they were the only remaining employees. (In most deals, professional staff is retained at least initially, but keeping clerical/secretarial staff is based on need.) During stage one the two retiring partners were paid 36% of the gross collections received from their original clients. Each retiring partner could reduce the time commitment to the firm and accept a pro rata reduction in income at any time. The death or permanent disability of a partner or a reduction in work hours below 50% of past efforts would trigger the buyout of that partner. If neither occurred, the buyout would take place 36 months from the effective date.

28 The deal was publicized as a merger, and all client billings moved to the XYZ firm name. Over the next three years each partner introduced his or her clients to the partners who would ultimately assume control of the account. The retiring practitioners were motivated to make the transition in this form because it let them keep control over their book of business, allowed them to come and go as they saw fit and let them continue to manage their clients. Their practice and estate were protected in the event either partner died or became disabled. Their clients did not lose a CPA but rather gained back-up, support and expertise from the newly combined firm. The partners kept their income whole while they remained fully committed to the practice. Because payments were made to their preexisting entity, they continued to incur perks and benefits and maintain existing retirement accounts. There was no need to adapt to the successor firm s plans and policies. The deal let them feel they had maximized their firm s value. The successor firm saw the following advantages: The merger eliminated many overhead redundancies, including staff, software and other technology, and rent. ABC, with its different list, provided additional services and generated additional revenues. Its clients were willing to refer business to the larger XYZ firm, and the transitioning partners contacts referred business the sellers would not have obtained before the merger. The full transition would occur relatively soon by the end of the third year at the latest. XYZ executed an excellent transitional strategy and retained virtually all the ABC clients. In the two years since this deal closed, XYZ hasn t lost a single business client to another local firm and has maintained the same retention rate of 1040 clients as the sellers had prior to the transition. Note: Drawbacks to a deal of this nature are limited, but they do exist. For the selling firm that seeks succession, It can be very difficult to go from an environment in which you have no accountability to one where you do, even if it is far less than in a traditional buyout. In most cases, the seller gives up a brand, location and sometimes even staff. Those changes can make the transition more emotionally and professionally charged. In the unlikely event a deal needs to be unwound, the seller may have significant needs in relocating. For the successor firm, the possible downside is Whenever you add additional personalities under one roof, there is always the potential for friction.

29 If the successor firm retains staff whose compensation is different from their existing staff in a similar role, conflicts can occur. If there are few cross-selling opportunities or savings from trimming overhead redundancies, stage one may not offer much financial reward.» Practical Tips Because clients normally choose an accounting firm based on their comfort level with key members, personalities are important. Don t do a deal with someone you don t enjoy having lunch with. Location and fees are important. Choose a firm that will maintain a comparable experience for your clients. Work out all the terms in advance and put everything in writing. Agree on the roles of the individuals and the brand names that will be used. Never agree to agree later. Consider hiring a professional who has experience with acquisitions and mergers. The risks and challenges of accounting practice combinations are unique. In another case study, sole practitioner John Smith, who had $150,000 in annual fees and wanted to retire in four years, structured a similar two-stage deal. Smith s clients were predominantly monthly and quarterly and required a lot of handholding. For the first year, a member of the successor firm went with Smith on 25% of his client visits. The second year Smith reduced his hours by 20% and accepted pro rata reductions in his income as the new partners became even more involved with his clients. In the third year Smith reduced his time another 20% and the transition picked up steam. Smith was so comfortable that his clients were well transitioned that he elected to retire after year three. Eight years later the successor firm has retained more than 90% of Smith s clients who still have viable businesses, fees have gone up and those clients have been a fruitful referral base. Although it s not the only way to go about succession planning, a two-stage deal shows how a compromise between a merger and a straight sale can give selling practitioners more control and input during a retirement transition, and make firms that use acquisitions as a part of an expansion strategy more attractive to sellers. It s win-win for them and for their clients.

