Why the Spike in Non-Traditional Firm Mergers?
There has long been three avenues of growth in the accounting profession: organic, adding a previously unoffered client service or merging with another firm. That trend is now changing.
With the advent of profession-altering technology trends such as blockchain, AI and automation promising to revamp the accounting process as we have known it, there will be significant changes afoot – whether the profession is ready or not.
For one, within five-to-seven years, the audit process will likely be automated, sending the folks who normally perform that Type A work, looking for something else to do.
As a result, the past few years have seen a number of firms adopting a fourth option toward achieving their respective growth targets – merging in “non-traditional” businesses.
In lieu of conventional unions, more practices are targeting entities such as HR consulting firms, IT/cyber security concerns, or other growth generating specialty companies such as financial planning, engineering, marketing and payroll.
For example, Top 100 firm Eide Bailly recently acquired Spring2 Technologies, a Utah-based IT consultant specializing in NetSuite, while Nashville, Tenn.-based LBMC added W Squared, an outsourcing company offering finance, payroll and procurement services to its widening portfolio. And more recently, another Top 100 firm, Cherry Bekaert, carved out the cyber-security practice of a New England firm and folded it under its Assurance and Advisory Services umbrella.
Earlier this year super-regional New Jersey firm Withum acquire digital services provider Portal Solutions, while Chicago-area firm Sikich LLP – one of the early practitioners of non-traditional mergers - purchased Evolution Retirement Services a Milwaukee-based provider of employee benefits.
Finding the Right Fit
Naturally, any merger whether it be traditional or non-traditional has to make sense for both the buyer and the seller. While it’s often difficult to discover what we like to call the proverbial “round peg in the round hole” in terms of an ideal fit, non-traditional deals should complement each other in terms of synergies as opposed to being counter-productive.
For example, a financial planning firm specializing in high net worth individuals and trust work would likely not make a good merger partner to a firm that that pumps out reams of $300 1040s.
Ditto for a firm that may not have made the transition to a paperless culture but who is courting an IT practice specializing in sophisticated services such as SOC audits or financial stress tests. Conversely, an engineering or construction firm might appeal to a practice that has a thriving cost segregation business.
Structuring the Non-Traditional Merger Deal
This is where it gets a bit complicated. The reason why accounting firms tend to be valued similarly compared to each other is because they tend to be structured and operated similarly. Not so for consulting companies.
For instance, some consulting firms have extremely high staff leverage, like 40-50 employees per owner, while others boast high growth potential. Some will have higher profit margins for the owner; some margins will be far lower. It often depends on the type of firm and the specific firm in question.
Of course, it also matters how you structure the deal. If you are buying the consulting firm outright you must come up with a sales price. That implies the current selling owner of the non-traditional entity will not be the long term operator of the firm.
If you are merging, are you merging it into the core accounting firm? If so, then just like in a merger of an accounting firm your owner agreement will dictate the value. If you are setting it up as a separate entity, then you have to draft a separate owner agreement with the principals of the consulting firm.
For example, if a consulting firm is generating $2 million in annual revenue, the merger agreement may stipulate that the first $2 million they make after the deal is closed they receive the same net profit, but anything over that is shared between them and the CPA firm.
Some consulting professions have rules of thumb on value like accounting firms do. Wealth management firms currently tend to value in the 2 to 3 times fees’ range. Payroll companies lie somewhere in the range of .75 to 1.5 times. Software companies tend to command values that can be very high. Insurance agencies tend to have standard valuation multiples.
During my CPE sessions throughout the year I stress to attendees that this is not your father’s accounting firm – you can’t run a practice in 2017 like you did in 1980. With the advent of the pending new technologies coupled with new growth trends such as non-traditional mergers, those that embrace those changes will prosper. The ones that do not are likely to create client and real estate opportunities down the road for those who do.