I have helped my firm, Michael Silver, merge and acquire five practices in the last seven years. Before I get into how we analyzed those important intangibles, let me offer a working definition of a merger and an acquisition. A merger happens when two firms combine their practices in order that each gains a new area of expertise. The end result is a broader range of services and talents for the combined firm's clients. Although an acquisition has some attributes of a merger, the acquiring firm usually is the larger one. The smaller finn has to conform and change its operating methods and may have less influence on the management of the practice.

In a merger or acquisition your most important consideration is whether the two practices arc compatible in policies, procedures, and personnel. Although I can get positive or negative feelings within the first few minutes of meeting someone, it takes at least three meetings in various settings to get a real feel for compatibility.

In the initial meeting I normally spend two or three hours asking questions about the other firm's practice-management style. Do they have a strong work ethic? Do they insist on the highest quality of work being done? How do they handle fee problems? How do they handle billing? How do they collect past due receivables? Is the composition of their practice compatible with our practice?

I know it might be difficult to ask this next question, but it is a critical one if the merger or acquisition is going to succeed: What problems does the other firm have, and are they problems we can help them solve?

In many interviews with prospective merger candidates, I have found small tractitioners do not know how much money they are making because they keep the books and records on the cash basis instead of the accrual basis. Many smaller practitioners don't use sophisticated computer programs for time and billing or to produce management reports to help them maximize their firm's profitability. The administrative part of their practice is an afterthought. From their standpoint an acquisition makes sense because the larger, more successful firms have managing partners who devote the majority of their time maximizing profitability.

After the initial meeting, I schedule a lunch or dinner meeting with all the partners so everyone can get together in a social setting to see how they feel about the prospective merger. If that second meeting goes well, and there is mutual interest on both sides, then we do our duc diligence. If the due diligence doesn't uncover any major problems, then compensation is the topic for the third meeting.

Negotiating Compensation

There is one critical question you need to ask the merger candidates. How much money did they make last year and how many hours did it take to produce the revenues and profits? I test the information for reasonableness by reviewing the financial statements and tax returns, and comparing those numbers with our firm's numbers.

Next, I tell candidates, "If you do the same amount of business in the same amount of hours, I will guarantee you the same compensation for the first year." Then, I promise them--

* a percentage of their gross billings;

* payment for each chargeable hour they produce themselves; and

* a bonus if they exceed last year's realizable average hourly rate or a penalty if they fall below it.

This compensation structure gives the partners of the merged firm the same financial incentives they had in their own firms. Keep in mind, these partners recently accounted to no one but themselves and came and went as they pleased. The transition to a more structured environment will take time and understanding.

But it is important that at least a minimum level of compliance with our procedures be achieved. Accordingly, there are several procedures we require them to follow:

* We assign a manager to every account;

* We insist each account be billed every month for the work completed in the prior month;

* We insist they follow our stringent collection procedures. First, we will give the new partners the opportunity to collect any past due accounts on their own so they can maintain the client relationship. However, if their methods are not fruitful, we reserve the right to impose our collection methods.

Our Track Record

Of the five mergers and acquisitions we have done, the fee volume ranged from $150,000 to $300,000. Two of our mergers were with partners from other medium-sized to large CPA firms who brought clients with them. They ultimately became partners with us.

Two were sole practitioners currently in their sixties. They have the freedom to come and go as they please and do the type of work they want to while knowing their clients can avail themselves of the full range of services our firm offers. Both these sole practitioners were attracted to Michael Silver because we structured a favorable payout to them if they died, were disabled, or wished to retire. One merger is in the second year of the buy-out mode, and the practitioner is still working in a consulting capacity with his clients.

Of the five mergers and acquisitions, only one is no longer with us. When this sole practitioner merged with us, he wanted to cut the hours he was going to work so he could spend more time with his family. He agreed to having our partners become involved with his accounts so we could offer additional services and improve his billings. He also agreed to have our lower level people do some of the work he had been doing so he could use his free time to market his services. He was a very good salesperson, was very personable, and had a very strong work ethic. But in the eleventh month of our association, he decided he didn't want to finalize the merger. Why?

* He didn't want to give up any work he was doing for his clients.

* He wouldn't let our people speak with his clients to improve the services. He didn't want to give up control.

* He had a problem seeing the write-offs generated on his accounts, even though his overall profitability and gross revenues exceeded our projections. In fact, within one year's time, his billings had gone from $225,000 to $295,000.

In the strict financial sense this was a very successful arrangement. However, the merger ultimately failed because he did not adhere to the original promises he agreed to.

The merger may have failed but I realized a valuable truth. Some will work out very well. But you also have to prepare yourself for the possibility it can fail regardless of how carefully you plan. The intangibles will ultimately come into play.

Earl Holtzman, CPA, is the managing partner of the accounting firm Michael Silver in Skokie, Illinois.