30 Keeping It Together Plan the transition to retain staff and clients (Part 2 of 2) by Joel Sinkin and Terrence Putney Retirement, health issues for an owner, the desire to grow all of these are reasons firms engage in mergers or acquisitions. Most firms decide to merge or acquire only after considerable analysis of financial and professional outcomes. Last month we gave general advice for ensuring a merger or acquisition goes smoothly. But a firm s ability to make a successful deal depends not only on deal structure and due diligence but also on the successor firm s ability to retain clients and staff. Unfortunately, an agreement between the partners of two firms to combine has nothing to do with whether staff and clients stay or leave. This article looks at the challenge of retaining clients and staff immediately after the merger. Retention should be addressed through a properly designed and executed transition plan, which should be divided into two retention sections: clients and staff. CLIENT RETENTION A client generally selects a firm based on chemistry between the client and the accountant, location of the firm s office, cost and perceived value of services, professional expertise, and trust. The announcement of the merger/acquisition deal may force clients to deal with the broad concern, Will my relationship with the firm change? More specifically, their worries relate to the reasons they selected the firm: Will the partner I have been dealing with still be there? Will my fees increase? Copyright American Institute of Certified Public Accountants, Inc. All rights reserved. Used with permission.

31 PRACTICE MANAGEMENT Will the staff I am used to dealing with and procedures I am accustomed to working with remain the same? Will the firm s location still be convenient? Addressing these concerns is critical to client retention. The message you deliver in the merger/acquisition announcement must speak to the issues and at the same time reinforce the reasons clients initially chose your firm over others. Whenever possible, when you inform clients about the transaction, reassure them that the things they depend on will not change; emphasize continuity regardless of what is changing; focus on things that are not changing; and stress what the client is gaining rather than losing. Your client transition plan should list action steps in these areas: 1. Timing of the announcement. Decide when various clients should be told of the transaction. Generally, all clients should receive a formal announcement fairly close to when the news becomes public to assure they are given the information they need so they will support the deal. How and when you make the announcement, however, depends on the importance of the client to the firm and the amount and timing of interactions with the client. Your best clients (usually measured by size of annual fees, or importance to the firm in other ways such as a referral source or stature in the community) may be told about the pending combination before it is consummated. If your firm has a number of annual clients (such as individual tax clients), consider waiting to tell them about the deal until close to the time of their annual visit to the firm (for example, when tax organizers are sent out). This approach minimizes the time during which clients may make assumptions about what the combination means to them and consider an alternative to their current service provider. This technique works best when the business combination will not likely become generally well-known for these clients. 2. The message. Whether you communicate with clients in person, by letter, or by phone, make sure you send a consistent, positive message about the transaction (for sample letters, see the online version of this article at accountancy.com; enter code in the search box). To assure consistency, some firms draft scripts for staff to use as they talk to clients. Focus the message on how the merger/acquisition benefits the client. The initial announcement might say: We are merging with Smith and Jones to provide How and when you address the concerns of both clients and employees affect a merger's success. our clients with new areas of expertise and access to more resources. Promote the new or specialized services the acquired firm offers. Additionally, include in the announcement reassurances of things that will not change especially staff, fee structure and client services, Focus on Continuity of Service Continuity of service is critical to retaining clients. Make the transition transparent by: Retaining contact information. Keep phone and fax numbers, domain names and addresses for at least a year. Answer the acquired firm s phone number on a dedicated line with a custom greeting that uses both firms names. Maintaining service and billing methods. Don t immediately change work processes and billing systems. Wait until clients are comfortable with the new firm. which are all key concerns. Is the combination deal a merger/ acquisition, or is it a purchase? In your communications with clients, the press and staff, avoid the term purchase. Clients do not like to think they have been sold. Even if the firm is purchased from an estate of a deceased practitioner, call the transaction a merger or an affiliation. 3. Deciding how to deliver the message. The importance of the client will dictate how the announcement is made as well as when it is made. For example, a personal visit by the partner in charge of the account is the best way to convey the information to important clients. If that is not possible, the partner should at least make a phone call. This allows the messenger to respond to questions immediately and reinforces the client s importance to the firm. Clients who are scheduled to be seen in the near future can be told in person EXECUTIVE SUMMARY When a merger or acquisition takes place, clients are chiefly concerned about who their accountant will be, if their fees will change, and if the office location will be convenient. Top staff worries include job security, changes in compensation and benefits, and restrictive employee agreements. A smooth transition that results in retained clients and staff carefully addresses all concerns. In the initial stages of the transition, care should be taken to make changes slowly so clients and staff can become acclimated to the new firm s operations. Joel Sinkin and Terrence Putney, CPA, are principals of Accounting Transition Advisors LLC. Their addresses, respectively, are jsinkin@transitionadvisors.com and tputney@transitionadvisors.com. April 2009 Journal of Accountancy 25

