Mergers: Five Structures and Determining Worthby
By Alexandra DeFelice
With merger mania heating up in the accounting world, it's likely most firms are either being eyed or are ogling another firm to achieve growth or, in some cases, to achieve a combination of growth for some partners and succession for others.
The question at the top of most people's minds boils down to the bottom line. They either want to know how much a merger will cost or how much money they'll get. But before looking at money, there are other variables to consider in terms of how a deal will emerge.
During a recent webinar by the CPA Leadership Institute, Joel Sinkin, president of Transition Advisors, discussed how to value your firm when selling externally or internally to other partners. While this topic could fill a book, following is a recap of the discussion.
First, Sinkin outlined five main deal structures:
1. Straight sale. Owners don't want to work full time or have an equity position, but they'll be there to ensure a proper transition and stay on in a reduced role.
2. Buy-in to a buyout. The buyer opts in an interest into the firm and may or may not bring clients into the newly combined entity.
3. Merger to a buyout. This is similar to the above, but no initial equity is purchased. There are many variants on this. Perhaps one person at first is a 20 percent partner then buys out the 80 percent partner. Some can buy in a minority interest on existing clients, then buy in new ones 50/50.
4. Carve-out/cull-out. Take your favorite clients and sell the others. This doesn't necessarily mean your most profitable clients, but the ones with whom you have the deepest relationships or some other factor upon which you place client value.
Another option is to cull out a niche. For example, one of Sinkin's clients had a $1.8-million compliance practice with some wealth management work on the side that he loved. Sinkin sold his accounting clients to a midsize regional firm that wasn't doing wealth management. Both firms signed a noncompete and communicated it as a merger of specialties. Sinkin was then exposed to new clients. This process can be a stepping-stone to succession – not giving up all of your clients but most of them – with the idea of transitioning off the rest later.
5. Two-stage deal. Smaller firms' clients are partner loyal, whereas larger firms' clients are brand loyal, Sinkin said. So it makes sense to keep the partners who the clients are accustomed to on board for a period of maybe two to three years. The problem ties in to accountability. No one wants to be clock-punching and reporting to someone the last two years of his or her career, Sinkin explained. The key is to figure out how to keep the partners doing their work, but give them autonomy to lessen the workload on their timeline and terms. Sinkin recommends a minimum two-year notification period, with a transition plan for internal succession plans.
Now to the money.
Consider the following five variables when considering the multiple of your firm's worth:
1. Cash up front, if any. Sinkin sees a range of zero to twenty percent, depending on the economy, time of year (related to billings), and treatment of accounts receivable, among other factors.
2. Retention clause. Buyers covet this, because it guarantees clients want to stay with the firm, and the seller wants the buyer to keep those clients. It helps ensure the buyer won't go out of business. This can be challenging for a seller, but potentially the best opportunity. Many deals are done with one- or two-year retention clauses, thereby limiting the guarantees.
3. Profitability. Not the seller's profit, but the successor firm's profit.
4. Duration of payout period. The most frequent buyout period for smaller firms is five years, then four, then six, according to Sinkin. The larger the firm, the longer the payout period.
5. The multiple. This is the effect; the other variables are the cause. If you ask someone to pay you faster, with more money up front, and with a shorter retention period, you'll be paid less.
Larger firms have lower multiples and longer payout periods than smaller firms. Very few larger firms are a total sale. Most have partners in different categories. For example, senior partners are seeking succession; younger partners are exchanging equity in one firm for another seeking growth. Partners usually place a value on hard assets, such as technology, that larger firms bring to the table; smaller firms rarely have such assets.
Some smaller firms have a set sum in mind that they're going to pay to buy out retiring partners. This can be dangerous, because in some small firms, partners have their own book of business, so what's the plan to ensure the transition will happen? To mitigate the risk, Sinkin recommends having at least a two-year notification period to create a transition plan.
- Here Comes the Baby Boomer Bubble - Valuing Your Practice for Partner Retirements
- M&A: Five Variables when Assigning Value
- Management Essentials: Five Merger Tips to Help You Seal the Deal
About the author:
Alexandra DeFelice is senior manager of communication and program development for Moore Stephens North America, and a regional member of Moore Stephens International Limited, a network of more than 360 accounting and consulting firms with nearly 650 offices in 100 countries. Alexandra can be reached at [email protected].