This article was first published in the April 2011 Singapore edition of Accounting and Business magazine
In any transaction there needs to be a willing buyer and a willing seller. This normally means that there needs to be some form of compromise by both parties in order for them to reach agreement.
Every sale of a certified public account (CPA) firm, or block of fees, will be different. Individuals on both sides of the deal will put a greater emphasis and weighting on the aspects of the agreement that they feel are crucial to them. This emphasis is often different for both parties, but agreement is essential for the success of the overall deal.
In this article we look at the main areas that need to addressed in deals involving the sale of a CPA practice or block of fees. These factors should be considered by the purchaser or merger partner, but are also relevant to the vendor, as he will want to make sure his house is in order prior to taking his business to market. Planning around these points can maximise the consideration achieved on the sale of the practice.
Whether buyer or seller, you will have undertaken some form of strategic planning to determine the rationale for either seeking to dispose of the business, or to grow through a proposed merger or acquisition. As the purchaser, you will probably therefore be aware of the type of practice you are seeking to purchase, and a determination of the fee quality, type of fee, staff numbers and annual fees that you can manage.
Purchasers must also be aware that ‘doing the deal’ takes time and resources away from client-facing work and ‘bedding in’ of the acquisition or merger following deal completion is also likely to detract from partners fee-billing time.
Whether buyer or seller, having made the decision, you will need to access the market, and the most straightforward way of doing this is via a broker consultant. Typically, brokers charge on a success fee basis, with an upfront commitment fee.
As specialists in this sector, brokers will be able to introduce you to the most appropriate parties, avoiding wasted time with speculators. A structured and managed approach will improve time management and your confidentiality will, crucially, be maintained throughout the process.
A good broker consultant will take time to understand the main drivers of the deal and what outcome you are seeking (this is discussed later under ‘profiling’). After this assessment, the broker is likely to recommend parties that fit your criteria and an exploratory meeting will be set up under confidentiality agreements.
Normally, initial meetings with a prospective purchaser or acquisition target address the key component of these types of deals – chemistry. If you don’t think you can work with a particular person or the servicing partners are not going to be compatible with your clients, the deal is unlikely to work.
Parties progressing to second and third meetings will need to ensure business compatibility by undertaking due diligence in the areas shown in the box below. Additional points to consider will normally include issues such as whether the transaction is a purchase of equity, or assets and goodwill. Consideration will also need to be given to websites, notification to clients, potential retirement dates and the completion date.
Key aspects, which in our experience have the power to either make or break a deal, include the following:
The calculation of the purchase consideration. The terms over which the consideration will be paid and any adjustments to the consideration for loss of clients over a pre-determined period following deal completion.
Substance of the deal
What is being purchased? – Equity, or assets and goodwill?
Do the gross recurring fees historically generate a satisfactory level of profitability and are these fees sustainable over the next five years? Does the combined entity fit in with the purchaser’s aspirations and strategy?
These can include items of litigation, past litigation claims, quality and commerciality. Commerciality covers issues such as client sensitivity to price increase, client servicing requirements and an understanding of whether these servicing requirements are purely compliance, specialist or advisory client fees.
We would also include here confirmation that the purchaser’s finance deal is in place. We have experienced a number of purchasers who, at the outset, say they have funds available. However, subsequent enquiries find that funds may not be available to cover the full purchase, even over a deferred period.
Prejudice and egos
There are often partners in both firms (acquirer and vendor), who turn out to be too difficult to allow the deal to work. As a rule of thumb, the practice should never invite its corporate finance partner to negotiate the deal. The corporate finance partner usually works for clients as an agent and is representing client business on a win-win basis.
However, when it comes to selling your own practice there has to be some compromise and the corporate finance partner is often in the unfamiliar role of principal. Asking a corporate finance partner to negotiate is often a recipe for failure.
If there are chemistry and leadership issues, particularly in the case of a merger, it is often an early indication the deal may not work and these points need to be placed on the table and discussed in order to save time and not protract a doomed deal.
The prejudices and egos can also have an impact on the style of management, the autonomy and contribution of partners, the client perception of the business and the lead partner contact. A strong autocratic leadership may attract partners with little leadership aptitude. These partners can be poor team players and provide limited succession capability.
We are aware through our consultancy assignments that team players and strongly driven practices are, to a greater extent, commercially focused with clear responsibilities for each partner. The introduction, through acquisition or merger, of traditional practices or partners who have worked under a traditional non-commercial style can lead to a difficult integration.
Such a deal will require substantial additional time to be spent bringing the new younger partners on board and inculcating the ethos of the larger practice. In our experience, some of the younger partners respond, some of them do not and further action needs to be taken to ensure the combined post-deal entity continues to thrive.
One of the most important phases of the deal process is the preparation of the practice for sale and this involves thought and planning.
The acquirer needs to be clear on what type of firm they are looking for and, when they review a practice to assess its suitability, the due diligence should be financial and commercially focused. The acquirer is usually looking for compatibility of client servicing and the prospect of a seamless integration.
Meanwhile, the vendor needs to prepare a profile of their own practice as part of their strategy review, possibly up to three years prior to taking the business to the market. This profiling discipline should be the centrepiece of a strategy review, and should highlight the strengths and weaknesses of the practice.
The principals then have the opportunity to implement changes to the practice in order to make it more attractive to a potential purchaser in two to three years’ time. It is often advantageous to engage a third party to undertake this review in order to achieve objectivity.
Some external factors also need to be taken into account when undertaking the profiling process. For example, there is no point in focusing on low level audit fees if the audit exemption levels are due to be raised in the next three years.
A purchaser will view this prospect as a declining business, and emphasis and marketing to new clients needs to be directed away from the compliance audit service to create a future-proofed practice.
At an early stage of discussion we ask the vendor to profile a suitable purchaser. Inevitably the vendor/partners will brief us with a profile almost identical to their current management. It is only by explaining that the practice needs to evolve and that the purchaser is likely to be a larger firm with its own ethos, systems and workflow routines, that can we talk about profiling and making the vendor practice transparent for a merger or acquisition by a larger firm.
The issues to be discussed would include client/partner contact, second-tier management client contact, billing procedures, work in progress and debtor management, optimisation of staff resources, staff contracts, partnership agreements, LLP/shareholder agreements and an assessment of the client receptiveness to the prospective change.
Profiling is often a refreshing evaluation for any practice. It is not only an opportunity to identify the weaknesses but, more importantly, the strengths and skills of a practice. The exercise can also be a catalyst for understanding and change from which a management can derive significant commercial advantage.
Practice management is an evolutionary process. A structured approach, perhaps with outside guidance, can be rewarding – improving performance as well as staff and partner satisfaction over the short and long term. It is never too early to make a start
Tim Underwood is a director in the Singapore office of Foulger Underwood, and Derek G Smith is senior consultant in the London office
Due diligence matters
Once a potential deal has progressed to second and third meetings, it is vital that due diligence is undertaken by both parties in the following areas:
- Number of partners and ages
- Break down of clients into servicing requirements and revenue streams
- Number of clients and break down into fee bands
- Staff numbers, salaries and copy of contracts
- Levels of work in progress and debtors for the last 24 months
- List of fixed assets
- Accounts for the last three years.