32 PRACTICE MANAGEMENT Case Study: A Successful Long- Distance Transition Larry, age 62, intended to sell his practice in three years, but his wife s health precipitated an early move across the country to Arizona. He wondered how he could sell his $300,000 personal tax-return practice when he couldn t personally serve his clients. Good planning salvaged the situation and retained his clients. Larry merged his practice with Michael s firm, which was very similar in operational style and expertise. They created a new entity with both their names in the firm name. Larry sent out a merger announcement letter emphasizing Michael s expertise and explaining that Larry would brief Michael on each client s needs. Michael would interview clients to find ways to reduce taxes; they would both review the return. Fees would not change, and Larry would remain the lead partner on the account. Larry called each client from Arizona and scheduled the meeting. Michael completed the returns and sent them to Larry to review. Larry called each client to review the return. If a client called Michael with questions for Larry, Michael called Larry. Larry called back the client, listened to the questions, then responded, Let me discuss this with Michael and get back to you with our joint opinion; Michael will call with the answer. With this process, clients became used to working with a new accountant, and the result was almost 100% client retention. Case Study: Transitioning Over Time Each of two equal partners in a $1.7 million firm had sights on retiring David in two years, Martha in four. The firm, which employed two CPAs, one paraprofessional, and one clerical person, had a profit margin of 40%. The firm reached an agreement with a successor firm that had excess staff and office capacity and a similar operating style. Client retention was high because of the way the transition was managed. An initial announcement letter was sent to the clients emphasizing the gain the clients would experience from the talent of the new firm and the continuity the combined firm would offer. David and Martha would each receive compensation equal to 20% of the collections from all of their original clients, consistent with their current profitability (including the cost of perks and benefits). If they needed labor in addition to what was used in the past, they would pay the successor firm 67% of the normal billing rate for the excess labor. At the end of the second year, David would retire and start to receive his share of the payout over the subsequent five years. At the end of the fourth year, Martha would retire and start to receive her share of the payout over the subsequent five years. This transition allowed clients to acclimate gradually to the successor firm. Starting immediately for David and in the final two years for Martha, clients were seen in person on an alternating basis by the original partner alone and then by the original partner and the successor partner jointly. By the time David and then Martha retired, clients were comfortable with the successor. No further announcement was required. The transition was completed fully, and the clientretention risk of the buyout was effectively eliminated. as those meetings occur. Send a letter or an to clients who are less critical to the firm s success. Do this, however, prior to a public announcement made through a press release. 4. Introduction of the successor. A personal introduction of the successor to the client helps assure an effective transition. It also helps prevent the client from praising the merger but warning that the existing partner must remain in charge. (A client is unlikely to say to your successor, Nice to meet you, but don t come back. ) If the business combination is occurring for reasons other than succession, it is not critical to take along or otherwise introduce the client to anyone in the new firm. However, if the plan is for the partner in charge to phase out (even over the next few years), that process is best started with the announcement meeting. You can introduce a successor as backup or additional support if the transition will be occurring over time. In addition to introducing the successor, defer to him or her whenever possible. For example, a client may call you (the partner who is transitioning) with a question or problem. Instead of responding as usual, yield to your successor. Allow him or her to return the call. This action supports the transition and shows that the successor is taking a sincere interest in the client. If you continue to answer every question, the relationship will not transition, and client retention will remain at risk. 5. Involvement of both firms in the communication process. Little things can make a difference in perception. For example, mailing the announcement letter in the predecessor s envelope but writing it on the successor firm s letterhead ensures the letter will be opened and sends a powerful but subtle message about the transition. 6. Time commitment of the seller to the transition. Sellers seeking to leave soon after the acquisition understand their presence is necessary for a successful transition, but they wonder how long they will have to continue working. It is not the number of hours spent 26 Journal of Accountancy April

