All posts by Ken Berry, CBI

So, what do you think…has the current economy created an increase in accounting practice sales prices, a decrease, or have selling prices of accounting practices remained stable? Last week, a CPA interested in buying a practice I represent for sale shared with me that he would have paid 1.15 for the practice two years ago, but in the current economy all practices are selling for one times gross. Beside the obvious comfort of going to the one times gross myth (see my July 2009 post about this), I found this observation quite perplexing.

Perhaps I am confused or naïve, but I do not see the direct correlation between the economy and value. Looking at the larger picture, when I go to the grocery store, I do not see a reduction in the price of a gallon of milk. I certainly have not seen much decline in the price of a gallon of gas. When I look at the corporate world, many companies have increased in value and massively overvalued transactions continue to take place in the high-tech sector. In fact, I believe Google is doing so well it just paid all employees a 10% bonus.

Some equate practice sales with home sales, so let’s look at that idea. There has been a pretty significant downward shift in home values across the nation, in some regions more so than others, but the basis of this shift has been a huge upswing in supply and a decline in demand as the sub-prime lending market went through upheaval, foreclosures increased to record highs and home mortgages became harder to secure.

In the accounting industry, we have seen the reverse as demand is outpacing supply. Fewer practices are put on the market because, for many, retirement has been put off until more certain times. At the same time, we have seen an increase in buyers with the growth on two fronts: 1) practitioners exiting the larger public firms and private industry looking to get their ownership start through an acquisition; and 2) existing practice owners that have identified an acquisition as the best way to increase the bottom line in the current economy.

So, I find this CPA’s statement fascinating because we find that a practice that has maintained its revenue and profitability during the past two years, and now finds itself in a higher demand market, has higher value than it did prior to being tested, and proving strong and stable, through the worst economy our nation has seen in 80 years. A practice that has grown during this time, and many have, is certainly doing the right things during difficult times.

The reverse is true as well. If a practice is struggling and having a tough time in these economic times, then its value is going to decline…just as it would in any other economy.

The economy has had an impact on accounting practice sales. Some regions have been hard hit and practices in those regions have declined. Financing has become more difficult to secure.

However, I would suggest that if you are not willing to pay as much for a strong, stable practice today as you would have two years ago, then your sense of fear and risk in the current economy is out of sync with the facts and maybe you should not consider an acquisition until we find ourselves in a more certain economy.

Comments (0) • Posted November 19th, 2010 at 9:00am

Three Crunch Bars and a Milky Way for a Six Pack of Oreos.

Sunday night, I had the fascinating joy of watching 5 pre-teens (ages 8-10) sit down on the living room floor and wrap up a great evening of trick-or-treating.  They each chose a section of floor space, poured out their bags full of candy and carefully sorted and organized the array of treats.  Then, they got down to business…the annual candy barter.

I was amazed to watch as three Crunch bars and a Milky Way were eagerly traded for a six-pack of Oreos.  It was a trade I would never have made, but I realize I appreciate Crunch bars and Milky Ways (thankfully it wasn’t a Snickers or I would have had to intervene) far more than Oreos and far more than the recipient of the six-pack.  However, both children were thrilled.  The trades went on and on, with only Milk Duds failing to raise interest, until at some point the energy faded and everyone settled on their final lot.

The whole process made me think of the power of the “eye of the beholder” and how this principle applies to practice sales and acquisitions.  Earlier this year, I was advising a partnership on an acquisition and the seller insisted on over a 1.35 multiple of gross.  I had run my pricing analysis and, based on market comparisons, found the practice to be worth somewhere between a 1.15 and a 1.20 multiple of gross.  I advised the partnership accordingly but with the caveat that I could not define what it was worth to them.  You see, this particular acquisition would have made the acquiring partnership the top firm in their market.  That didn’t mean anything in my analysis, but it meant everything to my clients.  So, they decided to pursue the acquisition at the high multiple and, only after due diligence, eventually stepped away because it turned out to be too risky.

