Sell to a Company or Find the Heir-Apparent Within?
More and more of my accountant colleagues are looking ahead. Regardless of their proximity to retirement, my friends, associates and trusted alliances are thinking ahead to retirement and making a similar calculus: Should I try to sell the firm to another accounting firm or find a successor in the company to take over the business?
Both approaches have their benefits. And each has potential drawbacks. While there may not be one definitively “correct” answer for all situations, one thing is clear: It’s better to know early on what your exit strategy is and to start planning as early as possible for the sunset of your own making.
The last thing you want to happen is for the exiting event to approach and be forced to make a difficult decision based on suboptimal options. Instead, start planning today for the tomorrow of your dreams.
Regardless of which strategy you ultimately choose, it is imperative to start planning today to set yourself and your business up for the best possible outcome, both for your financial future and your quality of life in retirement.
What Determines the Sell Price?
The two chief options in terms of succession planning for the owner of a CPA or accounting firm is to either sell to another acquiring firm or to find someone within the firm who wants to take over the business.
From what I’m hearing from my accountant friends, small to mid-sized firms are selling for multiples anywhere between .75 and 1.75 times gross revenue currently. Those that have more sophisticated and robust marketing engines tend to go for the higher multiple, while those lacking committed marketing and growth plans will go for something toward the lower end of that range.
A firm that has a large percentage of its revenue coming from one large client, for example, aren’t nearly as attractive to acquiring entities as those with a diversified portfolio of both clients and service offerings. The better relationships the firm has with its clients, the higher the multiple. The purchasing entity, whether it’s another firm or private equity and venture capital players entering the market to some degree, will want “stickiness.” They will look for assurances that your clients will transcend the transition, whether you are active and visible in the company or not.
They also look for repeatable and predictable revenue streams—those that aren’t cyclical nor seasonal. For that reason alone, many CPA firms are diversifying their service portfolios to add services like bookkeeping, payroll or even financial planning and wealth management offerings to their service suite. Such services are predictable, reliable, more permanent, and not subject to seasons or other fluctuations.
In other words, the days of CPA firms filing tax returns once per year and having little to no interaction with clients for the rest of the year is not a model that most acquiring entities will be attracted to. They want to see revenue that is more evenly distributed throughout the year, as well as service models that foster frequent, recurring and consistent client touch points for the full 12 months. Those clients tend to lock in and are less prone to flight.
Interestingly, bookkeeping firms and wealth management firms are seeing multiples of 2 to 3 times gross revenue. That’s a big difference when it comes to valuation of your business.
Remember: The sale event will be a disruption of some kind to business as usual. You want to present as few reasons as possible for existing clients to take the occasion of that disruption to reevaluate their vendor agreements and look for other solutions. If the acquiring company, successor or investment entity finds too many vulnerabilities to client loss, they will either turn away or be inclined to offer less for the business than they would to another firm with deep, firm client relationships and diversified, recurring revenue models.
If your firm doesn’t currently offer these ancillary service lines that more deeply entrench your clients into a fortified position with your firm, consider adding bookkeeping, wealth management or financial planning services. The ideal is to offer a model that feels like “full-service” to the client, so they never feel the need to consider new or additional vendors that could potentially displace part or all of what you currently offer them.
Sale or Succession? The Pros and Cons of Each Strategy
It’s also important to consider today what your options tomorrow present in terms of both potential upside and downside. If you can determine what you want the future to look like now, you can start immediately building the plan and the firm best suited to your exit goals.
If you plan to sell to another firm, the likely most noticeable upside is sale price and immediacy of cash influx. If you are able to raise the multiple of your valuation by diversifying and demonstrating deep roots with your clients, you’ll stand to receive an attractive financial incentive to sell the business.
The drawback is that the acquiring entity will likely condition the sale on a two- to three-year employment contract that keeps you operationally involved in the business over the course of the purchase term. Maybe you’ll want to continue working at that point, but you will no longer enjoy the rewards of the firm’s net profits at the end of the year once you sell. That big bonus check you’re used to paying yourself at the end of each year will now go to the company buying your business.
Sale Pros: The pot of gold you always hoped was at the end of the rainbow.
Sale Cons: Locked in, still working as hard or harder, no longer receiving net-revenue bonuses.
On the other side of the coin, if you choose the succession route, and can find a suitable candidate to take over the business from you someday, you can still spread the sale over a multi-year time horizon, but you can do so on your own terms. You may choose to spread the sale out over four or five years, or even longer.
The benefit of that longer time horizon, as well as the successor route itself, is that, as owner, you continue to benefit from the year-end net profits and can continue to bonus yourself out at the end of the year for as long as you remain owner. It’s very likely that, when all is said and done, that pursuing this path will yield greater income and profits as a result. It’s also likely that this form of sale will yield higher multiples, if recent history is any indication—probably 1.5 to 2 times revenue.
The challenge is finding a successor. Not everyone is cut out for business ownership, and even your best employees may be better off as workers than owners. Furthermore, once you do identify that successor and establish the succession plan, that person still needs to perform, as well as maintain their commitment to taking over the business at the end of the term. What if your heir-apparent loses interest, demonstrates an inability to lead, or for any reason becomes unsuitable to take over? Not only would you have to start over, you might have difficulty undoing what’s already partially done.
Succession Pros: More control, more income, likely higher sale value.
Succession Cons: Finding the right fit, and making sure he or she doesn’t “flake out.”
Starting Now
Whatever path you discover to be right for you, the key is to settle on it as early as possible and to start immediately building the plan and cornerstones for your eventual exit from the business you’ve built. Whether you choose to sell to an outside party or find someone in-house to hand over the keys to, the greater value you can build into the company the greater the proceeds will be once you move on to the next chapter of your life.
Find and integrate recurring revenue streams. Be as full-service as possible. Make your client relationships “sticky,” secure and enduring. Those are best practices whether you’re trying to grow your firm today or planning for a future that will be here sooner than you think.