There is an expression in the merger and acquisition industry, “Beauty is in the eye of the beholder, and so is value.” From that expression, we will build a foundation for value determination.
Every firm you consider as an acquisition candidate will value out differently. If you begin to value out your acquisition target based on their asking price or requested multiple, you are not riding the horse… the horse is riding you.
This is a common mistake. Often a firm refuses to meet with a potential acquisition candidate, or does so with inherent disinterest, because there is a perception that they are asking too much. An acquisition should not be decided on what you pay, it should be decided on what you get.
Let’s use a working example to clarify this position:
- Firm A does $750,000 in gross billings annually. The service mix is 15% review; 25% compilation; 10% consulting; 50% tax related work of which they prepare 270 individual tax returns at an average of $650 per return. One owner and five competent staff.
- Firm B also does $750,000 in gross billings annually. The service mix is 12% review, 22% compilation; 12% consulting; 54% tax related work of which they prepare 305 individual tax returns for an average of $600 per return. One owner and five competent staff.
Firm A wants a price multiple of 1X. Firm B wants a price multiple of 1.1X.
If we focus just on the expected multiple we begin to realize separation between the two. At this point, most would identify Firm A as being more attractive. Unfortunately, we now have the horse riding us, instead of us riding the horse. The price (or multiple) is rarely the critical factor. Why? Because, at this point, we are missing four key success variables which in their totality determine the fifth… the multiple. Value is heavily influenced by these five variables:
- Down payment at closing, if any
- Length of payout period on balance due
- Profitability of the deal including the tax treatment of the payments
- Duration of the post-closing retention period and adjustments for lost clients.
When a prospective client calls your office to ask what you charge for (fill in the service), you probably answer the question with a fee range depending on the complexity of the requested work. When the prospect says, “That’s too much!” and hangs up, you’re frustrated because the price shopper doesn’t even know what services he/she would get for your fee.
Do not make the same mistake with price valuation. You cannot make a price conclusion based on a snapshot of the practice (or declared multiple) without finding out what you can get for your money.
What you can get is often not clear on a practice or profile summary. Take the next step to further your knowledge of the details of the practice and the terms of the potential deal. If the next step had been taken in the examples of Firm A and Firm B it would have been discovered Firm B was offering much better terms and that two of the staff members are young, talented CPAs with great futures, a very attractive circumstance in our profession.
For example, let’s say Firm A wanted 1X but required 15% down, a 5 year payout, 2 year retention period and 50% allocated to good will. Firm B wanted 1.1X but no cash down, a six year payout and retention period structured in a method that yielded the buyer a current deduction. Which deal is more attractive to you?
Without understanding your firm’s definition of growth or having a clear picture of the reasons, priorities, goals or expectations for an acquisition, you will not be able to efficiently evaluate or value an acquisition opportunity.
More information on practice valuation:
- How to Value a CPA Firm for Sale by Joel Sinkin and Terrence Putney, Journal of Accountancy, c2013
- Pricing Issues for Midsize and Large Firm Sales by Joel Sinkin and Terrence Putney, Journal of Accountancy, c2014
- Pricing Issues for Small Firm Sales by Joel Sinkin and Terrence Putney, Journal of Accountancy, c2014
- CPA Firm Mergers: Is it A Buyers’ or a Sellers’ Marketplace? by Joel Sinkin, AccountingToday.com, c2012
- The Great Mystery: How Do Billing Rates and Profitability Affect a Firm’s Worth? by Joel Sinkin and Terrence Putney, The Practicing CPA/AICPA, c2011
- Succession Planning – Valuing Partner Equity in Larger Firms by Joel Sinkin and Terrence Putney, CPA Practice Management Forum, c2009