May 1999 Issue



By Dan L. Goldwasser

Editor's Note: This is the first in a two-part series discussing the practical concerns of buying and selling a CPA practice. Part 1 provides an overview of the practice environment and the topics to consider before making the decision to buy or sell a practice. Part 2 will appear in this space next month and will delve into the details of the negotiation process.

While it may seem hard to believe, there is a strong possibility that as many as 50 of the country's largest CPA firms as of January 1, 1998, will dissolve or merge out of business by December 31, 2000. There are a number of reasons why this seemingly rash prediction is likely to come true. First, there are distinct economies of scale within the accounting profession created by the need to provide high levels of expertise in order to compete. Moreover, the demand for the profession to provide zero-defect services requires quality controls and review procedures that only a practice of substantial size can support. Thus, the pressure to merge is, in large measure, driven by the economics of the practice.

Second, CPA firms are starting to provide a broader spectrum of services to their clients. Like McDonald's, the accounting profession has discovered that increased profitability can be achieved most easily by selling more services to existing clients, rather than by selling the same services to a broader client base. This largely explains why so many accounting firms are now seeking to provide investment advisory and financial planning services to existing clients. In order to provide those services, however, CPA firms must expand their rosters of professionals that possess the additional expertise needed to offer these new services.

Third, most small and mid-size accounting firms are faced with a succession problem that frequently compels them to merge with other (usually larger) firms. CPAs may feel uneasy about their younger partners' ability to continue the practice and to purchase and pay for it in the form of retirement benefits. They opt to merge into a larger firm, thereby hoping for retirement security. The rapidly changing nature of practice has added even more doubt as to whether a firm's younger partners will be able to successfully carry on the practice.

Fourth, being able to compete in the future will require substantial amounts of capital, both to fund the working capital needs created by expanding practices and to fund investments in new technology that will allow CPA firms to compete in traditional, cost-sensitive markets. Unfortunately, CPA firms do not have the luxury of seeking outside investors, and many banks are wary of extending substantial amounts of credit to professional firms. Thus, many CPA firms may seek to be acquired simply to satisfy their growing need for capital.

Finally, since the acquisition of Goldstein Golub Kessler & Co., P.C., by American Express Tax & Business Services, Inc. (TBS), the rate of acquisitions of accounting firms by nontraditional accounting firms (or consolidators) has greatly accelerated. The consolidators hope to provide comparable services with brand name recognition, which is likely to make it more difficult for independent CPA firms to continue to compete successfully. Many partners of small and mid-size accounting firms may therefore fear that they will suffer the fate of "mom and pop" retail stores when a Wal-Mart opened nearby.

No merger should be considered without some clear objective to be achieved through the merger. Each firm must adopt its own strategy for competing in a rapidly changing marketplace and must understand that many mergers fail to achieve the goals of both the acquiring and the acquired firm.

Assessing Your Practice

Any firm contemplating merger must make a self-assessment of its strengths and weaknesses.

Ability to Remain Independent.
A firm must consider whether it has the talent, clients, and other resources to attract new clients and remain a viable firm. The owners must consider whether their firm will face price competition from large, nontraditional accounting firms such as TBS, Century Business Services, HRB Business Services, and CenterPoint Professional Advisors.

Quality of Services. The firm must evaluate whether the quality of its services places it at an advantage or disadvantage with regard to its competitors. While every CPA firm likes to believe that it provides the highest quality professional services, more often than not this is not the case. Therefore, CPAs evaluating the future viability of their practices should exercise professional skepticism in assessing the quality of their services.

Ability to Attract Qualified Professionals. A firm that finds itself constantly having to reduce its standards in making new hires must realize that it is sowing the seeds of its ultimate failure. While hiring problems might have once been considered a long-term precursor of decline, the pace at which the profession is now changing has undoubtedly transformed it into a short-term indicator.

