8 Reasons Merging In a Small CPA Firm Is a Fabulous Deal

If you’re a CPA, you have had blinders on if you were unaware of the merger frenzy in the CPA industry for the past ten years or so.  An avalanche of aging baby boomers coupled with a voracious appetite for growth by larger firms (and “larger” can be a firm as small as a few hundred thousand of annual revenue) and a dearth of staff with partner potential has fueled the merger activity.

Unfortunately, some buyers seem to have made acquisitions simply because “everyone else is doing it.” We surmise this because of the shocking lack of due diligence and good business sense that we have seen in some mergers. But there are eight great reasons to merge in smaller firms and here they are.

1. A great growth strategy. For many firms, it’s easier to buy clients than to generate them internally. Most CPAs will be the first to admit that they don’t like business development and aren’t any good at it. So any strategy that allows them to abstain from business development is a strategy to love. Indeed, we have worked with many firms over the years whose primary, if not exclusive growth strategy is to merge in one small firm after another. They are perfectly content and successful with this.
2. A great investment. If you calculate the return on investment (ROI) of acquiring a CPA firm, the yield is an astonishing 30% to 70%, depending on the facts. The main reason for this high ROI is that the CPA industry has saddled itself with a notion that paying one times fees for a CPA firm, or even a small premium on one times fees is a reasonable sales price. The fact is firms should be selling at 1.5 to 2 times fees because they are worth it. But 90% of firms are sold for 80% to 110% of annual fees because that’s the market. If you do the math, this is a steal.
3. Acquire talent. The most difficult problem facing CPA firms for quite some time has been the shortage of talent, especially young talent, both at the partner and staff levels. Many firms value the personnel they obtain in a merger as much or more than the clients acquired. The larger the buyer, the more likely it is that the acquisition of talent is the #1 motivator to doing mergers.
4. Merging in a CPA firm is low risk. Virtually all deals are structured so that buyers pay the sellers, over a period of years, based on collected revenues from retained clients of the seller. Therefore, there is relatively little cash flow risk to the buyer.  As some put it, buyers pay for acquisitions from the seller’s own money!

CPA Firm Mergers: Your Complete Guide, was written because every year thousands of mergers are taking place but relatively few buyers and sellers have much merger experience in one of the largest transactions their firms will ever be a part of. We address: ►the keys to successful mergers ►the 22 steps in the merger process ►how to assess cultural fit, benefits of merging upward ►why buying a firm for one times fees is a steal ►what larger firms should expect to see from smaller firms & vice versa ►how to negotiate a merger – from both buyer and seller view ►14 things the letter of intent should address ►data that should be reviewed ►due diligence and other issues.

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5. Mergers enable buyers (and sellers) to afford “bigger firm things” sooner. Some refer to this as building a critical mass. Larger firms are better able to afford a sophisticated, costly management structure that includes top-notch technology, marketing plans, high-level administrators, university-style training, high-profile staff recruiting and other things. Smaller firms struggle to afford these features. So, a $7M firm that becomes $10M overnight with a $3M acquisition finds itself suddenly in a position to operate like a bigger firm.
6. A great way to build the client base of a new partner. When some firms promote a manager to partner, it takes a while until the new partner builds up a decent-sized client base.  This process is sped up when the buyer acquires a practice and assigns the clients to new partners.
7. It’s a buyers’ market. The retirement of aging of Baby Boomers has resulted in an avalanche of mergers. We were all taught in our economics classes that when supply exceeds demand, it becomes a buyer’s market, and that is what is happening in the CPA industry today.  In a buyer’s market, buyers have more to choose from, are in a position to cherry-pick their merger partners and in some cases, reduce the purchase price.
8. To make more money. Put all these reasons together and the result is higher profitability for the buyer. Multiple studies of CPA firm metrics consistently show that “bigger is better:” The higher the revenue, the higher the profitability. This doesn’t guarantee that higher revenues will translate to greater profits, but it usually works out that way.

A contrarian point of view

The merger market has changed dramatically in the past five years. It used to be that CPA firms would jump at the opportunity to merge in quality, compliance-oriented accounting firms. And jump they did. Hundreds, perhaps thousands of small compliance firms merged into larger firms in the past 20 years or so. By and large, these mergers or acquisitions were successful.

But in the past five years, many buyers have changed their merger strategy. As one MP put it to me: “We don’t want a firm that’s just like us.” A large percentage of buyers are now more strategic in their merger approach. Now, many buyers are primarily looking for consulting firms. Other firms only are interested in sellers that have a deep bench of young talent, both at the partner and staff level (or as one MP told us: “We don’t want a bunch of old guys hanging around.”) Still others have a strong preference for firms with an established niche or specialized expertise. As a result of these changes in buyers’ merger strategies, what used to be a seller’s market is now a buyers’ market, fueled by a staggering, continuous parade of small firms looking to sell as an exit strategy.

Obviously, buyers are entitled to devise and execute their own strategies. Who are we to question the strategy of large, successful firms? But to those buyers who now shun merging in small, compliance firms, we pose this scenario. Suppose you are a buyer with annual revenue of $10M. The average income of its seven equity partners is $500,000. Why wouldn’t this firm want to merge in a $2.5M compliance firm in their geographic market with two partners, each in their early 60s, both of whom earn $500,000? Further assume that the seller has great business clients, strong billing rates and the two partners are sharp practitioners. CPA firms are top-line driven. Why pass up an opportunity to add great clients and two sharp partners, which can only increase the profitability of the combined firm? We maintain that merging in successful compliance firms is an attractive investment that buyers should carefully consider.