plus: a powerful equation.
by joel sinkin
transition advisors
when i teach a cpe class on how to value an accounting firm, the first question people ask is what is the multiple? as you likely know, an accounting firm is traditionally sold on a multiple of revenues.
the multiple is just one part of the equation and not a place to end – let alone start – the valuation process. the overall terms must include factors such as how much money if any up front, how profitable is the acquisition, how long is the retention period that impacts the seller’s balance due based on client retention and how long is the payout period?
here is a powerful equation to keep in mind: the less money up front, the longer the payout and retention period is; plus: the more profitable the acquisition is for the successor firm, the higher the multiple you can expect. if the seller asks for more money down, shorter payout and retention periods, goodwill, etc. the result is likely to be a lower multiple.
think of the final price as a package of these variables. no one wants to buy a firm and break even – let alone lose money – so you need to work the balance of the seller being paid for their years of sweat equity and the buyer being in positive cash flow.
one thing about valuing a firm that is counterintuitive is the definition i use when referring to seller’s profitability. the variable i see as having the greatest impact on valuing a firm isn’t the seller’s profit, but the anticipated profit the buyer will receive.
here’s a case study of what i’m talking about:
we recently worked with a seller firm where the owner was netting 65 percent. it was a small firm, and it wanted the buyer to retain its location, staff and fee structure while getting paid based on a goodwill purchase structure. when we got to the due diligence phase, the buyer firm determined that its quality control process was much more robust than the seller firm. the seller had one pair of eyes reviewing most of the work while the buyer required two pairs of eyes.
the seller, by requiring the buyer to retain the seller’s location, was not getting any synergies there. it also determined the fees could not go up even though the work the successor firm would do was going to take more time and effort. thus the profit would go down because of the qc issue. in addition, the seller wanted a five-year payout, but the payments would have been deducted over 15 years because it was structured as a goodwill transaction. the buying firm was already operating under a traditional one-third labor, one-third overhead, one-third profit model. thus, the buyer’s profit would be far less than the seller’s so the valuation the buyer had was much less than the seller’s.
in another example, a seller firm, roughly the same size as in the case study above and netting about 40 percent, did not require the buyer to retain the location or staff, and was amenable to being paid based on deferred comp instead of goodwill. yet, because the buyer was able to absorb this firm with no incremental increases in overhead, it had the staff and space to move this firm in, and got a current deduction on the buyout payments. even though the seller’s net was less in the second firm compared to the first firm, the latter firm received a higher multiple in its offer than the former firm did.