33 PRACTICE MANAGEMENT Case Study: A Merger Resulting in Lost Clients In this case a $2.7 million firm with three equity partners was merged into a regional firm. Two partners intended to remain in the successor firm long term. The third, John, was to stay for three years and then be bought out. In this case, 20% of clients were lost when John retired. The firms in this case did not have a plan to transition clients. During the three years he remained on the job, John handled all his clients as usual, answered all their questions himself, and never actively got the successor firm involved with the clients. The substantial loss of clients affected John s buyout payments as well as the firm s profitability because his buyout was tied to client retention during the first two years following his retirement. with clients but the message sent to them that matters the most. For example, if you are a retiring practitioner, consider the amount of time you physically spend in front of clients. Often, it is no more than 200 to 300 hours per year, with the remaining client service time spent behind the scenes preparing, reviewing and supervising work. Therefore, if you spend the same time seeing clients and remaining available for consultation via phone and , the clients may perceive no difference in the relationship. Planning an appropriate amount of face time allows for the transition of most of that practitioner s client service responsibilities. STAFF RETENTION Most staff members have never been through a merger or acquisition. Their perspective is blurred by media reports about large mergers and acquisitions that focus on cost cuts and staff reductions. Furthermore, the prospect of a merger or acquisition holds the specter of significant change, and many people are uncomfortable with change. The keys to retaining staff are minimizing change, giving them a clear picture of why they will benefit from the combination, and providing constant communication. Effective staff-retention strategies address upfront concerns about job security, compensation and benefits, and employee agreements. No simple solutions can eliminate all of these fears, but one of the most effective actions is clear and frequent two-way communication in which you share your firm s vision and ask for (and listen to) their opinions. These actions create an environment in which staff feels someone is listening, they have input, and their opinion counts. Plan and execute your staff-retention plan carefully. Address basic concerns by taking these steps: 1. Inform the most senior staff members first. When it is possible to do so (considering the risk involved), announce the pending business deal to them before the deal closes. This reinforces these staff members importance to the firm. 2. Make firsthand announcements. Do not let the staff find out about a merger or acquisition from an announcement meant for clients and the public. Tell them in person. 3. Send an upbeat and positive message. Reinforce that the deal is not a threat to staff and emphasize the things that will not change. Remember that the topmost question of staff members is, Will I have a job after the merger? If you have no intention of reducing staff, reassure them with the simple message sent to both sides in the deal You are welcome and coveted. 4. Tackle the issue of compensation and benefits. Another concern staff members have is the deal s effect on compensation. The merging companies will almost certainly have different compensation programs. As your firms become one company, try to keep compensation at historical levels, even if existing levels at one company are not totally in sync with targets. Forcing pay cuts to bring people into line is a surefire way to run them off. A better approach to bringing salaries in line is to freeze compensation at existing levels and let natural attrition and time gradually bridge the gap. The same applies to benefit plans. If the acquiring firm s plans, such as health insurance cost sharing or paid time off, are not as generous as those provided by the old firm, one method to bridge the gap is to compensate for the loss of these benefits with a cash adjustment. The cost of attrition often far outweighs the minimal cost of keeping people whole (which actually costs nothing compared to the predecessor s historical cost structure). Also indicate how the transaction will affect perks. 5. Address employment agreements. New employment agreements are often a necessary part of a transition. But staff may view the restrictive covenants in these agreements as a negative. Present the agreements as a way to promote security and certainty. This focus will help retain staff and still protect the business. 6. Clarify reporting relationships. Describe what the transaction means to staff in terms of their roles, the management structure (and how they fit into it), and office facilities. 7. Talk about career opportunities. The firm s most motivated staff, the people who count on long-term career growth, may assume the transaction will limit their opportunities. If the deal presents a good April 2009 Journal of Accountancy 27

