merger? the 100 data points you need first

the finer points of getting to know one another.

by marc rosenberg
cpa firm mergers: new and updated

before negotiations begin, it is very helpful for merger partners to prepare a one-page, written description of their firms. this advice is for both the buyer and the seller.

more: one times fees isn’t the only way | thinking merger? first ask why. | why do you want to merge? be honest. | four reasons to fear a merger
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at the risk of offending some of you, we have found that when firms initially describe themselves, the person doing the listening does a terrible job taking notes. none of our memories are as good as we think they are. because in almost all cases, each firm will soon be describing the other to their partners, it’s always best to follow up the oral description of your firm with something in writing.

what follows is:

1. what the written firm description should include (12 items)
2. get-to-know-you meeting between buyer and seller (the agenda)
3. sample firm description
4. the get-to-know-you meeting cheat sheet
5. key questions for the first meeting (43 items)
6. 20 questions to ask right away
7. the data needed to evaluate a merger
8. financial and operating data to exchange (58 items)
9. client list (with 9 items for each)

what the written firm description should include:

1. generic name of the firm (i.e., north suburban chicago firm)
2. why the firm wants to merge
3. annual revenue
4. number of partners and their ages
5. personnel breakdown: partners, professional staff and admin staff, all totaled, in full-time equivalents
6. a rough breakdown of services: audit, accounting, tax, etc.
7. niches and specialties, if any
8. sellers’ office lease situation
9. sellers’ future work preferences
10. whether a one- or two-stage merger is sought
11. technology and applications used
12. other pertinent data, such as partner billing rates and what software is used

get-to-know-you meeting between buyer and seller

all merger discussions have to begin somewhere. after merger candidates have been identified, the two firms must formally meet each other, get acquainted and decide if they want to get serious.

at this first meeting, everything is confidential and informal. no exchange of financial statements. the two parties simply spend an hour or two – you guessed it – getting to know each other. many firms like to convene this meeting at a restaurant to give the encounter an air of informality and sociability. other firms like to do this in the larger firm’s office so that the smaller firm can get a house tour. i strongly recommend the latter.

the organized chap that i am, i always have a cheat sheet to get the conversation going and make sure the firms address the basics. but my goal as a good facilitator is to shut up as much as possible and get the two firms to ask the questions and talk to each other.

no one can or should try to legislate how this first meeting is conducted. it should be free, easy and natural. however, just to give you an idea, i also provide a cheat sheet i use.

sample firm description:

north suburban cpa firm looking to merge up

the firm has two partners, 62 and 57, with $2.1 million in revenue. excellent profitability. they want to merge up as a succession planning strategy. though they want to continue working for several years, they feel that now is a good time to start the process. they have reliable, capable staff, but none has the potential to become partners.

they are looking for a two-stage merger/sale.

service breakdown:

• • 10% audits (all nonprofit)
  • 40% other accounting
  • 15% 1040s
  • 30% other tax
  • 5% routine advice

staff breakdown:

• • 2 partners
  • 7 professional staff including 3 cpas
  • 3 admin and other staff
  • 12 total ftes

clients: generalist practice with two large business clients who are billed $85,000 and $125,000, respectively:

• • one valve distribution company; audited financial statements
  • a manufacturing company; tax and accounting work

partner billing rates: $350

office lease expires x/x/xx

applications:

• • 1040 tax prep: lacerte
  • client accounting: thomson reuters accounting cs
  • quickbooks

 

the get-to-know-you meeting cheat sheet

date: ___________________

	buyer	seller
firm name
contact name
phone
email address

 

key questions for the first meeting

(though not necessarily in this order, and not all questions will apply to all firms and deals.

