Preparing Your Firm for an Upstream
Merger
August 18, 2016
Terrence Putney, CPA
CEO-Transition Advisors
NASBA CPE Earned Credit Guidelines
Transition Advisors, LLC is a sponsor on the NationalRegistry of CPA Sponsors per the National Association of State Boards
of Accountancy (NASBA).
In order to receive your one CPE credit – You must complete two
requirements:requirements:
1) Participate in three of the four polling questions during the presentation.
2) Complete an online evaluation after the webinar.
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Transition Advisors, LLC
National consulting firm working exclusively with accounting firms on issues related to ownership transition
Polling Question
How many equity partners do you have in your
firm?
1) 1
2) 2 to 42) 2 to 4
3) 5 to 9
4) 10 to 19
5) 20+
Case Study
Selling/Merging Firm• 3 partners, $2.4M in fees, $800k in capital
• Frank, 63 yrs old– 70% of the equity
– Manages $1.3M of fees
– Comp is $450k
• Alice, 55 yrs old, indefinite retirement plans• Alice, 55 yrs old, indefinite retirement plans– 25% of the equity
– Manages $800k of fees
– Comp is $275k
• Dan, 42 years old– 5% of the equity
– Manages $300k of fees
– Comp is $150k
Case Study
• Buy-sell agreement requires
– Capital paid in first year
– Goodwill value paid over 5 years at 1X plus 6% interest on
total revenue times equity
• Alice and Dan believe• Alice and Dan believe
– They can’t afford the payments to Frank
– They don’t have talent on the bench to replace Frank
– They can’t manage the firm and clients on their own
Standard Goals for Merge Up/Sell
Risk Avoidance
• Liabilities to former and soon to retire
partners
• Specialized services that may be
unsustainable
• Lease renewals• Lease renewals
• Potential loss of key employees
• Potential loss of key clients
Case Study
Acquiring Firm
• 6 partners, $7M in fees
• 2 partners will be retiring in 4 and 6 years
respectivelyrespectively
• 4 partners-in-waiting on the bench
• Firm knows it needs to promote the partner
candidates but is concerned about diluting the profit
pool
Standard Goals of Merger for Growth
Primarily Buyers
• Pure Growth of Billings
• Addition of Talent/Services
• Geographic Expansion
• Brand Enhancement• Brand Enhancement
• Acquiring Clients to Cross-sell
• Strengthen Succession Team
Alternative Deal Types
• Outright sales
• Two Stage Deals
• Cull out sales• Cull out sales
• Sale vs merger
Polling Question
What issues do you see affecting your practice
most in next year?
1) Succession
2) Admitting new partners2) Admitting new partners
3) Client retention for retiring partners
4) Need for growth
5) All of the above
Outright Sale
• Purchase payments begin immediately
• If seller needs to keep working-what to pay
• Disadvantage: not a lot of time for transition
could lead to lower client retentioncould lead to lower client retention
Two Stage Deal
Stage One-usually up to 5 yrs
• Seller merges into buyer’s firm
• Starts the transition process
• Maintain reasonable control over • Maintain reasonable control over
clients
• Take on a principal’s or non-
equity partner role
• Maintains compensation level
Two Stage Deal
Stage Two-paying for the practice
• Seller transitions to a part-time or
retired role
• If working, comp @ a per diem rate
• Purchase is now based on a practice
that has ALREADY transitioned
Cull-out Sale
• Selling a part of the practice OR
• Retaining a part of the practice
such as
— Clients
— Services— Services
— Locations
• Breaking up the firm
Sale vs Merger
• Key difference is ownership
status
• Merger-sign onto successor firm’s
owner agreementowner agreement
Case Study
Deal Structure• Frank will bought out using a Two
Stage Deal
• Alice will be admitted as an
equity partner equity partner
• Dan will be admitted as an
income partner with a path to
equity if he can manage enough
business
Case Study
• Parties agree that Franks, Alice’s, and
Dan’s books of business are separate
and distinct, therefore
• Frank’s buyout will be tied to his book
and Alice’s equity will be tied to her and Alice’s equity will be tied to her
book
• Dan will either eventually be admitted
as an equity partner or be bought out
of his equity in his old firm
Frank’s Two Stage Deal
Stage One-
• Stage One contractually ends in 3 years
• Frank’s comp is tied to his historic comp by paying
him 35% of the collections from his clients in comp him 35% of the collections from his clients in comp
and benefits
• If he uses more labor than a historic base, comp is
adjusted accordingly (can happen due to growth or
Frank reducing client service hours)
Frank’s Two Stage Deal
Frank’s primary objectives in Stage One are:• Smoothly transition his clients to the new firm
• Maintain the client relationships and fees
• Gradually introduce the clients to their successor in the new firm
• Make the day he retires into a non-event for the clients eliminating • Make the day he retires into a non-event for the clients eliminating
most of the risk of transition based loss
• All while still maintaining his income
• Dan and other partners in the successor firm become Frank’s
successors
Frank’s Two Stage Deal
Stage Two-
• Frank retained his AR and WIP at the beginning of Stage
One
• Frank is paid based on the collections from his clients • Frank is paid based on the collections from his clients
over six years starting in Stage Two
• Replicates the type of deal he would have received in an
outright sale
• Frank has been paid separately for new clients he helps
generate during Stage One and Stage Two
Polling Question
Which best describes your personal situation
over the next five years?