This also applies to the seller side of the transaction.  I recently represented sellers who would not consider receiving less than 80% cash down at closing.  That was until they met their ideal buyer.  Once in dialog with this candidate, they became more comfortable with the idea of less cash down as the fit of the buyer diminished their sense of risk.  In fact, they still would not consider less down from other candidates.

How much is a practice worth?  I can talk with you about profitability, market demand, strengths and weaknesses of the selling practice, risk in deal structure and the related market comparables.  However, in the end, the value will always be defined, in part, by the eye of the beholder.

Comments (0) • Posted November 4th, 2010 at 5:56am

As the summer progresses, we are entering the busy season of selling accounting practices.  We have been scheduling lots of meetings between sellers and prospective buyers so thought it would be good to spend some time blogging on these meetings.

The initial meeting between buyer and seller is where many buyers either win or lose the opportunity to purchase a practice.  To a large degree, the success of this meeting will depend on the ability of the buyer to connect on a personal level with the seller.

Many factors influence the way the buyer is perceived and will affect the degree of rapport established with the seller.  The seller has invested both financially and emotionally in the practice and wants to insure that it is sold to an individual who will care about the practice and the clients.  We will explore several issues in this series of blogs.

The first, and perhaps most important thing to remember is this:  The meeting with the seller is a confidential meeting.  Do not discuss the purpose of your meeting with anyone who may be remotely connected with the sellers practice.

Selling an accounting practice involves many, many people.  Including the seller, it also includes:

•    The seller’s family
•    The seller’s staff
•    The seller’s clients

It is the seller’s responsibility/privilege to tell the story he or she needs to tell about selling the practice.  In addition, and of perhaps greater interest to the buy, if news of the potential sell leaks prematurely, it can cause the practice to lose value.

If word leaks that a Seller is contemplating a sale of the practice, it could raise anxiety among the staff.  It might cause clients to use the transition to find an alternative service provider.  It may even cause hardship in the Seller’s family if they are not fully aware of his or her intentions.  

It is always best that the Buyer respect the confidentiality of the Seller.

Comments (0) • Posted July 28th, 2010 at 9:13am

A while back we put out some statistics comparing our practice sales results to some For Sale by Owner (FSBO) statistics we received from the AICPA.  The comparison raised a lot of questions from practice owners on both the buy side and sell side of future transactions.  Today, I want to address the questions I most often receive from those thinking of selling a practice.

The main question I receive from potential sellers revolves around how shocking the FSBO numbers are:

Why, when people sell on their own, do they settle for such high risk transactions — Like no money down, percentage of collection deals?

The answer primarily lies in the emotion tied to selling a practice to an unknown person.  One of the biggest questions looming for any practice owner is “who can run my practice?” or perhaps more accurately “who can I trust to turn my practice over to?”  In our experience, this question can have incredible importance to a degree that the answer carries higher priority than price or terms.

Often, this is where the FSBO seller starts.  Who do they know?  Who do they trust?  Who is just like them and will get along with the clients?  It might be the practitioner down the hall, the one they have spoken with for years at the chapter meetings or a friend of a colleague they have heard great things from.

Starting with this base of known practitioners immediately limits the market the FSBO will explore.  Then the FSBO, having identified their buyer, has the job of convincing the buyer to buy.  Fair Market Value of a business is defined as the value of a transaction in which “neither party is operating under compulsion”.  In transactions we develop, we see value being defined by a seller and a buyer both operating under compulsion.  In the FSBO transaction we have just outlined, the seller is typically under more compulsion than the buyer.  In many cases, the buyer may have no compulsion and in fact may believe they are doing the seller a favor.

The disparity in the statistical comparison is due to the fact that we, like most business intermediaries and unlike FSBO sellers, do not pursue a single buyer.  We work to create a market of buyers around the sale of a specific firm and let the market determine the price and terms.