1. why is each firm at the table? why might each firm wish to do this merger? what’s the driver? what benefits will be expected?
2. tell each other about your firms:

• • a brief history of the firm
  • breakdown of personnel by partner, staff and admin
  • total full-time equivalents (ftes)
  • annual revenue volume
  • partners’ ages
  • markets you are in
  • services provided:
  • audit ____% accounting ____% tax ____% consulting ____%
  • industries served
  • specialties and niches
  • describe your staff

3. approximate data on each firm’s 1040 business:

• • percent of total revenue
  • minimum fee
  • the average fee per return

4. software used for tax prep and accounting
5. the buyer should share its vision with the seller.
6. any recent changes driving the desire to buy or sell?
7. does the buyer’s staff have the capacity to perform the seller’s work (in cases where the seller is or expects to be short of staff)?
8. is the buyer willing to hire the seller’s staff (within reason)?
9. (if the seller expects to phase out after a short time or a few years) how does the buyer see the client and administrative transitions taking place?

• • when would client transitions begin?
  • would any of the buyer’s partners and staff be assigned to the seller’s clients? to what extent?

10. how would the buyer assign the seller’s clients to the buyer’s personnel (if applicable)?
11. compare billing rates and fees:

• • if the buyer’s rates and fees are higher than the seller’s, to what extent will the buyer try to raise rates and fees? how sensitive will the buyer be to the seller’s clients’ willingness and ability to pay higher fees?
  • if the seller’s rates and fees are higher than the buyer’s, how will the buyer handle this?

12. how is the buyer managed? what is the organization structure? to whom will the seller’s partners be responsible?
13. has the buyer acquired firms before? if so, how have they worked out? if they haven’t worked out, why?
14. if the seller wishes to continue working for the buyer, is this acceptable to the buyer? to what extent?

• • full-time: is this affected by a mandatory retirement policy?
  • part-time

15. what attributes of the seller has the buyer found predictive of how successful the merger will be?
16. what characteristics, issues or events would doom it to fail?
17. what does the seller hope to get from this deal? how would the buyer answer these questions: “if we merge, how will your firm (the buyer) make this a good deal for us (the seller). how will we be better off?”
18. at this first meeting, specific terms for the deal are rarely discussed. however, either buyer or seller can give an indication of specific terms they are looking for if they wish to. both sides understand that nothing is binding, nothing is final and everything is subject to negotiation and due diligence:

• • purchase price
  • term of payment
  • down payment
  • compensation of the seller after the sale
  • deal-breakers and nonnegotiables

19. the two sides should share with each other dates by which they would like to close the deal.

questions to ask right away

these questions are best asked orally early in the process, before you exchange financial data. if sufficiently negative responses are obtained, a firm may choose to go no further in discussions. spoken responses are sufficient at this stage, but they should be formally verified in the due diligence process.

1. has the firm or any of its partners or employees ever been expelled, suspended or disciplined by any professional organization or regulatory agency, especially the aicpa or state society?
2. (for wealth management practices) are you properly licensed? has any disciplinary action ever been taken against individuals or the firm? any violations? are you in compliance with all regulations?
3. has the firm or any of its partners or employees ever been indicted or convicted by any court of any punishable offense, such as fraud, theft, embezzlement or other criminal acts?
4. is the firm or any of its partners or employees currently engaging in activities that could lead to an indictment or conviction?
5. have any of the firm’s partners ever been declared bankrupt?
6. regarding professional malpractice cases:

• • has your firm ever been involved in a case in which you were found guilty or settled?
  • are you aware of any current situations that could lead to a malpractice claim?
  • (for seller) do you now have malpractice insurance?
  • (for seller) can you obtain tail coverage?

7. are the firm, its partners and employees in good standing with the state(s) in which you are licensed and registered to practice public accounting?
8. do all the equity and non-equity partners possess a current, valid cpa certificate?
9. is the firm paying any expenses for a partner that will not qualify as reimbursable by the merged firm? at this stage, a general response is sufficient; details can wait until later.
10. regarding peer reviews:

• • has your firm ever failed to pass a peer review?
  • for all audits, reviews and other engagements that require peer reviews, has your firm been peer-reviewed?