1) Reduce my role and time in the practice
2) Having partners reducing their role2) Having partners reducing their role
3) Acquire another firm
4) None of the above
Principles of Value
Think about what creates value for a practice
An accounting firm practice value is primarily based on a seller’s ability
and that of the buyer to successfully get the seller’s clients to transfer
from the seller to the buyer
Terms-Five Primary Factors
1. Cash up front, if any
• Dependent on time of year
• The deal’s cash flow
• Accounts receivable
2. Retention clause2. Retention clause
• Collection deals
• Fixed deals
• Limited guarantees
• Economy clause
Terms-Five Primary Factors
3. Profitability
• Seller’s current profitability
• Buyer’s anticipated profitability
• Tax ramifications of deal
structuresstructures
(goodwill vs current deduction)
4. Length of the payout period
Terms-Five Primary Factors
5. Multiple
• Terms are the cause
• Multiple is the effect• Multiple is the effect
• Basic rule:
• Lower down payment, longer payout period
• Higher profitability, longer guarantees = higher
multiple
Frank’s Buyout Terms
Frank was paid-• No down payment
• 16.67% of collections from his book for three years
• Price locked after three years and the remainder was paid • Price locked after three years and the remainder was paid
over three more years
• Treated 50% as an asset sale, and 50% as consulting
agreement
Frank was essentially paid 1X of his managed book of business-
the multiples will vary depending on the market and quality
considerations
Alice’s Merger
Alice signed the partner agreement and-• Was conditionally guaranteed $275,000 of comp and benefits
for two years
• She received her pro rata share of the equity based on
revenues (8%)revenues (8%)
• She contributed her AR and WIP as a capital contribution to
the new firm
• She became bound by all the terms and conditions of the new
firm’s agreement
Dan’s Merger
Dan signed an Income Partner agreement• His base compensation was pegged at $150,000 for two years
• He is eligible for bonuses consistent with other income
partners
• His share of the AR and WIP was retained by the successor • His share of the AR and WIP was retained by the successor
firm
• If he is not made an equity partner within three years he will
be paid for AR and WIP
• If he is made an equity partner, AR and WIP will be treated as
contributed capital
Polling Question
Your firm’s most likely succession plan looks like:
1) Find an external buyer or upstream merger
2) Internal solution-prefer not to sell or merge
3) I don’t know what my firm should do3) I don’t know what my firm should do
Identify What Defines the Right Successor Firm
Four C’s • Culture
• What’s it like to be a client, employee and partner in this firm?
• Chemistry• Chemistry
• How well do you get along with key people in this firm?
• Continuity
• How will changes in your operations affect retention of your clients/staff?
• Capacity
• Does this firm have the capacity to take this on including replacing you?
You Are What You Are
However…
However…..
• Buyers hate inheriting problems and poorly
run practices
• Clean up your AR and WIP
• Present your partners and staff in a positive
light
• Consider jettisoning problem staff
• Clean up the physical office-eliminate
clutter
• Provide good time records
• Be willing to part with unprofitable clients
Tricks & Tips
Should you ask for as much money
up-front as possible?How do Buyers view that issue?How do Buyers view that issue?
What are you gaining?
What are you losing?
Using your A/R as an offset
Tricks & Tips
Should you shorten the retention period as much as possible?
Is one year retention better or not?
What message are you sending the Buyer about
your client base?
Limited retention periods
Economy clause
Replacement clients
For More InformationVisit the AICPA Succession Planning Resource Center
http://www.aicpa.org/InterestAreas/PrivateCompaniesPracticeSection/StrategyPlanning/center/Pages/default.aspx
Suggested Additional Info
The following webinars are available on our website:
www.transitionadvisors.com/archives.php
• How to Structure Your Partnership Agreement
August 11, 2016
• Art of Your Deal July 7, 2016• Art of Your Deal July 7, 2016
• Preparing Your Firm to Grow Through M & A
June 23, 2016
• Valuing Small Accounting Firms May 19, 2016
• How Tax Season Impacts M & A January 14, 2016
Articles
CPA Firm Succession Series
July, 2013 thru June, 2014
www.transitionadvisors.com/succession-planning.php
CPA Firm Valuation SeriesCPA Firm Valuation Series
October, 2014 thru December, 2014
www.transitionadvisors.com/valuing-accounting-firm.php
Roadblocks to Avoid in Accounting Firm M & A
September, 2015
www.transitionadvisors.com/succession-planning.php
• Gary Adamson, Adamson Advisory• Bonnie Buol Ruszczyk, bbr marketing• Sarah Dobek, Inovautus Consulting• Angie Grissom, The Rainmaker
Companies• Dustin Hostetler, Boomer Consulting
• Tamera Loerzel, ConvergenceCoaching
• Terry Putney, Transition Advisors• Carrie Steffen, The Whetstone Group• Sandra Wiley, Boomer Consulting• Jennifer Wilson,
ConvergenceCoaching
#SuperConf15
• Rita Keller, Keller Advisors• Roman Kepczyk, Xcentric
ConvergenceCoaching
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Bridging the Gap: Strengthening the Connection Between Current and Emerging Leaders in the
CPA Profession
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Free White Papers on Industry Trends
• CPA Firm Leadership: Communication Drives New
Possibilities
• Measuring Happiness at Work: How Firms Can Win • Measuring Happiness at Work: How Firms Can Win
With a Happy Culture
• Top CPA Firms Succession Challenges
Download at: www.cpaconsultantsalliance.com
For More Information
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