business owners face one of three exits

expect to sell your practice? not if you resist change.

by frank stitely
the relentless cpa

in talking to firms from around the country, i realized there are three types of firms out there:

1. firms and practitioners that are sliding into retirement, whether they know it or not
2. firms that see the need for change, but don’t know where to start
3. firms that see a clear path to the future through better practice management

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since publishing my first book and launching my firm’s workflow and collaboration application, i have talked to practitioners from firms of all types and sizes. my cpa firm pursued a few acquisition opportunities. during the process, i learned there are a lot of practitioners who are either incapable of adapting to our profession’s 21st-century changes or unwilling to adapt. that’s okay, if you are making an informed choice to retire and don’t care about realizing much in value by selling your firm.

however, i see firms that haven’t evolved, whose owners believe their firms still have significant value. their clients are old and dying. their practices are hemorrhaging revenue or just barely treading water. as anyone who is involved in mergers and acquisitions knows, a desperate seller is, well … a desperate seller.

we looked at buying one firm that lost 15 percent of their clients in a year. they wanted us to pay them a fixed price for their aging firm at an asking price of 1.2 times collections. while they became educated about the multiples that firms with primarily 1040 clients are getting, they never did get the concept that we weren’t going to pay them for resurrecting their client base.

our effort, our profits. buyers pay for what is, not what might be.

another firm owner told me that he hadn’t accepted referrals for five years, but he was certain he could just turn on the spigot from his referral sources. after five years, don’t you think his referral sources had moved on?

these firms aren’t adapting and growing. their practices are becoming empty gardens. a couple of small practices in our area just folded up and sent their clients to us. great for us, but sad.

let’s analyze why a practice full of 65-year-old clients isn’t very valuable. is a practice full of 55-year-old clients more valuable than a practice full of 65-year-old clients? of course, the practice with 55-year-old clients is more valuable. you know this almost by instinct. but why?

practice acquisitions mostly work as follows:

1. the buyer pays for the practice over five years.
2. the buyer works the practice for another five years.
3. the buyer sells to the next buyer in line.

will a 65-year-old client likely be around until age 75 for the next buyer in line? even if yes, will a then-75-year-old client have any value to the next buyer? the chain of selling these clients ends somewhere, hopefully not with you.

if a 75-year-old client has little value, the same client at 65 has diminished value. why would you pay full value for a 65-year-old client you won’t be able to realize full value from when you sell? it’s like buying a bond that doesn’t repay your principal.

financially, you can rate all clients very simply – by the cash flow each produces over the life of the relationship. that cash flow is produced by two factors:

1. firm profits produced by working for the client
2. the length of time the firm receives that profit stream

this is also called lifetime value of a client. if you follow tech companies, they live and die on this metric.

obviously, 55-year-old clients are more valuable than 65-year-old clients just on that math alone. they have more potential years to produce profits for your firm. you may be thinking you get a bump in revenue when a client dies. however, you are unlikely to get that bump. sometime before your elderly client dies, the next generation is likely to take over the financial affairs. the next generation is likely between 40 and 55 years old. if you don’t have them as clients before the transfer of financial affairs happens, they likely already have a relationship with another firm. you’ll never get that revenue bump, and you’ll likely lose your client five years or more before your client dies. guess who does get that revenue bump? the firm with the relationship with the 40- to 55-year-old next generation. that firm wins twice. the younger clients are even more valuable than they would at first appear. they control more than one relationship.

over 30 years, i have been on both sides of this. having the next generation is the more pleasurable financial experience. if you’re on the wrong side of this enough, your practice declines.

if you’re thinking, “what about all the referrals the elderly client will provide?” think again. whom do elderly clients likely refer? other elderly clients. whom do younger clients likely refer? more younger clients. and they have more years to refer clients. this is like compound interest.

the math works exactly the same way for business clients, only worse – for the cpa with the older clients. there are only three possible exits for business owners at retirement.

behind door number one, the business just closes and you lose the client. this is far and away the most likely outcome. most businesses never see a second generation of owners. there are lots of businesses, such as real estate agents, that never sell because they are so personal in nature.

this is also mostly true of very small cpa firms and sole proprietors. clients are loyal to the proprietor and not the firm. when a sole proprietor retires, the clients are changing relationships one way or the other. they might as well control the process.

behind door number two, there is a transition to a younger generation within the family. however, it’s the same story as with tax clients. if you don’t have the relationship with the younger generation, you lose the client.

finally, behind door number three, there is a sale to a third party. that third party likely has a relationship with another cpa firm coming into the transaction. not always, but mostly. again, you likely lose the client.

if you’re reading this, you understand that major changes are necessary, but you may not know exactly where to start.

let’s start with where not to start – practice management consultants who spent a few years in the profession and then decided that they knew everything there is to know about running a firm. most of them never even made it through a full business cycle. after 30+ years, i still don’t know much, and most of the things that i know won’t be true in another five years. at least i know what i don’t know.

stay away from the people with easy answers. nothing about our business is easy, from marketing to serving clients to practice management. but we can do this – together. we can make more money, have happier clients and lead saner lives.

posted on february 14, 2023