|  Succession
planning is like eating healthy food and getting
regular exercise: you know it is good for you,
but you procrastinate about doing it. The importance
of succession planning cannot be underestimated.
The demographic picture confirms this: succession
planning is the No. 1 challenge facing small to
medium-sized practices and 46% of these smaller
practice partners and sole practitioners are 55
years of age or older. According to a CICA survey
concluded in May, 99% of sole practitioners have
no succession plan at all.
So what
does succession planning mean in the context of
a public accounting firm? It is a process-based
journey that requires you to actively seek out
and interest a third party in assuming the ownership
of your accounting firm at a time and at a price
that works for you. Unfortunately, most practitioners,
whether sole practitioners or part of a smaller
partnership, wait until it is woefully late to
start thinking about how they are going to withdraw
from public practice. However, their options include:
- grooming
their successor;
- merging
years before exiting; or
- selling
the practice closer to date of their withdrawal.
As each
option could take up the space of this article
and more, I will focus on the process of a sole
practitioner selling an accounting practice. Selling
their practice to a third party is the most common
exit strategy used by sole practitioners and is
also the one burdened with the most pitfalls.
As Confucius said, “A journey of a thousand
miles begins with a single step.” There
are several steps to take in order to make the
process as smooth as possible.
Step
1: Get your house in order
The day-to-day operation of a practice should
differ somewhat from how a potential buyer would
see it. The world of real estate provides a good
example: when selling a home, the seller usually
ensures it is spotless before each viewing —
this should include tidying up the family room,
putting away the dishes and getting the children’s
bedrooms in order. The house must be in pristine
condition for a potential buyer to view. Similarly,
selling a practice should involve taking care
of dubious works in progress, potential bad debts,
disputed fees and untidy working paper files before
the outside world views the practice. Time spent
sweating the small stuff will be repaid handsomely
later on.
Step
2: Prepare an information package
Continuing the real estate analogy, a buyer would
expect an information sheet at the very least
outlining square footage of rooms, local taxes
and asking price. Any self-respecting buyer of
an accounting firm would also like to see the
firm’s “financial dashboard.”
Some introductory
text describing when the practice was established,
how it has grown, the services it provides and
a summary of the financial results of at least
the past three years should be prepared. This
should also include a staff list containing each
employee’s age, qualifications, length of
service, salary, charge-out rates and number of
hours worked each year, and clients listed by
fee size, industry and year-ends.
Step
3: Determine price range
Do some research. Talk to recently retired practitioners
and ask what deal they were able to get. Talk
to a practice broker. Do anything to get a true
reading of what the firm might be worth on the
open market. To determine the value of a business,
a multitude of factors should be examined —
price earnings ratios, goodwill, market share,
new orders, strategic alliances, and so on. Engaging
the services of a professional valuator is very
useful.
Yet when
it comes to selling a practice, many seem to settle
on the “dollar-for-dollar” theme based
on gross annual billings — the only variant
being the ratio attained. Although this approach
verges on nonsense, it is the way many set out
to sell their firms.
So what
determines whether it is 70¢ on the dollar
or $1.50? A number of issues are involved in setting
a price, including:
Quality
of working papers
Control the quality of the working papers, as
the quality is one of the most important issues
for a potential buyer.
Client retention and future revenue potential
It is all very well to say, “Client X has
been with my firm for 30 years.” However,
if Client X is nearing retirement and there is
no natural successor in place, that client doesn’t
appear to have much revenue-generating life left
for the practice. Client X is not as attractive
as Client Y, the 35-year-old who has been with
you seven years.
Charge-out rates and recoverability A potential
purchaser will, ideally, want to see billing or
charge-out rates similar to his or her own if
the transition is to be successful — and
profitable — down the line. But if the firm
is not recovering at least 80% of time spent on
client affairs, its charge-out rates may be seen
as artificially high when compared with the efficiency
or with the value that clients attach to services.
Either way, this is a red flag for a potential
buyer. It can be indicative of a problem, and
people do not like buying problems.
It might
be better to reduce an individual’s hourly
rate to $85 to recover 100% of the time as opposed
to $100 an hour and recover only 85% of the person’s
time. From a buyer’s perspective, higher
recovery rates are better indicators than billing
rates. It may also sow the seed that there might
be room for increasing rates in the future, post-merger
or post-acquisition.
Staff
Some deals make financial sense, if only to acquire
a quality talent pool. The fact that salaries
are covered — with money to spare —
by the fees that come with staff is a really nice
bonus.
If the professional
staff has been with the practice for a while,
is well-trained, and has numerous client contacts
(and gets on well with the clients), the individuals
comprise a huge asset from which the seller can
realize a capital sum.
Net profitability of the firm
If the practice is netting 40% or higher, it is
doing well; 50% or higher, is doing very well;
60% will put the firm near the top of the upper
quartile.
Availability
of out-going partner For most deals, the out-going
partner should be available for one or two years
after the sale.
Step 4: Determine negotiables
There are many issues to consider, the top four
being:
- Are you
prepared to bill your work in progress at closing
and be responsible for collection?
- Are you
able to assign the lease of the premises from
which you operate?
