Why Merge in Sellers Who Aren’t Ready to Retire?

There are two types of mergers:

– An outright sale in which a retirement-minded sole practitioner works for a short time to transition clients and then steps down. Buyout payments start immediately, financed from the savings realized not having to compensate the seller.

– A true merger in which the solo is relatively young, joins the buyer as an equity partner and has no finite timetable for retirement. No buyout payments are made to the seller until retirement.

I’ve spoken with many partners about their attitudes on these two types of mergers. Some are interested only in an outright sale because the net positive cash flow to the buyer is clear and immediate. These partners will often reject the true merger opportunity, rooted in this logic: The seller is going to expect at least as much compensation as he earned before the merger. Given this, how can a buyer profit from this merger?

A true merger has five benefits for the buyer:

Smarter pricing. The majority of small firms underprice their work. They generally have the mentality of “I’ll take anything that comes in the door and I’m not too concerned about how much time it takes to do the work.” Larger firms turn this around, having a goal of billing more with less work. Example: Assume the seller billed $1,600,000 while working 13,000 billable hours, resulting in a below-standard blended rate of $123. After the merger, the buyer raises rates (perhaps not immediately, but over a couple of years) with the intention of retaining most of the clients but losing low-end clients who are only interested in bargain-basement fees. The seller’s practice eventually is transformed into revenue of $1,650,000 on 11,000 billable hours, resulting in an industry standard rate of $150, a 22% improvement. The additional revenue of $50,000 coupled with the estimated savings of $78,000 from 2,000 less billable hours (1.3 people at $60,000 each) nets a profit increase of $128,000.

Additional services sold. Larger firms usually offer clients a more diverse portfolio of services than small firms, which is frequently a key reason non-retiring sellers choose to merge with larger firms. These additional services could include audit, IT and consulting, If we assume these additional services net increased revenue of $100,000, at 30% profit margin, the new services will provide the buyer with a net a profit increase of $30,000.

Additional profits from wealth management. Most firms under $15M don’t provide wealth management services. Not because it’s not a good idea, but because the partners simply are too busy to focus on building a wealth management practice. But the sizable minority of firms that engage in this area and devote the proper resources to it (i.e, the firm hires experienced money managers instead of having the partners do it in their spare time), earn substantial profits. If we can assume that the seller does not provide wealth management services and the buyer does, let’s further assume that the buyer net’s additional revenue of $100,000 (revenue, not money under management). At a 30% profit rate, this nets a profit increase of $30,000.

Utilize excess capacity of buyer’s professional staff. Let’s assume the buyer has 30 professional staff averaging 1,480 billable hours a year, for a total annual billable hour number of 32,174. (This firm would have annual revenues of roughly $7.5M). Most firms of this size should certainly be able to get another 1,500 billable hours out of their staff (only a 5% increase) to work on a small portion of the 11,000 hours of billable work coming over. This will enable the firm to employ one less person, which, at annual compensation of $60,000, nets a profit increase of $60,000.

More efficient and effective management. Without question, a $7.5M firm will be better managed than a $1.6M practice. One would expect the buyer to have a higher quality of staff, better training, more efficient systems, more sophisticated marketing, admin professionals in place such as firm administrator, marketing and IT director…I could go on and on. With this superior management in place, one would expect this to net increased profits that are immeasurable.
Moral of the story

The profit increases above add up to $248,000 for every year that the seller remains a partner of the buyer. This figure is merely an estimate of the profit potential from a true merger with a non-retirement-minded seller. Who knows what the actual number will be, but it could certainly be impressive. And this doesn’t include several long term and difficult-to-measure benefits such as adding a great partner to your firm (who trains and mentors your staff and strengthens the firm by adding his/her skills) and increasing the value of the firm.

So the advice to all you buyers reading this: Look very carefully into opportunities to merge in non-retiring sellers. If this firm is a “good firm,” buyers will enjoy tangible dollar benefits.

How mergers affect sellers’ retirement plans is addressed in both CPA Firm: Mergers: Your Complete Guide and CPA Firm Retirement/Buyout Plans.