Preparing Your Firm for an Upstream

Merger

August 18, 2016

Terrence Putney, CPA

CEO-Transition Advisors

NASBA CPE Earned Credit Guidelines

Transition Advisors, LLC is a sponsor on the NationalRegistry of CPA Sponsors per the National Association of State Boards

of Accountancy (NASBA).

In order to receive your one CPE credit – You must complete two

requirements:requirements:

1) Participate in three of the four polling questions during the presentation.

2) Complete an online evaluation after the webinar.

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Transition Advisors, LLC

National consulting firm working exclusively with accounting firms on issues related to ownership transition

Polling Question

How many equity partners do you have in your

firm?

1) 1

2) 2 to 42) 2 to 4

3) 5 to 9

4) 10 to 19

5) 20+

Case Study

Selling/Merging Firm• 3 partners, $2.4M in fees, $800k in capital

• Frank, 63 yrs old– 70% of the equity

– Manages $1.3M of fees

– Comp is $450k

• Alice, 55 yrs old, indefinite retirement plans• Alice, 55 yrs old, indefinite retirement plans– 25% of the equity

– Manages $800k of fees

– Comp is $275k

• Dan, 42 years old– 5% of the equity

– Manages $300k of fees

– Comp is $150k

Case Study

• Buy-sell agreement requires

– Capital paid in first year

– Goodwill value paid over 5 years at 1X plus 6% interest on

total revenue times equity

• Alice and Dan believe• Alice and Dan believe

– They can’t afford the payments to Frank

– They don’t have talent on the bench to replace Frank

– They can’t manage the firm and clients on their own

Standard Goals for Merge Up/Sell

Risk Avoidance

• Liabilities to former and soon to retire

partners

• Specialized services that may be

unsustainable

• Lease renewals• Lease renewals

• Potential loss of key employees

• Potential loss of key clients

Case Study

Acquiring Firm

• 6 partners, $7M in fees

• 2 partners will be retiring in 4 and 6 years

respectivelyrespectively

• 4 partners-in-waiting on the bench

• Firm knows it needs to promote the partner

candidates but is concerned about diluting the profit

pool

Standard Goals of Merger for Growth

Primarily Buyers

• Pure Growth of Billings

• Addition of Talent/Services

• Geographic Expansion

• Brand Enhancement• Brand Enhancement

• Acquiring Clients to Cross-sell

• Strengthen Succession Team

Alternative Deal Types

• Outright sales

• Two Stage Deals

• Cull out sales• Cull out sales

• Sale vs merger

Polling Question

What issues do you see affecting your practice

most in next year?

1) Succession

2) Admitting new partners2) Admitting new partners

3) Client retention for retiring partners

4) Need for growth

5) All of the above

Outright Sale

• Purchase payments begin immediately

• If seller needs to keep working-what to pay

• Disadvantage: not a lot of time for transition

could lead to lower client retentioncould lead to lower client retention

Two Stage Deal

Stage One-usually up to 5 yrs

• Seller merges into buyer’s firm

• Starts the transition process

• Maintain reasonable control over • Maintain reasonable control over

clients

• Take on a principal’s or non-

equity partner role

• Maintains compensation level

Two Stage Deal

Stage Two-paying for the practice

• Seller transitions to a part-time or

retired role

• If working, comp @ a per diem rate

• Purchase is now based on a practice

that has ALREADY transitioned

Cull-out Sale

• Selling a part of the practice OR

• Retaining a part of the practice

such as

— Clients

— Services— Services

— Locations

• Breaking up the firm

Sale vs Merger

• Key difference is ownership

status

• Merger-sign onto successor firm’s

owner agreementowner agreement

Case Study

Deal Structure• Frank will bought out using a Two

Stage Deal

• Alice will be admitted as an

equity partner equity partner

• Dan will be admitted as an

income partner with a path to

equity if he can manage enough

business

Case Study

• Parties agree that Franks, Alice’s, and

Dan’s books of business are separate

and distinct, therefore

• Frank’s buyout will be tied to his book

and Alice’s equity will be tied to her and Alice’s equity will be tied to her

book

• Dan will either eventually be admitted

as an equity partner or be bought out

of his equity in his old firm

Frank’s Two Stage Deal

Stage One-

• Stage One contractually ends in 3 years

• Frank’s comp is tied to his historic comp by paying

him 35% of the collections from his clients in comp him 35% of the collections from his clients in comp

and benefits

• If he uses more labor than a historic base, comp is

adjusted accordingly (can happen due to growth or

Frank reducing client service hours)

Frank’s Two Stage Deal

Frank’s primary objectives in Stage One are:• Smoothly transition his clients to the new firm

• Maintain the client relationships and fees

• Gradually introduce the clients to their successor in the new firm

• Make the day he retires into a non-event for the clients eliminating • Make the day he retires into a non-event for the clients eliminating

most of the risk of transition based loss

• All while still maintaining his income

• Dan and other partners in the successor firm become Frank’s

successors

Frank’s Two Stage Deal

Stage Two-

• Frank retained his AR and WIP at the beginning of Stage

One

• Frank is paid based on the collections from his clients • Frank is paid based on the collections from his clients

over six years starting in Stage Two

• Replicates the type of deal he would have received in an

outright sale

• Frank has been paid separately for new clients he helps

generate during Stage One and Stage Two

Polling Question

Which best describes your personal situation

over the next five years?