Ability to Adapt. Firm survival might be achieved by selling additional services to the firm's existing clients, by increasing productivity, or by charging more for the services that the firm currently provides. In most cases, there may be few opportunities to increase fees for traditional services, as competitors have found ways by which to reduce their costs of providing traditional services.

A firm must also consider whether it can generate sufficient revenue to support the training and supervision costs necessary to compete. This may mean expanding the client base. Moreover, an expanded clientele will support the costlier overhead structure necessary to provide the quality of services that most clients now demand.

To survive, the firm may also need to recruit professionals with expertise not currently available within the firm. The days of the general-purpose auditor are rapidly coming to an end. Most companies look to their auditors for experience in their own industries. Conversely, most clients have little patience for professionals that hope to train the firm's staff at their expense.

Ability to Finance Change. Each firm must analyze whether it is sufficiently profitable today to make the appropriate investments in people and systems that would enable it to expand its client base and scope of services. If the profitability of the firm has dropped to the point that the partners need all cash revenues simply to maintain their lifestyles, the firm may not be in a position to make the necessary changes.

Why CPA Firms Acquire
Other Practices

Expand Client Base. Expansion of client base facilitates economies of scale, which can enable the firm to reduce its overhead and prices. Some firms seek to acquire a practice because its clients are better able to pay for the firm's services. For example, an accounting firm that has traditionally serviced a manufacturing clientele whose fortunes have declined might welcome the opportunity to acquire a firm that services rapidly growing companies in expanding fields. In this way, the firm can upgrade its clientele and profitability.

Obtain Additional Expertise. Professionals with other areas of expertise can be cross-sold to the firm's existing client base. Having a broader spectrum of professional capabilities can open new opportunities for the firm, enabling it to bid on engagements that it might otherwise not be qualified to undertake. While many firms attempt to service clients that require professional skills that they do not possess through joint ventures, these arrangements are usually complex and not particularly attractive to clients that might prefer to deal with a single entity.

Introduce New Leadership. Acquisitions of other professional practices are often made simply to obtain highly qualified professionals to fill important leadership roles within the organization.

The Seller's Analysis

No firm should engage in merger discussions without undertaking a thorough analysis of its own strengths and weaknesses and an assessment of the partner.

What the Firm Has to Offer. The firm should look not only at the dollar volume of fees currently being generated by its clients, but also at the extent to which those clients might be able to pay higher fees for additional high-quality services. If there appears to be untapped potential, its clientele might prove extremely attractive to an acquiring firm beyond its ability to absorb the acquirer's excess overhead. Second, the firm should examine the expertise it possesses and should consider what firms or types of firms might best benefit from that expertise. For example, a firm that possesses a very good tax planning capability might be valuable to a firm with a sizeable audit practice.

Economic Analysis. The firm must also undertake a serious economic analysis of its practice in order to determine which acquirers would be economically compatible. In this regard, a CPA firm is not likely to be attractive to an acquirer whose per partner and per professional revenues substantially exceed its own. Would-be acquirers are not interested in firms with a lesser ability to generate revenues and earnings unless there are significant untapped resources within the firm. Similarly, a firm that lacks the resources to pay obligations owed to retired or retiring partners will also be of little interest to acquirers that do not have sufficient financial resources to meet those obligations.

In some cases, an acquiring firm may find untapped resources in its ability to cut operating and overhead costs. For example, if the acquirer has invested in extensive computer tax preparation software, it might be able to service the acquired firm's clientele at a lower cost. Usually, such greater efficiencies are achieved only through eliminating staff; therefore some partners and staff members may not survive at the combined firm, even assuming that the acquirer agrees to take all of the acquired firm's professionals at the outset. Therefore, a firm that has relatively low revenues per professional is likely to find that it will be most attractive to those firms that are capable of providing the same type of services at a very low cost and with its existing resources.

Compatibility of Salary Structure. If the acquiring firm pays its employees at a higher rate, the practice of the acquired firm may not be economical once its salary scale is adjusted. While split salary structures are occasionally acceptable in different departments within a given firm, they are awkward at best.