- Are you
going to insist that all staff be taken on by
the new owner?
- How much
time will you commit to the new owner for the
next year or two?
Also important
is to decide which issues are simply nonnegotiable,
including length of earn-out period, what happens
to staff and price.
Step
5: Set a date
Focus on a particular date or event to make sure
a deal is done. Consider when it would make sense
to start pulling back and work on putting a deal
together to achieve it.
Step
6: Spread the word
There are a number of popular methods for finding
a buyer:
- place
an advertisement in CAmagazine,
- use the
CICA’s practice listing service,
- network
with your peers and invite inquiries, and
- use a
broker.
None of
these methods is guaranteed to yield results.
No matter which is used, the seller needs to ask
one simple question: who is going to be the most
highly motivated to achieve a result?
Step
7: Meet and greet
The best policy is to be open and honest. Those
who have gone to the trouble of preparing an information
package may want to get a confidentiality agreement
in place before letting potential buyers walk
away with sensitive financial and client information.
Take time
with these meetings. Don’t rush them. Prepare
a list of issues to discuss and cover them in
a businesslike but friendly manner. Ideally you’re
looking for fit before finances.
Meet the
party several times to get comfortable with him
or her and try to picture the person with your
biggest clients. If that thought makes you uncomfortable,
you’re probably better off looking elsewhere
for a successor.
Step
8: Select a winner
When you have met a sufficient number of potential
successors, it is time to choose. Keep extensive
notes from each meeting and refer back to them
as often as necessary before coming to a decision.
Having someone
else to discuss this with can be a valuable asset.
Find a mentor, a coach or a consultant. Money
spent here (if necessary) is a sound investment.
Step
9: Come to an agreement
Based on your discussions, prepare a sale and
purchase agreement. Again, time spent face-to-face
preparing a draft of the agreement is time well-spent.
Discuss the terms, financing, earn-out period
and method of calculation. Also discuss the time
commitments required of you by the buyer (three
to four hours per client for the first year is
recommended) and wheth- er you’ll be compensated
for any additional time or work performed for
your former clients. Get lawyers involved at an
early stage and listen to their advice.
Step
10: Announcements and transitions
This is a sensitive issue that has to be tackled
head-on.
Most deals
are positioned as a merger for fear of losing
clients if the truth be told. And that’s
fine. It’s a little white lie where nobody
gets hurt. Clients are told you will still be
around (in truth, you will be — for a while)
and you will facilitate introductions to the new
partner.
As time
goes by and clients get used to dealing with the
new person, you can quietly slip off to the golf
course or wherever now that you have time on your
hands.
Step
11: Post-deal commitments
As a part of the agreement, you should be available
for a fixed period of time, at a rate agreed upon
for any additional work the new owner might want
you to do in the next couple of years. Make sure
you can honour these commitments, so don’t
buy the orange grove in Tuscany just yet.
You will
also need to verify client losses (yes, there
will be some) and your agreement should cover
this issue. An annual get-together during the
earn-out period is a good idea, taking place on
a set date each year to make sure life does not
get in the way of the new owner preparing financial
statements for the firm and assessing client retention
to calculate the payout due to you in accordance
with your agreement.
Tax consequences
should also be considered during negotiations.
Is this a capital item or a distribution of income?
Whatever your preferences, don’t let the
tax implications kill a good deal.
How
long will it take?
Finding a buyer is a demanding and time-consuming
task, not to be taken lightly. Very rarely will
you find the ideal buyer at the first time of
asking.
When looking
to sell a practice or to merge with another firm
as a part of your exit strategy, many variables
come into play. Some have been discussed, and
as such, you may be looking for a practitioner
who will be a good fit for your clients.
When meeting
potential buyers, one question well worth asking
is: 'If I were 20 years younger and all other
circumstances were right, would I feel comfortable
having this person as a partner?'
The answer
usually determines if it is a good fit or if you’re
just talking to him or her because the person
is interested and has a chequebook.
The amount
of time to find the right buyer can take from
six to 12 months, if you are diligent about the
process.
Roadblocks
There is a saying that “forewarned is forearmed.”
A few of the most common roadblocks in securing
a deal include:
- price,
- earn-out
period,
- payment
terms,
- post-deal
time commitment of exiting practitioner,
- compensation
for time commitments,
- name
of the new firm (especially in a merger situation),
- tax treatment
of the deal,
- method
of calculating the earn-out distributions,
- monitoring
lost clients, and
- payment
for special services sold to clients.
Review the
list and give some thought to these issues before
any meetings. Remember, pick your battles carefully.
Giving in graciously on a small point may help
you score favour on something you consider to
be a major issue.
Start the
process early. It is amazing how much time and
effort a succession planning project can consume.
--------------------------------------------------------------------------------
Steve McIntyre-Smith
has developed for the CICA a succession planning
toolkit for CA firms. For more information, go
to www.knotia.ca/store/succession.
He is president
of MFA Group Inc., a boutique consulting practice
that only works with public accounting firms.
He can be reached at 905-257-2284, or steve@mfagroup.com
or at his website http://www.mfagroup.com |
