Merger Best Practices

Terry Putney is President of Transition Advisors, a company that consults  CPA firms on mergers & acquisitions. This is the first of a two part series on the highlights of Putney’s presentation to two of my Chicago-area managing partner roundtable groups.

Downpayments. Sellers are keen on getting as large a downpayment as they can possibly extract from buyers. The downpayment is seen as protection in the event that the buyer defaults on future payments that are not guaranteed. It also respects that time-honored principal of finance: money today is worth more than money tomorrow. But pressuring the buyer for a sizeable downpayment may be misguided. First, downpayments reduce future payments, so the seller should keep in mind that total payments will be the same, regardless of whether downpayments are made or not. Second, most buyers don’t want to make any downpayment, so, sellers can dramatically reduce their universe of potential buyers by pressuring buyers for money up front.

“Must-haves.” These are merger terms that the seller feels he/she must have in order to do the deal. Examples are a minimum sales price, downpayment, compensation during the transition, a title, a compensation guarantee, continuation of certain perks, assurance that all the seller’s staff will be hired by the buyer, etc. The more “must-haves” a seller has, the more likely it is to scare off viable buyers. Savvy sellers try to keep their list of these items to those that are truly essential, knowing that buyers will most likely try to negotiate other terms that offset the seller’s “must-haves.”

Gaps in billing rates between buyer and seller. This is overblown by both buyers and sellers. Sellers fear that a big gap in billing rates will result in the buyer raising his billing rates, thus risking the loss of his clients, which reduces his sales proceeds because payments are contingent on collections. Buyers often shy away from smaller firms whose owner billing rates are substantially lower than their own, fearing that the gap in rates can never be overcome.

Both buyers and sellers need to understand that one of the reasons that owners at smaller firms have lower billing rates is that they usually perform a lot of billable work typically done by low level staff at larger firms. As a result, they have lower standard rates because clients won’t pay partner level rates for low level work. So, once the small firm owner is part of the larger firm, much of her billable work will be delegated to staff, thereby enabling her to carry a much higher standard billing rate.

Falling in love. Many sellers make the mistake of rushing into a merger or sale before taking the time to assess the fit of their culture and personality with the buyer. This happens especially in cases where the seller has known the buyer for a long time. Because of this long-standing friendship, the seller “assumes” the merger will work and takes a pass on doing his/her due diligence on the buyer. It’s like “love at first sight.” Most of the time, when we see mergers or sales fail, it’s due to either the buyer or the seller failing to take the time necessary to check out the other firm and ask critical questions.

State of the market. There is lots of pressure on organic growth at firms. Partners are struggling to get used to the “new normal” – a sluggish economy that is unlikely to return any time soon to the golden age when firms grew at 10% or more per year. As a result, firms are much more active in looking to merge in smaller firms to satisfy their appetites for growth. The larger the firm, the bigger the appetite for growth. This boundless push for growth, the lack of any new services being developed for clients in recent years (such as SOX work a few years ago) and the continually growing number of firms that must merge up or sell due to a lack of younger successors, are all fueling a frenetic merger market. Putney feels that it is likely that prices paid for small firms will go down as more and more sellers flood the market, allowing buyers to cherry-pick their mates.

Thousands of firms are currently seeking the most viable exit strategy available to them: merge into another firm. But most partners have never negotiated a CPA firm merger. How do you get started? What can your firm do prior to the merger to insure its success? What actually needs to be negotiated? The answers to these questions and many more are addressed in Marc Rosenberg’s monograph How to Negotiate a CPA Firm Merger.