Why Small Firms Should STOP Fearing an Upward Merger
Being an owner of a CPA firm is one of the coolest jobs anyone could want (assuming your dream job isn’t to be a Hollywood producer, astronaut or shortstop for the Cubs). You make great money, do work you enjoy and work with clients with whom you have a mutual relationship. You do this for 30 years or so and then, seemingly in a flash, you are nearing retirement age.
If you are like 80% of all first-generation firms, your staff has neither the desire nor the ability to become partner. It’s not because you didn’t want this, though it may be because you didn’t try hard enough. There are two reasons for this troubling predicament. First, it is exceedingly difficult to find and retain staff. The CPA profession suffers mightily from a labor shortage, with no end in sight. Second, the operating model for most CPA firms doesn’t lend itself to succession planning. Owners are simply too busy with client activities to spend the time needed to properly mentor staff. Also, most multi-partner firms don’t incentivize their partners to excel at developing people.
So, the reality sets in for many firms that the only succession strategy they have is to sell to or merge with a larger firm. This is where panic and anxiety take over. Not only do partners fear that they cannot adapt interpersonally to working at another firm, but they worry that the merger won’t be successful―and may even be miserable.
Here are five reasons partners should stop fearing an upward merger. One caveat for the remainder of this blog: We primarily address mergers in which the seller(s) continue to work at the buyer’s firm for a few years. Many of the following may be inapplicable in the case of straight sales where aging sellers will retire in a very short period of time.
- Loss of control. Partners’ concern here is at least partially warranted. For 30 years or more, they have been masters of their own fiefdoms, with no one telling them what to do, few rules of conduct to follow and virtually no accountability. They have been in near-total control over their professional life. It’s natural to fear losing this control.
Loss of control is more a mindset and a fear of the unknown than a reality. I’ve spoken to many sellers about this. When I ask them specifically what they fear losing control of, they usually are unable to articulate it. This doesn’t mean that they have no reason to fear loss of control. But most sellers find that this fear dissipates once the merger takes place. Caveat: If the sellers fear being held accountable for things they know they should be held accountable for but failed to do―collect receivables, bill WIP on time, submit timesheets promptly, mentor staff, learn new technology, to name a few―then fearing loss of control is a valid concern.
- The buyer will tell you what to do. Sellers tell me all the time they fear being made to feel like an employee. Examples include “clocking” in and out (not literally but figuratively), workpaper techniques, counter-review of work products, how much WIP to bill, restrictive client acceptance and retention policies and what work to delegate to staff. The reality is that if the sellers are productive, drive profits, manage a decent-size client base, have acceptable technical skills and maintain good relationships with clients and staff, the last thing a buyer wants to do is mess this up.
Balancing the above is this: Don’t ever believe a buyer who says nothing will change. It most certainly will. Sellers might not like all the changes. But they will learn to adapt way more quickly than they thought.
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.
- The buyer will introduce so much trauma in your practice that it will cause you to lose clients. All sellers fear that the buyer will increase rates and fees so significantly that it will cause clients to leave (in the majority of mergers and acquisitions, the buyers’ rates exceed those of the sellers). Clients also fear that their fees will go up when informed of the merger.
A more indirect concern is this: The buyer’s quality standards, work processes and workpaper requirements are often more rigorous than the seller’s. This often will require more work to be performed than before the merger, which may lead to increased fees.
This issue can be addressed to the seller’s satisfaction during the due diligence process. In all mergers I have been involved in, I make sure that the seller asks the buyer what they will do with the seller’s fees and billing rates. In almost all instances, buyers have been willing to commit to not increasing rates in the short term or at least collaborating with the seller regarding all rate and fee changes. Of course, if the buyer says it will increase rates, this is a red flag to the seller, who then must decide if this is acceptable.
A major due diligence step is the buyer’s review of the seller’s client files. This is important for the buyer because they obviously want assurance that the seller’s work quality is acceptable. But it’s also important for sellers because they need to know if more work will be required to bring their work quality up to the buyer’s standards.
- “We hear that mergers don’t work.” Information based on hearsay, rumors and third-party observations are awful sources that many in our society accept as fact, despite the veracity of these information sources being highly suspect. Our experience has been that mergers do work … if you do them right. Let me explain.
- Both the buyer and the seller carefully assess the likelihood that their reasons for doing the merger will be realized. Example of a scenario I observed: One of the main reasons a seller wanted to merge into a bigger firm was greater access to staff. After the merger was completed, the buyer said they didn’t have any staff to assign to the seller. Amazingly, the seller never sought a commitment on this from the buyer during merger negotiations.
- Examine the fit of the two firms’ personalities and culture. This is one of those areas that is hard to define but you know it when you see it. The only way to address this is to (a) meet as many times as possible with the merger partner, both in a business and a social setting, and (b) don’t rush the process―take the time to properly get to know your merger partner.
- Do your due diligence really thoroughly. Don’t assume anything. Ask lots of questions, especially the tough ones. Voice your concerns.
- Get crystal clarity on what will be expected of the sellers and what their roles will be: billable hours, realization, business development, specialization vs. generalist, delegating work to staff, remote working options, etc.
The message: Mergers do work if you do your homework.
- “Why aren’t we jumping for joy?” A long-time, seven-partner client of mine sought an upward merger because the partners were all in their late 50s and early 60s and had no staff with partner potential. I led an all-day meeting to assess a very attractive offer made by a much larger buyer. Toward the end of the day, a vote was taken, and they unanimously elected to accept the offer. Then one of the partners said: “We’ve just spent all day doing a very thorough job of evaluating the buyer’s offer, and we decided to merge. Why aren’t we jumping for joy?”
The problem with this is that this partner’s bar for satisfaction with the merger was unrealistically high. Let’s be sensible about this. You’re a partner at a small, cozy firm with a tight-knit partner group. You are proud of the firm’s reputation and legacy. There isn’t much accountability. The partners can’t help feeling they failed the firm by being unable to remain independent and are feeling guilty about perpetuating the firm’s legacy. No one “jumps for joy” at this, regardless of how sweet the deal is. No one.
The partners should feel very pleased if they achieve some or all of the following goals:
- They solidify their buyout.
- The seller’s partners that continue working at the buyer are happy with their role at the new firm and continue to enjoy their work and their clients.
- The seller’s partners are reasonably satisfied with their compensation.
- Clients and staff react well to the merger and are retained.
- Access to younger partners and staff is achieved.
- Because the buyer’s portfolio of services was more diverse than the seller’s, the seller is able to satisfy additional needs of their clients that previously were unmet.
- Some of the seller’s biggest headaches are addressed. Recruiting, which was impossible before the merger, is now improved (no firm will ever find recruiting easy). Technology is more available and more sophisticated. Administration previously done by the partners is now done by the buyer’s support staff such as directors of marketing, HR, administration and technology.
The above is a more realistic bar for measuring the seller’s satisfaction with the merger. As the Righteous Brothers famously sang, the seller will have “lost that loving feeling because it’s gone, gone, gone.”
New Second Edition! The merger market is in frenzy, yet few firms have experience with mergers. Our step-by-step guide provides the keys to implementing successful mergers: assessing cultural fit, critical negotiating terms, pricing strategies, due diligence and legal issues.Learn More