check the math.
by marc rosenberg
cpa firm mergers: your complete guide
partners in accounting firms are familiar with the rule of thumb that a cpa firm’s goodwill (excluding capital) is worth one times fees. however, like many rules of thumb, this notion is often incorrect.
more: thinking merger? first ask why. | why do you want to merge? be honest. | four reasons to fear a merger
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when buyers begin to think about how much they will pay for a smaller firm, they often have this one-times-fees notion in the back of their minds. then, when sellers are bold enough to ask for a price in excess of one times fees, buyers often balk.
the purpose of this post is to demonstrate that buying 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 in excess of 1.0. let me illustrate my point.
assume the following:
- an $800,000 practice is sold to a buyer.
- the purchase price is one times fees, or $800,000.
- down payment is 10 percent, or $80,000.
- payment term is five years.
- revenues increase 5 percent a year after the sale.
- the buyer will earn profits from the new revenue source of 30 percent of fees before making buyout payments to the seller.
here is what the cash flow looks like to the buyer (numbers in $000s):
| payment to seller | annual fees | annual profit | start-up exp | net cash flow | present value @ 49.5% | net present value | |
| down pmt |
(80) | (80) | 1.0000 | (80) | |||
| year 1 | (144) | 800 | 240 | (50) | 46 | 0.5050 | 23 |
| year 2 | (144) | 840 | 252 | 108 | 0.2550 | 28 | |
| year 3 | (144) | 882 | 265 | 121 | 0.1288 | 16 | |
| year 4 | (144) | 926 | 278 | 134 | 0.0650 | 9 | |
| year 5 | (144) | 972 | 292 | 148 | 0.0328 | 5 | |
| total | (800) | 4,421 | 1,326 | (50) | 476 | (0) |
the return on investment (roi) is a wonderful 49.5 percent, which most people would consider a steal.
caveat: the above assumes that the buyer acquires a seller and the compensation to the seller is minimal because the latter wants to be gone soon after transitioning the clients. if the seller wishes to continue working, either full-time or part-time, then the roi will be lower, though still solid.
now let’s look at the roi if the firm sells for 1.3 x fees instead of 1x:
| payment
to seller |
annual
fees |
annual
profit |
start-up
exp |
net
cash flow |
present
value @ 29.0% |
net
present value |
|
| down pmt |
(104) | (104) | 1.0000 | (104) | |||
| year 1 | (188) | 800 | 240 | (50) | 2 | 0.7100 | 1 |
| year 2 | (187) | 840 | 252 | 65 | 0.5041 | 33 | |
| year 3 | (187) | 882 | 265 | 78 | 0.3579 | 28 | |
| year 4 | (187) | 926 | 278 | 91 | 0.2541 | 23 | |
| year 5 | (187) | 972 | 292 | 105 | 0.1804 | 19 | |
| total | (1,040) | 4,421 | 1,326 | (50) | 236 | (0) |
despite paying a 30 percent higher price, the buyer still nets an outstanding 29 percent on the deal. a great investment any day of the week!
conclusion
this post illustrates that paying well over one times fees should not make buyers feel they are overpaying for the firm. a buyer can earn a very handsome return despite paying a premium price.
there is a critical caveat: the buyer must be able to earn respectable profits from the revenues acquired. if this is not the case, then it’s probably not a good idea to pay a premium price. in fact, i would seriously question acquiring any firm at any price if the buyer has valid concerns about not earning an acceptable profit from the seller.