How do you value a practice with a view to a sale? Tim Underwood looks at some of the factors in valuations and structures that prospective sellers need to consider
This article was first published in the January 2020 International edition of Accounting and Business magazine.
One of the first questions we are asked when discussing the sale of a practice with a prospective client is ‘What is my practice worth and what deal structures are on offer?’ The answer has changed over the past five years for a variety of reasons, which we explore below.
In a nutshell, ‘back-of-the-envelope’ valuations for a general practice remain stubbornly linked to a multiple of fees, or gross recurring fees, between 0.8 and 1.25, with the structure of payments being made in 30% instalments on completion and the two following anniversaries of the transaction.
These offers remain common, especially for general practices with a client book heavily dominated with audit and assurance services. But things are changing.
Firstly, just to give some context to these key features of a transaction, it is important to decouple valuation and deal structure as both have an impact on one another. As extreme examples, if a practitioner wanted to sell their firm and receive 100% cash on day one, they would need to discount the price/valuation significantly. The reverse may also be true: extending the payment period and receiving a higher price. But there are a variety of factors that can impact the structure and valuation, a good number of which are related to the aspirations of the vendor and plans the buyer has for the practice.
Putting these softer, more personal aspects to one side and focusing on the sector as a whole and the firm itself, there are a variety of reasons why valuations and deal structures are being approached differently now.
- Practices are moving away from a dependence on audit services. Some of this is regulatory, with increasing audit exemption levels, but practitioners are also increasingly aware that the greater margins are in compliance and recurring services such as company secretarial, payroll, tax and bookkeeping. In most markets, these services are less labour intensive, carry less regulatory risk and can be provided without the need of institute regulatory oversight or government regulation.
- IT has taken the profession through various step changes illustrating how these compliance services can be streamlined, with repetitive processes being automated and artificial intelligence underpinning various aspects of the work. There has been an impact from IT on the audit side as well; with the right technology, you can now incorporate a company in minutes, run a payroll calculation and ‘push it’ up to a client back account, or reconcile a client’s supplier invoices in seconds employing OCR. Cost and labour resource is being removed, driving margins.
- We have also witnessed firms becoming specialists. This could mean only taking on certain clients in specific industries, providing a limited menu of services or moving up the value chain by offering higher value crossborder tax or transfer pricing services. From the discussions we have with firms across Europe and Asia, it is clear that clients are not always looking for a general, one-stop-shop provider but to be advised by the best in breed for the specific advice they need.
- In the context of all the points above, different staff skillsets are required. This has allowed some firms to employ lower cost bookkeepers, strip out layers of higher qualified middle management and streamline their compliance process. The direction of travel on the HR side is definitely to provide flexitime and/or allow staff to work remotely, reducing office overheads. We have an example of an accounting business we worked with in the US, which generates US$12m in revenues with one small office of six staff and the rest based at home.
- The final key factor is the purchasers. Especially in Asia, this segment of the market has changed significantly over the last five to six years: new entrants, with new models, are looking at valuing businesses on multiples of EBITDA rather than a multiple of fees. We had an example last year of a firm in Thailand that was offered 1x fees for the practice. When we introduced our client to a range of non-traditional accounting purchasers, the offer, which was based on EBITDA, was 2.8x fees. This isn’t an extreme case, and we have numerous similar examples.
Look at the profit drivers
These five points, which individually cover a range of underlying factors, are driving change in the broader accounting sector when it comes to M&A valuations and deal structures.
For the general practice, it is prudent, when looking to sell, to profile your firm, look at the profit drivers and segment different service lines. Our view is that it is pretty antiquated to apply a fairly arbitrary multiple to gross fees and that the individual business units should be valued independently. The final multiple may be similar to 0.8-1.25x gross fees, but in many cases we are seeing final valuations at enhanced levels.
In terms of deal structures, we are also seeing some change: higher proportions of the consideration are being paid upfront on completion of the transaction. In some cases, this can be in excess of 70% of the total consideration, with the balance payable within 12 months.
Tim Underwood is managing director of Foulger Underwood Asia.
"It is prudent, when looking to sell, to profile your firm, look at the profit drivers and segment different service lines"