Common Misconceptions of Succession Planning
Now that busy season is safely in the rearview mirror, it’s probably sage advice for owners and partners to take a holistic view of their practice and assess what needs to be done in terms of growth and, particularly, with regard to succession.
Perhaps a good place to start is asking the following questions:
- How many more years do I want to work full time before slowing down?
- Do I have the right people on my “bench” to ensure a smooth leadership transition?
- If not, do I have to look externally for a succession plan?
Your specific approach will largely depend on the answers to the above. But whether your firm’s leadership transition lies externally or internally, it’s imperative to begin planning a minimum of five to seven years before one or more of a firm’s owners begin to slow down.
While that may initially sound like an eternity, think about this: Most CPAs meet in person with their clients just once a year – usually at tax time. So, if you plan to slow down in five years, for most, that’s just five client visits to secure that all-important “hand-off” for transition. We cannot effectively transition relationships through email or on the phone nearly as well as we can in person.
Above all, remember that succession procrastination leads to only one of two possible outcomes – a hastily arranged merger under unfavorable terms or closing up shop for good.
Unfortunately, too many firms currently thinking about succession tend to harbor an almost obsessive focus on such issues as firm valuation and the ongoing myth of hiring young talent as the solution.
Sorry, but here are some harsh doses of reality regarding each.
Let’s first address the issue of relying on finding young talent. There are roughly 50,000 CPA firms around the country searching for the same thing, and that is what I like to call “The Holy Grail” – young talent with or without an existing book of business.
If you have a weak internal bench, don’t naively think that a young “high potential” employee will miraculously walk through your door ready to assume the leadership reins. And even if you are successful in bringing someone aboard, what assurance do you have that he or she will be “partner ready.” If they’re not, then this vicious and often unfruitful hiring cycle begins again. If your succession solution doesn’t lie internally, then you’ll need to look at external solutions, such as an upstream merger.
The three questions I am frequently asked each year are: What’s the multiple? What’s the multiple? What’s the multiple?
Unfortunately, firm valuations have been dropping steadily in past years, turning many areas of the country into “buyer’s markets.” Unless you are in a major metropolitan area, such as New York or Chicago, many firm valuations in secondary or tertiary cities have dropped significantly under 1X revenues. The misconception many firms have is they depend on receiving a high multiple, and in more cases than not, they wind up disappointed.
While many firms think that the multiple should be the first thing to negotiate in a potential merger/sale, in reality it should be one of the last.
Often, the biggest decision for most firms looking to merge upstream is not how to determine who has the deepest pockets or greatest skill set, but who has the personality, culture, capacity, and ability to offer the most continuity.
There are four C’s integral to any successful merger: culture, chemistry, capacity (i.e., does a potential successor firm have the capacity in terms of staff and space to take you on?), and continuity (i.e., how long have they had their clients, and how long have their partners been partners?) No affiliation will be successful without them.
Bigger Isn’t Always Better
And along those lines, many firms looking at an external succession solution have a popular misconception that a larger firm makes a better merger partner.
While in many cases that may be true, bigger isn’t always better. There are a number of criteria that have to be taken into consideration with a bigger partner – firm cultures, mandatory retirement ages, equity (for multiowner firms that may have young partners not ready to slow down), billing rates, as well as perks and benefits. In addition, smaller firm clients are accustomed to and expect more handholding than normally practiced by the larger firms.
Another misconception that begs to be put to rest: Larger firms go for higher multiples. In a word: no.
Why? Because larger firms have a lower profit margin and, therefore, cannot afford to pay a higher multiple – often based on a percentage of collections.
Conversely, a smaller firm can frequently be absorbed into the successor practice with no incremental increases in overhead. The reality is that outside the Big Four and the tier of firms below that, very few firms can easily absorb a $10 million practice.
Remember to begin planning your succession early, especially as the market values for firms begins to steadily decline. Don’t make the oft-made mistake of becoming fixated on the multiple – negotiate your deal as a total package, including client retention, payout periods, and tax structure of the deal. But act now!
Firms that are not proactive now with regard to their succession planning will no doubt create real estate and client opportunities for firms that are.