34 PRACTICE MANAGEMENT opportunity for their careers, be clear about how growth can occur. 8. Orient new employees. Remember that employees of the acquired firm are new. Distribute employee handbooks; obtain signed agreements; conduct training on all major systems such as time and billing and tax prep software; and consider holding a get-acquainted Write Now! At every company or firm, there s an accounting professional who knows the business like no one else. Do you have a story to tell that few have heard and everyone ought to know? event for the employees of both firms. 9. Maintain an open dialogue. Give staff a way to ask questions and explore what the merger or acquisition means for them after the deal is consummated. Provide opportunities for one-on-one conversations by assigning a go-to person with whom staff can work. Small firms may designate one individual as a go-to person. Larger firms may consider assigning the role to several individuals one for each category of employees, such as managers, senior staff and junior staff. AICPA RESOURCES JofA articles Mergers & Acquisitions of CPA Firms, March 09, page 58 Securing Succession Success, Dec. 07, page 34 Two-Stage Deals, March 06, page 43 Price Equals Value Plus Terms, Dec. 04, page 67 CPE Mergers, Acquisitions and Sales of Closely Held Businesses: Advanced Case Analysis, a CPE self-study course (#732863) What You Need to Know About Accounting for Business Combinations, a CPE self-study course (#182000) Publications Adviser s Guide to Mergers, Acquisitions, and Sales of Closely Held Businesses (#091027) Compensation as a Strategic Asset (#090493) Securing the Future: Building a Succession Plan for Your Firm (#090486) For more information or to place an order, go to or call the Institute at Don t be shy. Tell us what you know. We welcome articles on a variety of accounting-related topics; request submission guidelines from authors@aicpa.org. Questions? Call for more information. We look forward to working with you! JOURNAL OF ACCOUNTANCY Reliable. Resourceful. Respected. Private Companies Practice Section The Private Companies Practice Section (PCPS) is a voluntary firm membership section for CPAs that provides member firms with targeted practice management tools and resources, as well as a strong, collective voice within the CPA profession. Visit the PCPS Firm Practice Center at For additional resources on succession planning and successful staff management, visit the PCPS Success Planning Resources Center at Succession+Planning and the PCPS Human Capital Center at Resources/Human+Capital+Center. 28 Journal of Accountancy April

35 News & Views Succession planning: The future is now Here s how to build internal and external succession plans that work By Joel Sinkin and Terrence Putney, CPA You have devoted years to building a practice. By creating a realistic business plan, you can maximize the value of this asset and establish a succession plan that works for you, your successor, clients and staff. A premise with which to start Why do you have your clients? Most of your clients really do not have a yardstick to truly measure the skill level of their accounting firm. If they understood enough to measure your technical skills, they might not have to hire you, and instead could handle it themselves. So, since a client accepts on faith the fact that you are competent, why do you have your clients? The first answer typically is chemistry a personal and professional comfort level. They are your clients because they trust you. They feel comfortable with how you run the practice philosophically and how you service your clients. They feel comfortable with your staff, your location and, most of all, you as a person. In many ways, this basic concept is the underlying factor that impacts many aspects of planning your succession. We are not buying and selling people. Therefore, knowing why you have your clients will play a major role in most facets of the succession planning process. When should you start the process? As discussed above, most clients remain with their accountants because they are comfortable doing business with them. In addition, a substantial percentage of most firms clients (both business and personal) are dealt with in person on only an annual basis by the firms principals. When someone says they are five years from either retiring or devoting less time to their practice, it sounds like an eternity. In reality, though, that may amount to just five visits with a substantial portion of the client base. It takes time to get your successor and your clients acclimated to each other. This applies to internal and external succession plans. Your practice has its greatest value while it is running at top efficiency. By creating your succession plan in advance when the practice is peaking, you can structure the most lucrative deal. There are other variables that can affect when you start a succession plan. If you are about to make a major investment in technology, relocation, staff and other such items, this may be the time to review your succession plan. Perhaps there is a firm or individual with whom you can affiliate who will either participate in this investment or, by virtue of your affiliation, satisfy your need. For example, if you need additional staff capacity or technology and were thinking of reducing your role in the next five years or so, why not affiliate now with a firm that has that technology or excess capacity and accomplish multiple goals simultaneously? Whatever you are paid for your practice or interest in your firm, it will normally be based in large part on the acquiring firm s expectation of its ability to retain your clients. It takes time for your successor and clients to become acclimated to each other and to transition the trust and loyalty your clients have in you. This applies both to internal and external succession plans. The longer and more actively you are involved in the transfer of trust, the more likely the transition will be successful. This expectation of high retention should elevate the value of your firm, and the successful transition of client relationships will be more satisfying for you. One way to actively participate in the transition is to remain involved as needed after your ownership interest has been transferred. Another technique is what we refer to as a two-stage deal. This technique will allow the seller to maintain his or her current level of income, independence and control over the practice and still start the process of acclimating clients to a successor. The valuation process of an accounting firm in an external sale Most firms are priced based on an inter-relationship involving the following five variables: 1) Cash upfront. 