Comments (0) • Posted July 22nd, 2010 at 1:40am

We present several webcasts per month and frequently poll the audience about the old industry rule of thumb that all practices are worth one times gross.  So, we thought we should take a look at this rule of thumb and let you be the judge.

For a basis of our analysis, let’s say we are looking at two practices each grossing $500,000 annually.  Under the one times gross rule of thumb, they are each worth the same amount, $500,000 or one times gross.

But wait, we delve into the practice information and find one of these practices is netting $250,000 and the other is netting $150,000.  Are they still worth the same amount?  In our webcasts, our attendees almost unanimously agree that the $250,000 net is worth more.

Now, let’s say the owner of the $250,000 net firm is personally billing 2,000 hours per year and the owner of the $150,000 net firm is personally billing only 500 hours per year.  Now which one is more valuable?  This is where it gets tricky.  Is 1,500 billable hours worth only $100,000 in additional net?  What is the line between quality of life and money made?  A very personal determination, but all our webcast attendees unanimously flipped their perception of value with this additional layer of information.  Not a single one across all of the webcasts we have held believed the $250,000 gross was more valuable if it required the owner to personally bill 1,500 additional hours.

You can draw your own conclusions, but we have just barely scratched the surface of these two example practices and already the one times gross rule of thumb is looking pretty flawed.  Our experience is that not all practices are worth one times gross.  How could they be?  A practice is far more complicated than just a gross and differences like staff, billing rates, location, length of service, types of clients and owner’s billable hours among dozens of others are critical components that need to be factored to determine value.

Year in and year out, we see practices selling for 1.0 times to 1.35 times annual gross, with very strong practices selling above 1.35 and struggling practices selling for less than 1.0.  In the end, if a practice sale is well executed, the market will determine the price and it will be based on far more than just the gross.

Comments (0) • Posted July 19th, 2010 at 3:29am

I have presented several webcasts in the past month and in all of them there have been questions about the use and value of a Letter of Intent (LOI) — in our process this is typically a non-binding agreement that signifies agreement in principle on the core deal points and agreement to negotiate in earnest on all remaining items.  Some brokers advise to skip the LOI and go straight to the purchase agreement and an LOI is not typically used in the market at large. So, why do we advocate the use of an LOI when purchasing a business?

In our experience, an LOI is a critical component in structuring a win-win transaction.  We use them on virtually every deal. Here are the main benefits we see:

• More efficient use of time

• Proceeding with a clear understanding and agreement in principle

• Trigger point for taking the next steps

More efficient use of time:   Some people feel an LOI puts the cart before the horse. We find exactly the opposite to be true.  If you were to go to an unknown area, would you want a map of the area? Well that is exactly what the LOI is: a map of the major deal points. In today’s busy world it is important to be sure two parties are going down the same road and in the same direction before spending too much time working out all the details of a transaction.

Proceeding with a clear understanding and agreement in principle:  The key elements of the LOI should be negotiated beforehand and can be used as a guideline to prepare the purchase agreement. It should state that, if all information during due diligence confirms what was represented, that the buyer intends to complete the purchase under certain conditions. The key elements should include:

• All parties to the transaction
• Type of deal structure
• Price
• Payment structure
• Non-compete
• Transition plan
• Closing date
• Contingencies (i.e. due diligence, financing, etc.)
• And identify other items to be negotiated.

Trigger point for taking next steps: In addition to setting the key elements of the deal, the LOI is also a trigger point for critical milestones during process. Those trigger points are:

• For the seller to remove the practice from the market and focus on the single buyer.
• For the buyer and seller to begin conducting their due diligence.  With agreement in principle on the main terms the seller will have more comfort in opening the books and sharing client information and the buyer will have more comfort in providing financial information.
• For the buyer to pursue financing.  The financing process takes times and banks require either an LOI or purchase agreement as part of the loan package.  So an accepted LOI is a critical component to securing financing.