11. if a staff person decides to leave after the merger, is there any chance he or she will take clients and/or staff?
12. is the vast majority of time spent on client work recorded on timesheets and posted to wip?
13. if the top line of the seller’s p&l is billings, do they differ substantially from collections?
14. is there anything unusual about your firm that might cause a merger partner to break off discussions?

data needed to evaluate a merger

i have always been a big believer in the buyer and seller exchanging financial and operating information as early in the process as possible. numbers aren’t everything, but they do speak volumes. the data enables each firm to gain an understanding of the other in a manner that is not always possible in conversation.

the data is also a good way to corroborate things that are said. here are some examples:

• in conversation, the buyer says its realization percentage is “strong.” but the data shows 82 percent, for which the word “strong” would never be used.
• in conversation, the seller says that its partner charge hours are high. but the data shows an average of 1,000, clearly not a very high figure.

data speaks volumes.

before exchanging the data, each firm should sign a nondisclosure and confidentiality form.

exchanging financials early on can corroborate the strength of a solid merger candidate, raise red flags about a firm that is overstating its strengths or provide insight into a certain aspect of the other firm that was either intentionally or inadvertently omitted in conversations.

many merger discussions stop at this point because the financial data of one party is such a turnoff to the other that it’s no longer interested in the merger. so exchanging data early in the process can avoid a lot of wasted time.

financial and operating data to exchange

unless stated otherwise, all the data requested is for the most recently completed fiscal year. the term “partner” always refers to equity partners and excludes non-equity/income partners.

1. financial statements for the last three years and the latest statements for the current year
2. revenues and expenses that will not continue when the firm is sold, such as:

• • rent
  • employees who will not move to the new company
  • personal expenses that will not continue after-sale, etc.

3. earnings of each partner for the past three years. include everything: base, draw, bonus, interest on capital, commissions, undistributed net income, etc.
4. a schedule of all personnel (partners and non-partners, part-time and full time, currently and formerly employed) who worked at your firm for the most recently completed fiscal year. data for each person should include:

• • name
  • title
  • age
  • years with the firm
  • educational attainment, including who is a cpa
  • billable hours for the year
  • total work hours for the year, including non-work hours such as holidays, vacation and sick time
  • standard billing rate
  • billable dollars (rate x hours)
  • realization rate
  • compensation, broken out by base, bonus and commission

5. billable hours for the firm, by month, for the most recently completed year
6. list of clients (see the form at end of this post). try to follow the 80-20 rule: list the top 20 percent or 30 percent of your clients that comprise 80 percent or 70 percent of your fees. for each client:

• • industry
  • annual amount billed
  • realization
  • major services provided
  • years as a client
  • issues that may cause clients to leave

7. if a firm has more than one owner, a breakdown of client billings by the owner, including gross fees, net fees and realization percentage on each partner’s client base
8. software used for the following applications:

• • accounting and write-up
  • tax preparation
  • tax research
  • audit
  • document management
  • time and billing

9. aged work in process (summary only)
10. aged accounts receivable (summary only)
11. for tax returns processed:

the number of returns and average fee per return, by type:

• • individual
  • corporate, partnership
  • estate and trust

12. breakdown of practice as a percentage of total revenue, by:

• • audit
  • reviews
  • compilations
  • bookkeeping
  • tax, 1040s
  • tax, other
  • consulting (specify: it, valuations, etc.)

of course, it should total 100 percent.

13. list any niches or specialties more than 10 percent of total revenue.
14. breakdown of annual billings by the number of clients in each category:

• • number of clients under $5,000 per year
  • number of clients  $5,000-$20,000
  • number of clients $20,000-$50,000
  • number of clients over $50,000

15. list industries that comprise 10 percent or more of the firm’s revenue
16. last two peer-reviewed reports
17. list of assets that the seller wishes the buyer to purchase
18. promotional materials (brochures, newsletters, etc.)

client list

the list should include the 20 percent of the firm’s clients that comprise roughly 80 percent of the fee volume.

type of business (examples)	location	type of service	years as a client	annuity vs. one-shot	owners’ ages	frequency of work	annual billable hours	annual billing	comments, status, & transition issues
contractor
retail
manufacturing
nonprofit
real estate
auto dealer
marina
doctor
law firm
wholesaler
engineers
restaurant
etc.
etc.
etc.
all other
total

 

posted on may 12, 2022