2) The profitability of the deal for the buyer, which includes items such as billing rates, realization rates and the tax structure of the payout. 3) The duration of a retention period, if any. This refers to whether or not the purchase price is adjusted based on client retention. 4) The length of the payout period. 5) The multiple. Here is the basic concept: The less cash required at closing, the longer the payout and retention period, the more profitable the deal is structured to the buyer, the higher the multiple. The opposite is true as well. Would you pay the same for an accounting practice with all cash at closing as you would with an extended payout and retention period? A premise that will make this case study clearer involves a practice that was able to be absorbed by the buyers with no incremental increases in overhead. Let s say the seller would accept no cash down and a payout based on 17.5 percent of gross collections from the seller s original clients, structured as a consulting agreement. Would you do that deal? Many firms would, even though the multiple is 1.75X. In this deal, the buyer has little or no risk. But let s say the seller altered the terms and wanted 33 percent cash down, a four-year payout period structured in a manner that created a 15-year deduction for the buyer (a sale of a practice) and a 12-month retention period (thus, if a client is lost after month 13, it would have no impact on the balance 12 STATEMENT

36 due). In this case, most buyers would lower the value to between 1:00X and 1.25X If that same seller demands all cash at closing, most firms would be hesitant to offer 1X, let alone.75x. Obviously, many other factors would be required to perform a full valuation. The above was more to illustrate the formula of how each variable can impact the final price. Other important factors would include (but not be limited to) assets coming along, staff, general financial health of the clients, accounts receivable, realization rates, services provide, and the seller s transition plan. A good deal is a fair deal. The seller should be well paid for the years of sweat equity, but the buyer must make a living. Is your firm prepared for an internal succession? Many firms find out too late they are not as prepared for partners to leave as they thought. Here are some helpful things to review to ensure your fate is different. How much interaction will there be to get the clients and their new contact partner acclimated with each other? Is there adequate time and opportunity to create a smooth transition? How many billable and non-billable hours does the outgoing partner devote to the practice? Does the firm, especially the partners taking on these responsibilities, have the capacity to take on this workload? Does a retirement-minded partner have any specialties or licenses that a firm would lack once the partner leaves? If the current team members can take on this workload (whether by passing down work or other means of creating time) and have adequate time and skills to make clients comfortable, you may be in a strong position to handle the succession internally. If the time required to replace the professional is not there or a technical skill or license is lacking, you must rethink your plans. This can be overcome in several ways. The two used most often are bringing in additional talent and merging with a firm that has the capacity to ensure the succession goals. Though not easily accomplished and filled with its own issues, this step is important in achieving a successful succession. Accomplishing this in advance may be the key to a successful plan. How do I value the retiring partners equity in the firm? All of the five variables mentioned earlier impact the internal valuation of a practice. For the purpose of this article, though, we will give you one basic concept that must be the framework of any valuation plan for an internal sale. If the buyout for retiring partners (hopefully detailed in your partnership agreement) calls for the remaining partners of the firm to make less money during the buyout of senior partners than they were making immediately before the buyout payments commenced, you have a problem. Over the past 15 years, I have seen many partners leave a firm shortly prior to a senior partner s retirement for this reason. Worse, there might be defaults and other problems related to the buyouts after the partner retires. The idea of buying something is to make more money, not less. At worst, you d like to break even. Therefore, let s review a basic method of approaching this growing concern as the baby boomers age. Start by reviewing the amount of total compensation the retiring partner makes. From such total, subtract the cost of replacing that partner s time. For example, let s say a retiring partner earns a total compensation package (including salary, benefits, profit distributions, etc.) of $200,000. If the firm needs to hire an additional accountant to help pick up the workload, and that accountant s total cost is $100,000, that will leave a balance of $100,000 in additional cash flow to the firm (assuming everything else is constant). The negotiations can now begin over how much of that goes to the retiring partner and how much remains in the firm, and for how long. In this way, the remaining partners should achieve a financial benefit, yet the retiring partner can also receive compensation for his or her years of sweat equity. More for firms Visit our online resource center for more firm-related information: If it sounds too easy, it is. Remember, this is a starting point. Many other factors have to be placed into the equation to make it work for everyone. Create an appropriate transition plan Unlike the sale of hard assets, loyalty and relationships cannot be bought or sold. This is why we emphasize a longterm plan. The key to any transition includes clients who don t know they are being transitioned. Over the course of years, clients need to get acclimated with additional talent