Pricing Issues for Small Firm Sales: What Partners Need to Know to Maximize Proceeds When Selling Their Practice
[ILLUSTRATION OMITTED] For CPAs looking to sell their accounting practice, it can be a big plus to be in a small firm. That's because small firms generally can command higher multiples than big firms, and external sales usually produce higher prices for accounting practices than internal ownership transfers. Those are two of the trends that will be explored in a three-part series on valuation issues in accounting firms. This article focuses on small CPA firms. The next two articles will address valuation issues for large CPA firms and internal transfers of ownership. Here are a couple of definitions specific to the series: * Value is not meant to be consistent with the conclusions that a CPA Accredited in Business Valuation (ABV) would reach in a formal business valuation performed for, say, litigation or an estate. Instead, value refers to the price to be paid for the practice--which often is expressed as a multiple of revenues, as is discussed in further detail later in this article. * Small firms, generally speaking, are those with four or fewer owners. This is because the vast majority of business combinations involving the acquisition of firms with more than four owners are at least partially a merger rather than a sale. In a merger, some or all of the acquired firm's owners become owners in the successor firm. This is an important distinction because, in a merger, the successor firm's owners' agreement usually dictates the value of the equity for owners who are a party to the agreement (though not always, as will be explored in next month's article on large firm valuations). In transactions with smaller firms, it is much more likely the transaction will be in the form of a sale. The sale can be immediate, meaning the payment of the proceeds commences at closing, or in the form of a two-stage deal, in which the proceeds are delayed for a few years, with the selling owners continuing to work full time while transitioning the practice (see "A Two-Stage Solution to Succession Procrastination," JofA, Oct. 2013, page 40). The primary factors that drive the value of a small firm in a sale are (1) the terms of the transaction; (2) the number of buyers potentially interested in the practice; (3) the attributes that will affect the profitability for the buyer of the practice; and (4) the nature of the practice. This article explores those factors in more detail. 1. The Terms of the Transaction As mentioned earlier, the price paid for a firm often is expressed as a multiple of revenues. However, the multiple a seller is willing to sell the practice for, and the buyer is willing to pay, is directly related to other terms of the transaction. The five primary terms that affect the multiple are (1) the upfront purchase payments; (2) the number of years the remaining payments are made; (3) the period during which the payments are subject to adjustment for retention of acquired clients and the extent of the possible adjustment; (4) the tax treatment of the payments; and (5) the potential profitability of the practice for the buyer. The more those factors favor the seller, the lower the resulting multiple will tend to be and vice versa (see "How to Value a CPA Firm for Sale," JofA, Nov. 2013, page 30). Retention of acquired clients tends to be the factor that most significantly affects a small firm's value. The reason for this is that client relationships in smaller firms tend to be much more connected to the firms' owners. Those owners are often much more hands-on with clients, who often can't differentiate their relationship with the firm from their relationship with one of its owners. The larger the firm becomes, the more likely it is that clients will see their relationship as institutional. In those cases, the clients will have relationships with several key people in the firm and be less tied to a particular owner. In virtually any deal that places value on the transfer of client and staff relationships, provisions restrict the seller from competing with the buyer firm for those relationships for a reasonable period following the sale. …