Show me the money: How CPA firms are sold
Sellers and buyers always want to know value. But even before one speaks of value it is helpful to know something about terms - how accounting and tax practices are sold. There are four basic ways firms are sold.
With seller guarantees:
1. Collection Pricing
This is a type of seller financed transaction in which the seller receives payments based on what the buyer collects (or, perhaps, bills) over a period of time. The down payment, percentages, and payout years can be adjusted. One example would have the buyer paying down 20 percent of the estimated final price and then paying 20 percent of receipts collected each year for the first four years. Buyers like this method because it gives them easy cash flow payments and puts almost all of the risk of client retention onto the seller. Sellers do not like assuming most of the risk in a method that has them guaranteeing the work and abilities of the buyer years down the road. Sellers also complain of having to do the accounting and due diligence involved in the calculations. If such a method is used, both buyers and sellers need to be sure everything is spelled out very clearly. For example, how are new clients to the business counted in the mix and how are collections applied and accounted for?
2. Look-back Pricing
In this type of sale the buyer looks back after a period of time at how much has been collected (or, perhaps, billed) and the total sales price is then adjusted up or down. For example, a buyer agrees to pay $325K for a practice that grosses $300K with a price adjustment of one dollar for each dollar variation in actual collections the first year. In this example, if the practice actually collects $250K for year one then the final price becomes $275K; if the practice collects $330K the final price is $355K. One year is what is most often used in this type of pricing, but there is room for creativity in the look-back period, caps, percentage adjustments, etc. This pricing is similar to collection pricing in that seller guarantees are involved, but it can be used with both cash and seller financing. Although not nearly as common as collection pricing, sellers are somewhat more comfortable because of a shorter period of time that they are at risk. The risk that is covered by the seller is essentially the risk that clients won't give the buyer a chance rather than the risk of a bad buyer. The variations can be complicated so each party needs to be especially certain they understand the implications of various scenarios.
Without seller guarantees:
3. Cash Pricing
This would be a method with no guarantees in which the seller receives the full price at closing. This refers to cash paid to the seller. The buyer may be obtaining cash from personal funds or, more often, from an outside lender. This latter can really create a win-win for both parties -the seller receives cash and the buyer is able to obtain often favorable payout terms. Most owners are going to naturally prefer the all cash option not only because they are reluctant to guarantee the abilities and work of the buyer but also because it allows the owner to complete the deal and move on with life. This option has become more and more common especially with solid firms in desirable locations. Two things have contributed to this: there are more and more outside lenders looking to loan on accounting practices and brokers like Accounting Practice Sales are creating a more efficient market with larger pools of buyers.
4. Fixed Seller Financed Pricing
This is defined as any fixed price without a guarantee on client retention that is paid out to the seller over a period of time. Interest is usually a part of the deal but not always. This type, while very common in our lives, is often misunderstood in the area of accounting practice sales. That is because seller guarantees have been so common in the past that even now when someone mentions seller financing they are often really talking about #1 or #2 above. Buyers would want seller financing for a number of reasons:
- It is much simpler than the outside financing process,
- They don't qualify for outside financing,
- The perception persists that this keeps the seller in the game and motivates him or her to work harder in a good transition, or
- They might get favorable interest rates or tax benefits.
One reason buyers might not want this type is that outside lenders can often offer better terms (lower down payments, longer payout periods, working capital, etc.) than sellers will. Sellers are more favorable to fixed financing than the seller guarantee options but they still worry about collecting their funds. Sufficient down payments, good credit on the part of the buyers, strong buyer experience and credentials can mitigate the fear.
Buyers need to understand the dynamics of each offering so they can make the deal work for them. Sellers need to offer their practice in such a way they can attract the largest number of quality buyers.
Reprinted with permission from Accounting Practice Sales.