Buying A Practice – Coping In A Seller’s Market

Acquisition; the very word conjures up images of late night secret meetings, high-level negotiations and behind-the-scenes political manoeuvrings; it’s exciting, invigorating and financially rewarding.

We often see it taking place at our clients’ businesses, but (with some exceptions) we usually get involved only when a target company has been identified and approached by our client, and they now need to prepare financial projections and ‘put the numbers together’ to see if that particular deal makes financial sense and whether the money is available or can be made available to finance the transaction.

With the ‘Baby Boomers’ now approaching retirement age, and the general demographics, shouldn’t this be a buyers market?

Well, the statistics, on first reading, would overwhelmingly support that to be the case, however, one needs the benefit of market insight to start to understand why the seller still holds the key.

We have a situation where there are a number of ‘Serial Acquirers’ who are highly active in the marketplace. They will talk to anyone and everyone, no matter where they are located, and if they can do a deal, they will. If it means adding a new location for a while and gradually merge the newly acquired clients into the central location, shutting down the ‘old’ office after a few years, or simply turning it into a satellite office, then so be it.

If it means actively supporting a new location and putting their own people in senior positions there, again, so be it.

These types of firms might acquire two or three practices each year, (some more than that) adding momentum to the downhill snowball called critical mass.

Just look at Meyers Norris Penny in Western Canada. They have experienced phenomenal growth, passing the $120 million fee mark with 35 offices and 120 Partners according to The Bottom Line 2005 ‘Top 30 Accounting Firms’ survey, published in the April 2005 edition.

Then again, there is a growing number of entrepreneurial CAs who aspire to hanging their own shingle, but don’t want to start in their basement, who see an acquisition as the perfect route to go to jump start their own practice.

Another valid (and regularly occurring) reason for an acquisition is to allow the accommodation of the introduction of a senior staff member to the partnership. A typical approach I receive goes something like this:

“We have this great, young, energetic CA who has been with us for seven years. We don’t want to lose them, so we want to invite them into the partnership, but at present, we don’t quite have a big enough fee base to do so. Can you find us $500,000 in fees to buy to give us the critical mass to admit them as a partner?”

These are just some of the reasons why buying a practice or block of fees makes sense, but there are many others too, for example:

· To take control of one’s career
· To have more time for the children
· To make more money

Whatever the motivation, the one thing that is common to most prospective purchasers is the excitement they feel and the passion they have for the public accounting domain.

However, passion does not pay the bills!

The path ahead of any potential buyer is laden with obstacles, so let’s look at the top five obstacles that await you if you’re considering buying a practice or block of fees:

1. Fixing A Price

Dollar for dollar seems to be the common theme, but some practitioners seek a better deal for their hard work. I have seen some ask $1.75 per dollar of revenue – surprise, surprise they did not get it.

What makes one group of clients worth $1.10 per $1.00 of billings when another might sell for 90 cents in the dollar? It’s mostly about:

· Value
· Age of clients (or perceived potential for longevity post-deal)
· Length of time as clients with the seller
· Return on investment
· Discounted cash-flow (or earn-out period)
· Efficiencies of scale
· Quality of staff
· Quality of services provided to, and additional services bought by, these clients
· Amount of cash required as a down payment
· Niche market penetration
· Potential to up-sell and/or cross-sell clients additional services
· Potential to increase rates over time while holding costs constant

The above list is certainly not exhaustive, but these are the most common issue arising that effect price.

There are times when one book of business is worth more than another, such as yield, longevity of clients, relative youth of clients, higher fees per client than usual and other such factors, but these are few are far between.

If you’re looking for a fair deal, then $1 for $1 or thereabouts seems to be the going rate.

2. Finding ‘Nemo’

Finding the right blend of services, clients, industries, staff, salaries and fee scales can be a time consuming exercise. Indeed it can seem overwhelming at times. The task in hand is somewhat akin to Nemo’s fathers in the animated film, ‘Finding Nemo’.

3. The ‘Method’

How does one go about finding that elusive firm for sale? Well there are a number of choices:

· The classified adverts in this magazine
· One could pick up the yellow pages and make cold calls or send mailings to other firms
· The potential to network at CA district association meetings
· You might know an older practitioner in your area that might be suitable for an approach.
· And finally, there is the option to work with a broker

Whichever way you decide to go, you will need to set aside substantial amounts of time. Even working with a broker, while cutting out the calling and mailing, will still require you to have time to attend a number of meetings with different potential sellers.

As a broker myself, you might expect me to be biased toward the last method listed, but no. I often find that my best clients are the ones who have tried all the other options first and then realize the value that a broker brings to the table.

4. Tax treatment

Is this an allocation of income? Is the ‘retiring’ partner joining the acquiring firm for a period to enable this to happen? Is it a capital transaction? The answer is ‘it depends’.

I have seen deals where a sole practitioner rolls their practice into a professional corporation the day before the sale and the acquiring firm buys the shares of the PC instead of goodwill from the sole practitioner, in order to take advantage of any available tax allowances.

Every deal is different and I am afraid that there is no ‘cookie-cutter’ solution.

The tax treatment of the deal should be discussed early in the process so the buyer can calculate the true after-tax dollar cost of the transaction and assess the real value of the deal.

5. Due diligence

A thorough inspection of the seller’s working paper files, correspondence and practice inspection notes should take place somewhere between signing a letter of confidentiality and a letter of intent.

Indeed many due diligence visits take place after the letter of intent and the letter states that ‘subject to a satisfactory due diligence inspection…’

Sometimes the fear of God can be struck into the heart of the potential purchaser from a close examination of the vendor’s working paper files, sometimes the momentum is accelerated by a very positive inspection.

Always ask about recent practice inspections and recommendations by the professional body and – of course – about Professional indemnity Insurance, and take heed of any of the inspector’s recommendations (assuming there were some) to see if they have been implemented.

6. The earn-out

Usually somewhere between three to five years is the ‘norm’ for an earn-out period. This should not need explaining, but I will clarify one or two issues here.

· Only clients that are retained each year qualify for a payout to the seller
· He average retention rate is around 80%
· Don not pay too big a deposit on closing, unless the price is being discounted

One other point that I have come across is the requirement of some practitioners for a substantial (more than 30%) down payment on closing. This is an unrealistic expectation, as it places more risk on the buyer.

Let it be clear – the buyer wants to pay you 100%, they are looking for a book of business your size – that is why they are talking to you in the first place – but they would be foolish to put 40% or more down on day one.

Some Other Potential Pitfalls To Keep In Mind

They say that the road to hell is paved with good intention, and there is a lot of truth in the saying. Some of the common pitfalls that await you include:

· Disparity in charge-out rates and thus fees between the previously separate firms
· Constant write-offs in the new client base, hidden from view
· Unattainable turnaround times expected by newly acquired clients
· Inexperienced staff whose skills were ‘oversold’ by the retiring practitioner
· Disparity in salaries of the ‘old’ and ‘new’ staff
· Differences in ‘practising styles’ between the two parties
· Differences in culture between the ‘old’ and the ‘new’
· Polarized expectations of staff, partners and clients
· Insufficient experience at the ‘new’ firm in niche markets served by the ‘old’ firm
· ‘Skeletons in the closet’ – Professional indemnity issues from earlier years surfacing later

The only real solution to these issues, and others, is to make sure that you ask detailed questions, conduct a thorough due diligence inspection and engage in frank and open discussion at all times during the process.