A Startling Revelation: 1x Fees is a Steal
Marc Rosenberg, CPA
Partners in accounting firms are familiar with the rule of thumb that a CPA firm’s goodwill is worth one times fees; however, like many other “rules of thumb,” this notion is often incorrect.
When buyers begin to think about how much they will pay for a smaller firm, they often have the “1xfees” concept in mind. Then, when sellers are bold enough to ask for a price in excess of one times fees, buyers often balk because they feel that the asking price is too rich.
The reality is this: Acquiring a small firm for one times fees is a steal (for the buyer). In fact, it’s still an outstanding investment at a premium price, say, 1.3 times fees.
To demonstrate, I will have to painfully take you back to your college days when, maybe, you learned how to perform return-on-investment calculations.
Space doesn’t permit me to share with you the calculation details, nor do I want to test the limits of anyone’s attention span. So, you’ll have to trust me on this:
- The ROI on purchasing a “vanilla” firm at 1xfees is an astronomical 50%,
- The ROI on paying 130% of fees still will net the buyer a very satisfying 29%.
Memo to buyers: if you have the opportunity to acquire a good, smaller firm, be willing to pay more than 1xfees because there are consultants like me who are routinely selling these firms for a nice premium.
Sellers, don’t be shy. If you have a “good” firm, set your sights above 1xfees because you can get it.
For 14 chapters and 152 pages on merger topics like this, purchase our newly revised and greatly expanded CPA Firm Mergers: Your Complete Guide
9 Comments
Get our expertise delivered to your inbox.
Has this same concept affected buyouts from within a firm or are they still running at less than 100%. I have found your various monographs to be informative and helpful. Thank you,
Ric – great question. There is a lot of confusion among practitioners because they see small firms selling for 1.2 to 1.5 times fees and wonder why their internal buyout plans range from 70-100% of fees, with the national average being 80%. There are several explanations for this variations. 4 that come to mind quickly: (1) In an external buyout, there are many buyers and they bid against each other. In an internal retirement, there is only one buyer – your own firm. So, the rules of demand and supply take over and for internal purposes, a much more conservative number is used. (2) Younger partners get very anxious about paying large buyouts to older partners. One way to ease this anxiety is to agree on a more affordable buyout than one time fees, (3) External buyouts are based on collections; for internal buyouts, firms don’t like to get into the blame game if a retired partner’s clients leave after he/she retires, so they pick a lower valuation that makes up for client loss and (4) For internal buyouts, firms simply like to be conservative and this pushes the goodwill valuation down.
I disagree with your article. I have looked at dozens of small firms and the majority have low billing rates, low profit margins, little to no bench strengh and owners that want to retire in a couple of years. Purchasing firms are not sitting with abundance of people resources nor are they able to attract cpa’s in any great number. Your article gives false hope to 1,000’s of firms thinking they can get more than 1 times billing. We are seeing just the opposite. We focus on bottom line and not top line. When you calculate ROI do you include the time and expense of transition? Do you include cash flow cost? I also think the industry is in a buyers market. There are more sellers than buyers which should decrease what they can get and if they can get anything. That is what we are seeing in the non major markets of the midwest. I request that my identity be kept confidential. I can understand that the numbers can be screwed higher when you focus on the firms that have sold and exclude the ones that could not find a buyer.
You cite all the reasons why many firms are NOT worth a premium price and theoretically, you’re logic is correct. But that doesn’t stop firms from paying the premium. There are well managed, profitable firms that have so much confidence in their skills that they feel that they can take just about any sub-par firm and build it INTO a profitable firm. The first thing the buyer usually does is get the billing rates up because the seller has been under-billing. Also, the owners at solos and very small firms use a standard billing rate that is low by multi-partner firm standards because these owners not only do partner-level work, but they do a ton of staff-level work. So, they reason that their billing rate must be a blend of partner and staff rates because clients won’t pay a high fee for a low-level project. In my market, Chicago, I have had almost no resistance getting firms to pay over one times fees for small firms.
Further to your questions, yes, I DO factor in time and expense of transition, cash flow costs, etc. The merger market is moving towards being a buyer’s market, BUT, for a reasonably decent small firm in a market with a metro population of over 1M, where there are many buyers, its still a seller’s market. Smaller population markets (you describe them as non-major midwest markets) will definitely be closer to a buyer’s markets because there are fewer buyers.
Marc,
I appreciate all the discussion on this topic – very interesting. This particular answer has me scratching my head. From my work in business valuation, I remember a statement that I heard Shannon Pratt make a number of years ago – when advising a seller in a transaction temper their expectations as an astute buyer will not pay a seller for improvements the buyer will make to the business. The above comments seem contrary to that advice & I would hope most accountants would be astute buyers. Your thoughts?
Hey Marc, now you tell me! FYI, my buyers were on time with every payment and your counsel helped me sell for a fair price for me and for the buyers.
Jeff, glad to here everything went well for you.
So Marc, while these general statements may be true in a metro area like Chicago, is it true for small firms in small towns where there are few, if any, buyers? Perhaps the most important term here is good firms – what would be your definition of a good firm? Is a high-volume 1040 practice with paper files for business and 1040 clients a good practice in today’s environment?
Carl, the merger market is dramatically different in a big city like Chicago (where I am based) than in a small city (say under 250K metro population). In Chicago, a seller has 50 good firms to choose from as buyers, which makes it a seller’s market. In small town in Iowa or South Dakota, where there are few buyers, then this can rapidly become a buyer’s market.
You ask what a good firm is. These variables make for a good or stronger firm and the opposite make for a weaker firm: Profitability, higher billing rates, fees and average 1040 fee, more business and less 1040 clients, more audits of for-profit businesses, good, young talent vs. retirement-minded owners who want out, clients who are young enough so that they won’t retire when the CPA firm owner(s) retire, be current with technology, a specialty vs. a generalist, etc.