1) Reduce my role and time in the practice

2) Having partners reducing their role2) Having partners reducing their role

3) Acquire another firm

4) None of the above

Principles of Value

Think about what creates value for a practice

An accounting firm practice value is primarily based on a seller’s ability

and that of the buyer to successfully get the seller’s clients to transfer

from the seller to the buyer

Terms-Five Primary Factors

1. Cash up front, if any

• Dependent on time of year

• The deal’s cash flow

• Accounts receivable

2. Retention clause2. Retention clause

• Collection deals

• Fixed deals

• Limited guarantees

• Economy clause

Terms-Five Primary Factors

3. Profitability

• Seller’s current profitability

• Buyer’s anticipated profitability

• Tax ramifications of deal

structuresstructures

(goodwill vs current deduction)

4. Length of the payout period

Terms-Five Primary Factors

5. Multiple

• Terms are the cause

• Multiple is the effect• Multiple is the effect

• Basic rule:

• Lower down payment, longer payout period

• Higher profitability, longer guarantees = higher

multiple

Frank’s Buyout Terms

Frank was paid-• No down payment

• 16.67% of collections from his book for three years

• Price locked after three years and the remainder was paid • Price locked after three years and the remainder was paid

over three more years

• Treated 50% as an asset sale, and 50% as consulting

agreement

Frank was essentially paid 1X of his managed book of business-

the multiples will vary depending on the market and quality

considerations

Alice’s Merger

Alice signed the partner agreement and-• Was conditionally guaranteed $275,000 of comp and benefits

for two years

• She received her pro rata share of the equity based on

revenues (8%)revenues (8%)

• She contributed her AR and WIP as a capital contribution to

the new firm

• She became bound by all the terms and conditions of the new

firm’s agreement

Dan’s Merger

Dan signed an Income Partner agreement• His base compensation was pegged at $150,000 for two years

• He is eligible for bonuses consistent with other income

partners

• His share of the AR and WIP was retained by the successor • His share of the AR and WIP was retained by the successor

firm

• If he is not made an equity partner within three years he will

be paid for AR and WIP

• If he is made an equity partner, AR and WIP will be treated as

contributed capital

Polling Question

Your firm’s most likely succession plan looks like:

1) Find an external buyer or upstream merger

2) Internal solution-prefer not to sell or merge

3) I don’t know what my firm should do3) I don’t know what my firm should do

Identify What Defines the Right Successor Firm

Four C’s • Culture

• What’s it like to be a client, employee and partner in this firm?

• Chemistry• Chemistry

• How well do you get along with key people in this firm?

• Continuity

• How will changes in your operations affect retention of your clients/staff?

• Capacity

• Does this firm have the capacity to take this on including replacing you?

You Are What You Are

However…

However…..

• Buyers hate inheriting problems and poorly

run practices

• Clean up your AR and WIP

• Present your partners and staff in a positive

light

• Consider jettisoning problem staff

• Clean up the physical office-eliminate

clutter

• Provide good time records

• Be willing to part with unprofitable clients

Tricks & Tips

Should you ask for as much money

up-front as possible?How do Buyers view that issue?How do Buyers view that issue?

What are you gaining?

What are you losing?

Using your A/R as an offset

Tricks & Tips

Should you shorten the retention period as much as possible?

Is one year retention better or not?

What message are you sending the Buyer about

your client base?

Limited retention periods

Economy clause

Replacement clients

For More InformationVisit the AICPA Succession Planning Resource Center

http://www.aicpa.org/InterestAreas/PrivateCompaniesPracticeSection/StrategyPlanning/center/Pages/default.aspx

Suggested Additional Info

The following webinars are available on our website:

www.transitionadvisors.com/archives.php

• How to Structure Your Partnership Agreement

August 11, 2016

• Art of Your Deal July 7, 2016• Art of Your Deal July 7, 2016

• Preparing Your Firm to Grow Through M & A

June 23, 2016

• Valuing Small Accounting Firms May 19, 2016

• How Tax Season Impacts M & A January 14, 2016

Articles

CPA Firm Succession Series

July, 2013 thru June, 2014

www.transitionadvisors.com/succession-planning.php

CPA Firm Valuation SeriesCPA Firm Valuation Series

October, 2014 thru December, 2014

www.transitionadvisors.com/valuing-accounting-firm.php

Roadblocks to Avoid in Accounting Firm M & A

September, 2015

www.transitionadvisors.com/succession-planning.php

• Gary Adamson, Adamson Advisory• Bonnie Buol Ruszczyk, bbr marketing• Sarah Dobek, Inovautus Consulting• Angie Grissom, The Rainmaker

Companies• Dustin Hostetler, Boomer Consulting

• Tamera Loerzel, ConvergenceCoaching

• Terry Putney, Transition Advisors• Carrie Steffen, The Whetstone Group• Sandra Wiley, Boomer Consulting• Jennifer Wilson,

ConvergenceCoaching

#SuperConf15

• Rita Keller, Keller Advisors• Roman Kepczyk, Xcentric

ConvergenceCoaching

www.cpaconsultantsalliance.com

Bridging the Gap: Strengthening the Connection Between Current and Emerging Leaders in the

CPA Profession

Amazon.com

$49.97

Free White Papers on Industry Trends

• CPA Firm Leadership: Communication Drives New

Possibilities

• Measuring Happiness at Work: How Firms Can Win • Measuring Happiness at Work: How Firms Can Win

With a Happy Culture

• Top CPA Firms Succession Challenges

Download at: www.cpaconsultantsalliance.com

For More Information

Please visit our website for resources including

FREE reports, whitepapers and case studies.

tputney@transitionadvisors.com

1-866-279-8550

www.TransitionAdvisors.com