M&A: Five Variables when Assigning Value

 

By Joel Sinkin
 
In this world of merger mania and baby boomers dealing with succession, many wonder how accounting practices are valued when being sold externally (not to partners), and what the multiple is. Most accounting firms are sold on a multiple of gross revenues but the multiple is the effect. Underlying any effect there is a cause, so what we need to understand is what the causes are.
 
There are five main variables we look at when assigning value to small firms, with one to three partners. (Larger firms have the same five, but there are several additional pieces.):
 
1. Cash upfront, if any. Most of the deals we have been involved in have somewhere between 0 and 20 percent of the anticipated purchase price paid at closing. There are many factors that impact cash upfront, for example:
  • Time of year: If your firm bills 75 percent of their fees by May 1 and you are closing July 1, it is unlikely to get much of a down payment, and the opposite is true if closing January 1. 
  • If your clients are slow payers, you have a lot of receivables and expect to have the buyer give you the first dollars in to cover those receivables, since the buyer will have to fund the operation that much longer prior to cash flow; once again, you may receive a lower offer of cash down. 
  • Cash flow: How quickly will the buyer get a return on that down payment.
 
2. Duration of the retention period. Most smaller firms sold externally have the balance due them adjusted, based on client retention post-closing. With most deals, the entire payout period is the retention period (for example, the practice sold based on a percentage of collections over a given period of years), while other retention periods may be as short as one to two years.
 
3. Profitability of the deal for the buyer, not the seller's net. For example, if the buyer can absorb your firm with little to no incremental increases in overhead, the deal is more profitable. Therefore, the buyer can pay more and still make more. The buyer's profit can be impacted by many items including, but not limited to:
  • Tax ramifications of the payout period.
  • Billing and realization rates.
  • Overhead that the seller asks the buyer to retain, such as leases and unneeded staff.
 
4. The duration of the payout period on the balance due. For smaller firms, the range we have experienced is from three to eight years, with most four to six. Larger firms typically have longer payout periods.
 
5. The multiple. Here is the concept: the less money upfront, the more profitable the practice is for the successor firm, the longer the payout and retention periods, the higher the multiple. The opposite of course is true as well. While there are many other factors that impact the valuation, these five are the general starting points we have used in over 500 closings over the last 20+ years. 
 
The trend is certainly lower multiples today as well. Ten years ago, in many markets seeing multiples of 1.5X, was far from outlandish for smaller firms. Twenty years ago, it was even higher in some cases. In 2012, we see multiples are traditionally lower, and we expect this trend to continue as the baby boomers age and the supply and demand curve alters. The challenging economy has kept practice values higher than expected since as organic growth slows, M&A growth becomes more appealing. Thus, as the economy improves plus add the aging of the baby boomers, it is likely to see values reduce even greater over the next five years.
 
Related articles:
 
About the author:
Joel Sinkin (jsinkin@transitionadvisors.com) is president of Transition Advisors, LLC, which exclusively consults on succession and growth strategies for accounting practices nationally and ownership transition. He can be reached at (866) 279-8550 or at www.transitionadvisors.com.
 

You may like these other stories...

Accountants without a succession plan are hurting not only themselves but their clients as well. Here are seven ways to see your practice continues after you retire—some of them are better than others.What Are Your...
Boehner, Camp profit from corporate bid to avoid US taxesRichard Rubin of Bloomberg reported on Tuesday that House Speaker John Boehner (R-OH) and House Ways and Means Committee Chairman Dave Camp (R-MI) profited from a...
In my last article, I discussed the model of value pricing and the benefits this billing structure offers you and your clients. However, in order to set up the right value pricing for your client, you need to know what...

Already a member? log in here.

Upcoming CPE Webinars

Aug 28
Excel spreadsheets are often akin to the American Wild West, where users can input anything they want into any worksheet cell. Excel's Data Validation feature allows you to restrict user inputs to selected choices, but there are many nuances to the feature that often trip users up.
Sep 9
In this session we'll discuss the types of technologies and their uses in a small accounting firm office.
Sep 11
This webcast will include discussions of commonly-applicable Clarified Auditing Standards for audits of non-public, non-governmental entities.
Sep 26
In this jam-packed presentation Excel expert David Ringstrom, CPA will give you a crash-course in creating spreadsheet-based dashboards. A dashboard condenses large amounts of data into a compact space, yet enables the end user to easily drill down into details when warranted.