We have a saying in our firm that smooth transactions make successful transitions. Basically, if two parties cannot agree on the elements of the LOI, they will probably have a hard time negotiating while dealing with the minutiae of the purchase agreement. Normally, once the key points of the deal are negotiated up front, the rest of the transaction tends to work much more smoothly.

Comments (0) • Posted June 21st, 2010 at 4:23am

I’ve often heard two things in life are certain: death and taxes. Taxes, for a tax or accounting professional, are usually a very good thing. Death, on the other hand, is not so good and, without proper planning, can be very bad.

Some time ago, we had a call from a CPA interested in selling his practice. He mentioned that he was ill and would not be able to work much longer. He wanted our help selling his practice.  However, he kept pushing aside our paperwork and focused on taking care of other issues in his life. He mentioned to his wife that he had contacted us about selling, but did not involve her in any planning. When he passed away a few months after our initial conversation, he had never finished the paperwork we required to market his practice for sale.  He also did not leave any instructions for his wife.

Months later his widow contacted us to get the practice listed for sale.  Unfortunately, it was too late.  Most of the clients, who knew of the CPA’s illness and death, had already found other suitable accountants.  As a result, his wife and family received zero proceeds from the practice.

If you die without developing some form of practice continuation plan, your family is at risk of receiving nothing for your business.  Having a plan should enable your family to insure the continuation of practice through an internal buyout with an employee or partner or an external sale.  Whether you draft a plan or not, your family or estate will need to move very quickly.  Word travels fast and within a matter of weeks the value of your practice can decrease dramatically.

To help your family address the issues surrounding the transfer of your practice in your absence, we recommend you write a letter to be opened upon your untimely death.  The unexpected loss of you and your earnings will be hardship enough and handling the details of your business will likely be overwhelming to your family.  Help them profit from your years of hard work by documenting your plan and providing instructions for them to follow.

We are available anytime to discuss this or any concerns you may have.  It may be too early to begin a transaction, but it is never too early to begin planning.

Comments (0) • Posted May 6th, 2010 at 7:44am

John Ezell wrote a blog last week on the unfortunate truth that sometimes brokers lie to get listings.  This blog has generated quite a bit of discussion and email with one of the most common questions being, “what are the ethical guidelines for business brokers?”

Before we address the ethical guidelines, let’s define what we are talking about.  We need to understand that in selling a practice (a listing) a broker is establishing an agency relationship based on a contract. This is a relationship that involves one party (the broker) acting for the benefit of another (the seller).  For this reason, when entering into a contract it is important for an agent, in this case the broker, to disclose all facts which could be considered material even if not expressly asked about.

A false statement of fact made by one party to another party, which has the effect of inducing that party into a contract, is known as a misrepresentation.  There are several bodies that have statutes, canons or codes of ethics that address misrepresentations:

• First, there is the Uniform Deceptive Trade Practices Act.  This is federal legislation and addressed in statutes in every state in the nation.  Direct reference in this Act is given to “Using deceptive representations in connection with goods and services” as constituting a deceptive trade practice.  The FTC and many states also prohibit unfair practices that include taking advantage of bargaining power of vulnerable groups.
• A handful of states regulate business brokerage through their Department of Real Estate. Most enforce the National Association of Realtors code of ethics.  Article 12 states, “Realtors shall be careful at all times to present a true picture in their advertising and representations to the public.”
• In addition, there are many state and national associations for business brokers. The International Business Brokers Association has a code of ethics and business broker standards for its members. Article 1 of their code of ethics states, “Business Brokers should avoid exaggeration, misrepresentation, or concealment of pertinent facts relating to properties and business transactions.”

So the ethical guidelines for business brokers are out there, published and readily available for all brokers to follow.  Be aware of the tricks and deceptions some use and avoid being induced into an agency relationship based on a misrepresentation.