in the firm before their main contact retires. In this way, these clients have already become comfortable and trusting of the new partner involved in the account. If a professional retires while still serving as the main contact for clients, a potential retention problem will exist with those clients. One key to a successful transition is adding someone else, not merely losing the person the client trusted. This is true whether or not your deal is for an internal or external exit strategy. A useful approach is to utilize the age of specialization. For example, if we were to transition a client who is a high net-worth individual, it may be done as follows: The senior partner brings in a professional who will replace the partner on this account and explains to the client that this new partner is an expert in new tax laws. This specialist may also be able to plan new approaches to help potentially reduce the client s tax liability and provide other benefits. That is why the new partner is working side by side with the current partner. Over the course of time, the senior partner can gradually withdraw from the client and create a smooth transition. continued on page 14 May / June

37 Succession planning: The future is now continued from page 13 Most announcement letters and transition plans need to emphasize several things. The seller is remaining of counsel, the fee structure is remaining intact, the practice is remaining geographically sensitive, and the critical staff is part of the newly combined dedicated team. Get help! In a creating an internal or external succession plan, there are numerous things to be worked out valuing the practice, structuring the deal, treatment of accounts receivables, WIP, liabilities, what to look at in due diligence, names, roles, transition strategies, partner buyout provisions, documentation of the deal and so much more. This is not only a critical business decision, it can get emotional as well. Having an experienced professional on your side can be the most important step in obtaining a win-win deal for everyone. Joel Sinkin and Terry Putney, CPA, are senior partners at Accounting Transition Advisors, LLC. They can be reached at (866) or via at jsinkin@transitionadvisors.com. Their Web site is 14 STATEMENT

38 SMALL FIRMSOLUTIONS WI N N I N G ST R A T E G I E S F O R PR O F I T A B L E FI R M S SUMMER 2007 THE NEXT GENERATION SUCCESSION PLANNING: WHERE DO YOU STAND? By Joel Sinkin CPAs help clients to plan their retirements and exit strategies many years in advance, but many fail to take their own advice and wait too long to start the process of succession planning. By considering the answers to a couple of questions, practitioners can gain a better perspective on what steps they need to take to ensure a smooth transition. When do you start to plan your exit strategy? If you expect to sell your practice one day, there are interim steps that you can take to maximize the value of your firm. Many professionals want to gradually reduce their time commitment to the practice and ultimately sell, but may not wish to walk away completely. How will that transition work? The first thing a practitioner must do is try and envision how many more years or tax seasons they want to work full-time. Most smaller accounting practices have a significant number of personal and business clients they deal with only annually. Some other clients may have contact with the office or staff throughout the year, but see the owner only once a year. If you are five years from seeking to reduce your role, that may seem like an eternity, but in reality it adds up to just five visits for many clients. That s important because, in most cases, if clients were able to perform the work we do for them, they would not have hired us. Thus, they really aren t equipped to judge whether we are great, adequate or inept at what we do for them. So, why do they choose your firm? The answer in most cases is because the client likes and trusts you! Of course, fees, location, service procedures and other elements all are critical as well. But if the client was not comfortable with you, in most cases they likely would choose another alternative. With that in mind, it s important to remember that the key to any firm acquisition is client retention. That s why it s important to start the process by reviewing any how much longer the owners will have client contact. In a perfect world, we should affiliate with our ultimate successors well enough in advance to give the clients an opportunity to gain a comfort level with them. There are methods of affiliating that enable the retirement-minded members of a firm to maintain control and income while gradually acclimating their clients and successor to each other. For more information on to this process, see the Journal of Accountancy article, Two-Stage Deals ( What are your firm needs and commitments? Besides years until retirement, there are other variables that can affect succession. If you are about to relocate, make a major investment in technology, add staff or institute another significant change, this may be the time to review your succession plan. Before you act, consider whether there is another firm or practitioner with whom you can affiliate that will participate in the investment. Or, perhaps the affiliation itself may satisfy your need because of the other firm s resources. If you need additional staff capacity or technology to enhance your practice but you are thinking of reducing your role in the next five years or so, an affiliation now with another firm that has that technology or excess capacity can possibly achieve all your goals. Lease terminations also can play a significant role in the timing of your succession plan. If you are fewer

