Merging in a Smaller Firm? Here’s What to Expect

Looking to merge in a smaller firm?

If so, your reasons are likely along these lines: (a) Baby Boomers are retiring in droves, (b) The post – recession malaise continues to hold back growth and (c) You’ve done an ROI analysis (assuming you can remember how) on buying a small practice and found that it’s a steal!

So, if you’re revving up your merger efforts, here’s a little snapshot of what you’ll encounter:

Small firm owners don’t really want to retire.  Don’t assume that the seller is expecting to retire.  Selling a firm as an exit strategy has little to do with mentally deciding to retire. The vast majority of CPA firm owners aged 60-70 either aren’t sure when they want to retire or would prefer not to retire.  This is one of the most important issues to spell out before the merger is completed.  If it’s not clarified during negotiations or in the first year of the merger, the buyer will have a very awkward problem:  getting an aging seller out of the firm when he wants to stay.

Unrecorded time.  Especially sole practitioners.  A prevailing small-firm mentality is  “do whatever it takes to bring in revenue, regardless of the time it takes..”  They rarely record billable time if they know it can’t be billed.  Buyers should plan on doing plenty of analysis of the sellers’ billings compared to the time worked.

Low billing rates, especially for the owner(s).  A buyer’s typical knee-jerk reaction when analyzing sellers is to reject them if their billing rates are lower than their own.  Owners of small firms do more staff-level than partner-level work.  As a result, sellers’ billing rates are a meld of partner and staff level rates.  When a buyer merges in a solo, most of the staff-level work performed by the seller will be done by the buyer’s staff.  Therefore,seller’s billing rates can be increased substantially without fear of losing clients.

Low profitability of the seller.  This is one of those “is the glass half-empty or half-full” issues.  Pessimists will reject low profitability sellers if the earnings gap is too large, fearing an earnings dilution.  Optimists look at a firm with marginal profitability as an opportunity to use their superior skills and knowhow to increase the seller’s profitability and pocket the increment.

Loosey-goosey management style.  Owners of small firms are used to being kings of their realms, accountable to no one.  Their management style is invariably less formal and structured than larger firms.  Buyers must be prepared for multiple confrontations over management style.  Early and often the buyer must make it crystal clear to the seller that their compliance with the firm’s processes and policies is not optional.

Marc Rosenberg just completed his revised and expanded CPA Firm Mergers: Your Complete Guide, which lists 13 more things buyers should expect, plus 150 pages of additional “how to” guidance.