September 1999



By Steven Weinstein

Consolidation, franchising, and the entrance of new competitors have changed the face of the accounting profession. In light of these continuing developments, smaller firms are faced with tough decisions. Do they sell to a consolidator and sacrifice their decision-making authority? Should they accept the big firms' leftovers and learn how to survive with smaller clients and revenues? Fortunately, the answer is neither. Although clients are demanding multiple services under one roof, there are still many options available for meeting their needs and maximizing revenue.

Hitting the Wall

Most small firms initially form a client base by taking whatever work they can find, serving those inaugural clients well, and expanding via marketing and referrals. But a few years later, an all-too-familiar scenario often emerges. The firm, consisting of two or three partners, reaches a point where they're billing somewhere between $500,000 to $1,000,000. Low-margin, older accounts comprise the client base. Because of staffing limitations, the partners can't delegate the older, less-profitable work to others. This places extreme demands on the partners' time and prevents them from pursuing bigger accounts. Even if the firm is lucky and lands a lucrative new client, questions quickly arise regarding how it will be serviced. Soon, the partners' resources are exhausted and so are they.

In other words, the firm partners have hit the wall. They're too busy to pursue profitable new accounts and too financially constrained to surrender their old ones.

Scaling the Wall

Depending upon the age of the partners, there are many ways for the small firm to improve client service and expand income. These methods focus on using mergers, acquisitions, and affiliations to expand a firm's client base and maximize revenue from each account through multiple services. A well-structured move can also help practitioners manage their workloads, secure adequate staffing, and plan for succession.

One way for small firms to stay competitive in today's marketplace is to emulate the structure and service offerings of larger companies. The most prevalent example of this in today's marketplace is the trend toward smaller firms aligning themselves with Series 6 or Series 7 financial planners. The two entities then refer business to each other, share administrative duties, and participate in some sort of profit-sharing arrangement.

Although a financial planner partnership works well for some practitioners, there are other less apparent, yet equally viable, methods for forming a joint client base and maximizing revenues from each account. These include alliances with information technology specialists, management consultants, organizational experts, full-service financial purchasers, real estate agents, and insurance brokers. The business structure of these affiliations may take the form of mergers and acquisitions.

Acquisition of a Retirement-Minded Seller

A growth option for a small practice staffed with younger partners is to find a retirement-minded seller. Sometimes, a seller may wish to remain active while reducing work hours. Under this type of arrangement, the buyer would acquire the seller's practice, while inviting the retirement-minded practitioner to stay involved as an employee or a consultant. The acquiring firm would take over the managerial duties, with the option of keeping the office staff intact or folding it into the buyer's location. For example, if the seller previously worked five days a week and took home an annual salary of $250,000, now she would only work two days per week and take home $60,000. This leaves $190,000 in incremental business that can now be worked by the acquiring firm.

In other instances, a seller might choose to retire after the completion of a short, but necessary, transition period. This kind of transaction offers the acquiring firm the opportunity to expand its client base and to drop the additional revenues to the bottom line immediately.

Analysis. Many advantages accrue to both buyer and seller in these scenarios. For instance, a common fear among sellers is that they will no longer have a place to work after the sale. This is one case where perception does not match reality. It is absolutely essential for a seller to stay involved during the transition to ensure client satisfaction and retention. Plus, the industry-wide problem of finding good staff members is creating numerous opportunities for sellers to remain active after the transfer. This concept also applies to the seller's loyal employees. More often than not, the acquiring firm decides to retain the seller's staff members due to the dearth of qualified help available in today's marketplace.

In this type of acquisition, the buyer instantly increases income by expanding his client base, while the seller reaps the rewards of her hard work and secures a smooth transition to a new phase of professional life. Other incremental benefits can also be obtained. By gaining additional staff members, the acquiring firm can make great strides in attracting larger, more profitable clients, which are often attracted to larger firms. The buyer may also be able to expand its geographic scope, depending upon the location of the seller and the structure of the deal.

Merging Up

If the partners of a small firm aggressively want to enhance their income by pursuing larger clients, an upward merger often makes sound financial sense. The reality is that a one- or two-person firm cannot provide the full scope of services that will be demanded by a $10-$30 million client. Larger clients seek the comfort and convenience of knowing that their accounting firm can provide everything they need, ranging from basic tax preparation to complex strategic planning and financial project management.

Analysis. The obvious advantage to merging up is the ability to attract a more sophisticated clientele. Of almost equal importance, however, is the capacity to provide more services to existing clients, which ultimately aids retention and maximizes revenues. For example, take a small practice that has 500 clients to whom it offers general services such as estate planning, tax planning, and business and personal returns. If this unit merges into an entity that has 15 different departments offering complementary services such as representation, financial products, and valuation, then incremental revenue could be realized by offering clients these additional services. A profit-sharing arrangement could then be structured so that both the merging and acquiring firm benefit from these new revenue streams.

In addition, merging into a larger infrastructure can also help younger practitioners manage their workloads and secure their financial futures. With more administrative support, these individuals will have more free time to pursue new business. They also will have better retirement plans, equity positions, and options for future earnings.

The biggest fears of the smaller entity in this situation is loss of control and autonomy. But once again, market conditions are influencing the roles these individuals are now playing in larger firms. Because bigger firms are also having staffing problems, they are giving newcomers more autonomy than ever before. This has, in recent years, kept new talent motivated and encouraged them to bring in new business.

Succession Planning Through Mergers & Acquisitions

Firms with older partners approaching retirement age may consider merging with another firm. Typically, many firms don't accurately address succession planning, which can create a large age disparity among partners. For example, a firm might have three senior partners age 60 that hold about 80% of the equity and two other partners age 40 that hold the rest. This type of asymmetry raises several challenges as the older partners approach retirement age.

The older partners may, in fact, wish to incorporate the younger partners and turn over their equity to them as they retire but worry that the younger individuals may not have the money or the experience to handle the practice. In other words, the retirement-minded partners may be concerned about recouping their money should the practice slump, yet they sincerely desire to take care of their younger colleagues.

A possible solution to this quandary is a well-structured merger into a larger firm. Here's how it works: When merging into the new firm, the older partners can leverage their accumulated equity to gain greater stability, and the younger partners can leverage theirs to grow with the larger firm.

Analysis. The advantages to using this type of merger to aid succession planning are clear for both the younger and older partners. A typical fear for both groups is that they will lose control of the practice. This concern is often unsubstantiated. But to avoid any misunderstandings, it should be addressed up front, when the deal is structured. In most instances, it behooves the acquiring firm to capitalize on the experience of the older partners. Cultivating the entrepreneurial spirit of the younger partners requires soliciting their input and granting them sufficient autonomy.

A Willingness to Explore

Obviously, merging, acquiring, or selling may not be the solution for everyone. But for practitioners aggressively seeking to increase their income, it's important to know that options do exist. More demanding market conditions do not have to mean client attrition and declining revenues. On the contrary, the new accounting environment offers many opportunities to thrive and prosper. *

Steven Weinstein is the executive director of The Practice Transfer, Inc.,
specializing in assisting firms in achieving growth objectives.

James L. Craig, Jr. CPA
The CPA Journal

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