VALUING A SMALL ACCOUNTING PRACTICE--A MULTIPLE OF WHAT?

By Michael Goldstein, CPA

A valuation for what purpose? A purchase, sale, merger, or whatever? Do the factors to be considered differ depending on the purpose? What method is most acceptable? Considering that a purchase and sale are opposite sides of the same transaction and many mergers are thinly disguised purchases or sales, let's look at the considerations from the point of view of the purchaser. The facts remain the same. It's only a matter of how you look at them, depending on which is your side of the transaction.

While no universally recognized formula exists, the most frequent expression of a firm's value, particularly a smaller firm, is in terms of a multiplier of its gross revenues. Life in the buy-and-sell world would be a lot easier if accounting practices could be quickly identified as being worth a multiple of annual gross revenues, but a number of factors must be considered before being able to use a simple multiplier, if indeed this method is the most appropriate. The multiplier for one practice is very likely inappropriate for another. Even if the gross revenues are identical, the revenue components, or practice emphasis, may be quite different, as well as the net realizable billing rates, salary costs, overhead, and last, but certainly not least, the resulting bottom line before individual owner or partner distributions.

Many people do, however, try to classify a practice according to the primary or major revenue component and set up or designate a multiplier based on that component, or a number of the components. For example, the following chart represents what certain revenue components might be worth in the minds of some buyers and sellers based on a multiplier, probably developed from some kind of averaging of bottom lines of various types of practices, grossed-up.

Revenue Components Multiplier

Audits 1.50

Reviews 1.25

Compilations 1.00

Tax Panning 2.00

Tax Compliance­level 1 1.00

Tax Compliance­level 2 .75

Consulting--specific

industry oriented 2.00

Consulting--ongoing 1.00

This process appears to assume that all practices made up of a particular revenue component must have something akin to standard realizable billing rates and overhead. This assumption does not hold water.

As a purchaser reviewing the financial value of a small firm acquisition, doesn't it make more sense to go right to the heart of the matter: How is the acquired practice going to affect your bottom line? First, make all the necessary adjustments to salary, occupancy, and other overhead costs on a combined basis. If the pro forma bottom line expected is 50% and you're willing to pay three times that amount for the practice, you can at least anticipate a chance of getting the return that you bargained for. If that practice happens to be made up primarily of revenue components in what the market refers to as a 1.5 multiplier category, then by chance you will also be paying what some presumed average market calculation calls for.

But what if the prospective acquisition, when combined with your present practice yields only a 30% bottom line? How would you feel about paying five times an annual bottom line for the practice just because you relied on marketplace talk that this kind of practice, e.g., audit, is valued at 1.5 times annual billings or even collections? While annual revenues are easier to check out, what's really at the bottom line for the purchaser? Guarantees can still be related to client gross billings retention.

Valuations are, of course, affected by a number of other acquisition considerations, such as quality of partners, staff, and clients; client and firm specialties; firm stability; and investment in office facilities, to name only a few.
But simple solutions are rarely the answer. *