39 W I N N I N G S T R A T E G I E S F O R P R O F I T A B L E F I R M S SMALL FIRMSOLUTIONS than five years from reducing your time commitment to your firm, then now s not the time to enter into a long lease for your space. If you have a lease, you will limit your potential audience of successor firms to ones that can live with another location or do not currently have one. Firms that take on leases at this stage likely will reduce the size of the offers they receive by this additional cost factor. Enabling a successor firm to move your practice into their infrastructure makes a more profitable deal for the successor firm, which means they can afford to pay you more for your firm. Taking Action Now Your practice has its greatest value while it is running at top efficiency. By creating your succession plan in advance when the practice is peaking, you can structure the most lucrative deal. Remember, it takes time to transition the relationships that took years for you to establish and nurture. This action agenda will help you begin the process: 1. Decide how many years you have until retirement or a reduction of hours. 2. Review your exit strategy options. If you expect to sell your firm, assess the following: Is our current staffing sufficient? Will we need more staff in the near future? Is our technology adequate as is? Will it need to be updated soon? Will we need to relocate in the near future? If not, how long is our current lease? When does it expire? 3. Given the answers to questions 2, what steps should be taken to make the firm more attractive to a prospective buyer? Would an affiliation with another firm satisfy our staffing/technology/space or other needs? Would any commitments or investments made now limit the offers from prospective buyers in the future? Joel Sinkin, an editorial advisor for Small Firm Solutions, is a senior partner in Accounting Transition Advisors, LLC ( which exclusively consults on the merger & acquisition of accounting practices nationwide. He travels cross-country to teach CPE for state and national accounting associations has consulted on 850-plus accounting f i r m closings and succession plans, and published books and articles nationwide. He can be reached at or at jsinkin@transitionadvisors.com. THIS IS A PUBLICATION OF THE AICPA S PRIVATE COMPANIES PRACTICE SECTION

40 COVER STORY SUCCESSION PLANNING By Joel Sinkin and Terrence Putney, CPA YOU HAVE DEVOTED years to building a practice. With proper planning, you can maximize the value of your firm through a sale where everyone wins: you, your clients and the successor firm. The basic concept: How do accounting firms, especially smaller ones, attract and retain their clients? Most people assume all CPAs are competent. Your clients chose you and stay with you primarily because of chemistry, your style and their trust in you. Your staff, location, level of fees and types of services you offer also are important. Your clients value these intangibles of your practice. Understanding this is a key aspect of succession planning. Even though you sell your practice, and therefore your client list, your clients make the final decision if they will move to the successor firm. Knowing why you have your clients will help you successfully transfer those relationships to a successor and capture the value in your practice. Starting the process: There are many issues that influence the timing of succession planning. One critical factor is the frequency of interaction with your clients. The less frequently you see your clients, the sooner you must start your transition and succession plan to capture full value. However, as is explained later in this article, starting your transition does not have to mean you will give up your control or reduce your earnings. The partners in many practices see a substantial number of their clients only once a year. Many clients drop off records, work primarily with staff during the year, or are simply annual business or individual clients. If a partner is five years away from reducing his or her role, that may mean only five visits with many of their clients five opportunities to complete a positive transition. The general rule of thumb is to start planning five years prior to when you, or a partner, plan to start transitioning. One way to accomplish this is by affiliating with your successor in advance of your planned phase-out. A technique called a two-stage deal allows you to maintain your earnings, come and go as you see fit, have back-up support, and have a deal in place that will allow you to retire when you are ready. This technique can be used with an internal successor, as well as an external successor firm, or even a combination of the two. Your practice has its greatest value when you are still around to assist in the transition and when it is running at top efficiency not when you are forced into succession with inadequate planning. Choosing your successor: The key is to look for a successor (partner or new firm) that will provide the greatest continuity in servicing your clients. If location is important, find a successor in close proximity to you. Fee structure and staff servicing the clients should remain as constant as practical. In a two-stage deal, you practice at, or with, the successor for at least a short time after the affiliation. This automatically provides positive endorsement for the successor, which is what most clients are looking for. By the time you reduce your role, clients will have had an opportunity to become acclimated to the successor and vice versa, enhancing continuity and retention. If your clients require special expertise, look to affiliate with a successor that has this same expertise. You should analyze your role and the quantity and quality of your time, especially client service time. If you have staff that will not be retained by the successor, the same analysis should be done for them. Confirm that the successor either has the excess capacity to replace that time and those roles or the ability to find that capacity. Keep in mind that a well-run firm normally doesn t have a lot of 8 FLORIDA CPA TODAY > NOVEMBER/DECEMBER 2006 >