Compatibility of Practices. For example, one firm may derive a substantial portion of its revenues from servicing the accounting needs of lenders, while the other firm may derive its revenues from the customers or potential customers of those lenders. Serious conflicts could arise if the combined firm obtained adverse information concerning a borrower which might significantly affect one of its lender clients. Moreover, some clients object to their accountants working with their competitors.

Compounding of Problems. All too often, professional firms in trouble pursue a merger strategy in the hope of curing their problems. Unfortunately, merging one problem firm with another not only may not cure their respective problems, it may even aggravate them. At best, the two merging firms may achieve some economies of scale. They may be able to solve their financial problems only by significantly reducing their cost structures. Accordingly, they will likely have to terminate one or more partners and staff members in order to achieve the economies necessary to return the combined firm to financial health.

Size Considerations. The size of the would-be merger partner is often resolved not on the basis of economics, but more on the basis of personality. For example, if a firm seeking a merger is controlled by a partner who wishes to exercise a leadership role in the combined firm, she may wish to look only for a merger of equals, rather than acquisition by a much larger firm. It is more important to focus on what the firm is trying to achieve through the merger and to give primary emphasis to what type of acquirer is most likely to achieve the firm's goals. Examining the economic compatibility of the two firms and the extent to which their practices complement each other should be given the greatest emphasis in determining the best merger candidate. An individual partner who has real leadership skills is likely to rise to the top of the merged firm, irrespective of its size.

The Consolidators

One recent development is the advent of a group of consolidators that are now seeking to acquire accounting firms around the country. These nontraditional firms are currently focusing on mid-size firms that are prominent within one or more of the 25 largest metropolitan markets. In particular, the consolidators are looking for CPA firms with more than $10 million in revenues that service middle-market businesses and high-net-worth individuals. It is their intention to make such firms the focal points of their growth strategies. The CPA firms that they find most attractive are those that view acquisition as a means of expanding their practices through the consolidator's resources. Strong management is a selling point for any firm wishing to be acquired by a consolidator. Additional expansion will undoubtedly be achieved through these foundation firms' subsequent acquisition of complementary (or "tuck in") firms.

Perhaps the main advantage of seeking an affiliation with a consolidator is the cash payments that will be made to the firm's owners, a very important consideration to those partners facing retirement. However, nontraditional accounting firms are generally looking for CPA firms that wish to build their practices and will be turned off by partners simply looking to bail out.

Nontraditional accounting firms can provide certain services to tax preparation clients at a reduced cost as well as tap the market of advisory services. Thus, a firm experiencing difficulty in making money out of a practice that is heavily dependent upon individual tax preparation services might find itself valuable to a nontraditional firm. Conversely, an accounting firm with a large audit practice may find that its practice could be jeopardized through an affiliation with a nontraditional firm, especially one that prevents acquired firms from accepting new public company clients.

Other Considerations

Timing. The acquiring firm must consider the timing of any acquisition. For example, if it has recently completed a significant acquisition, it may not have the cash to fund another, no matter how desirable the acquisition of that firm may appear. Moreover, every acquisition involves a certain amount of assimilation; and it is not always easy to assimilate a very large group of new practitioners in a short period of time. There may be a period of growing pains following each acquisition, and an acquirer needs time to address the problems that may arise out of an acquisition before taking on additional practitioners.

Cash Needs. Firms seek to be acquired to satisfy their cash needs: Any firm engaged in acquiring other firms must carefully consider the needs of each potential acquisition as well as its own ability to satisfy those needs. The acquiring firm must consider that the fortunes of an accounting firm frequently follow the fortunes of its clients. During a weak economy its clients are likely to forgo many services the firm might otherwise offer or may balk at paying the firm's bills for past services. Thus, the acquirer's analysis should try to contemplate likely economic changes and their impact on the combined firms. *

Dan L. Goldwasser, Esq., is a partner at Vedder, Price, Kaufman & Kammholz, in New York City.

James L. Craig, Jr. CPA
The CPA Journal

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