Comments (2) • Posted April 27th, 2010 at 6:09am

In our Becoming a Rainmaker seminar, we remind our participants that prospective clients buy for an emotional reason.  They need an accounting service performed, of course.  But there are many ways to satisfy that need and many accountants willing to do it.  The most successful accountants take the time and have a process to uncover the client’s emotional motivation underlying the need and then cater their service to encompass this motivation.

We can apply this same principle to buying and selling accounting practices.  Buyers buy for emotional reasons and for a successful acquisition it is important for them and those they are in dialog with to understand their emotional motivation.

We all function alike.  Human behavior involves three parts – motivation, intention and action.  

• Motivation is the driving force.  It is the need, want, or desire that inspires movement.
• Intention is what we aim for.  It is what we hope to accomplish.  
• Action is what we do.

It is also the case that sellers sell for an emotional reason.  The decision to sell a practice is an emotional decision.  When a practice owner offers her practice for sale, she is offering many years of work to the world.  

• Risking investment in property, furnishing, fixtures, equipment and training.
• Slowly developing the value of the business one precious client at a time.
• Long days and nights during tax season.
• Building trust in the business community providing one careful audit after another.
• Advising clients to make strategic business decisions.

When it is time to sell a practice the seller is filled with many complex emotions, some of them will be conflicting emotions.  

• I am burned out, but I do enjoy many aspects of the job.
• I am aging and just can’t keep up with the work-load any more, but I love what I do.
• I am going through a divorce and need to sell my practice in order to divide the assets with my ex.
• My spouse is ill and needs me at home.

We have encountered all of these scenarios over the years.  When a seller meets two prospective qualified buyers, he or she will sell the practice to the one that feels right.  The wise buyer will be sensitive to the feelings and emotions of the seller and the wise seller will be sensitive to the feelings and emotions of the buyer.

Comments (0) • Posted April 5th, 2010 at 10:05am

I coach youth soccer and have worked with a team for several years now.  They have become a very good team, ranked in the top 50 of all Northern California teams in the age group, and the games have become incredibly competitive.  Last season I implemented something that helped push them to the next level.

See as a coach, like a business manager, you are striving to get the best from all your players all the time.  What a lot of us do is focus on the technical stuff, in soccer this is touch and control, vision, moving the ball, moving off the ball, passing and finishing among dozens of other skills and techniques.  In an accounting firm, this might be answering the phone, greeting visitors, running client meetings, processing returns, balancing ledgers, filing, reviewing, auditing and dozens of other critical functions.

Last season my boys were in the championship game of a tournament.  They had dominated their bracket winning all three games and outscoring the opponents 15-0.  They were playing in top form when we went into the final game.  In this final game they came out flat, were out of sync, were not moving well, were not passing well and were not creating chances.  They gave up two great chances to the opponent, one resulting in an opposition goal.  It was 97 degrees on a Sunday afternoon in September when they came off the field at halftime down 0-1.

As a coach, like a business manager, you have all sorts of choices of how to respond and give direction when your team is not performing the way you desire.  My boys know how to play the game, they know each position, its role and how to execute their jobs in those roles.  They did not need me telling them how to do this again.  I needed to tell them they could do this and put them in a good frame of thought to go get it done.

At halftime we discussed three corrections to make in the play of the game and then… I told the boys two jokes.  After the second joke, they were all laughing and commenting on the jokes to each other.  We huddled up then and, in this new frame of mind, focused on the second half.  The boys went out and scored 5 goals and won the championship game 5-1.

Right now in your office it is likely 97% stress on a Tuesday morning.  Your team is in the final stretch of tax season and they might need you to help them reframe their thinking.  Check in with them regularly, let them all know you are in it together and then have a good laugh.  I suspect the end of the season might go more smoothly, be more enjoyable and everyone will perform a bit better.

Comments (0) • Posted March 23rd, 2010 at 6:17am