m&a candidates: valuations and vetting

plus consultant fee structures and integration committees.

by domenick j. esposito
8 steps to great

last year alone, over 200 firms merged up and this year is tracking the same. at this pace, a very large percentage of the approximately 14,000 multi-partner cpa firms (about 90 percent of which are under $10 million in revenue) will be looking at an upward merger in the next few years.

more on strategic planning: m&a: sometimes bigger is better | use compensation to shape partner behavior | the importance of m&a culture due diligence | are you attracting the new breed of equity partners? | quality work, quality service not the same thing | who will be the next category killer? | why is strategy execution so difficult?
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so let’s take a deep dive into what you need to know about merger combinations, which are as much about the addition of talent as they are about the addition of clients.

cpa firm valuations

the two typical valuation components in most merger combinations are capital and goodwill.

capital is straightforward: it is a firm’s accrual-based capital adjusted for the fair market value of fixed assets, work in process and receivable reserves. it is paid as cash or a note (in some cases the note bears interest), over a relatively short term.
goodwill is always expressed as a multiple of revenue; the generally accepted value of goodwill in the old days (circa 2001 to 2007) used to be one times revenue but today, as profits have declined, cpa firm valuations average about 80 percent of revenue. partners of the merged-in firm allocate firm valuation by using a “multiple of compensation” model based on relative partner compensation over a period of three to five years. average compensation is then multiplied by a factor to arrive at a partner’s share of goodwill that is paid out upon retirement over five to 10 years. some firms also provide an option to younger partners (i.e., offering the retirement benefit or deferred compensation plan offered to existing partners).

approaching the market

when approaching the market, most cpa firms retain a professional consultant who has significant credentials with m&a and strategy. fees generally are structured as follows:

an upfront retainer, plus monthly progress bills and reimbursement for out-of-pocket costs
a significant contingent fee paid upon closing for identifying potential candidates and for assistance in closing the transaction. it mirrors the “lehman formula” summarized below:

cumulative fee	purchase price
5% of	the first $1 million of firm revenue, plus
4% of	the second $1 million of firm revenue, plus
3% of	the third $1 million of firm revenue, plus
2% of	the fourth $1 million of firm revenue, plus
1% of	any amount in excess of $4 million of firm revenue

identifying viable candidates and working the circuit

identifying candidates can be an exhausting process for the ceo so it is important to define what should and should not be looked at. some potential targets, local “tuck-ins,” will be obvious because of local geography. other potential targets are more strategic and require that the “circuit” be worked. once you have determined the desired geographic markets and strategic add-ons, you have to make contact, develop a relationship with the targets and narrow the candidates down to one or two firms.

making sure it feels right

before you decide whether to proceed to due diligence or not, you need to make sure that the targets feel right by chatting with the senior partners about respective histories, cultures, “sacred cows” or deal-breakers in a possible transaction and the potential upside and synergies that might be derived. this is the magic sauce that will make a potential merger combination very exciting.

once the senior partners get comfortable with each other, the next step is to create broader buy-in with a meet-and-greet with all the partners from both firms and establish several committees that focus on integration of the different areas in the practice:

human resources and continuing education
information technology
marketing and sales
finance and accounting
partner matters

due diligence, closing the transaction, integration

due diligence consists of three components:

culture fit (very important)
commitment to technical excellence and quality client service
kicking the financial and operational tires

when it comes to kicking the tires, most firms use a cpa firm combination program that drills down into the operational aspects of the target. once potential deal-breakers have been successfully dealt with, attorneys draft a letter of intent that is followed by a detailed combination agreement. the easier part of a merger combination is getting the contract signed; the harder part is the integration of the two practices, which typically takes about two years.

from an acquirer’s perspective, there are wonderful opportunities to grow firms through merger combinations and as long as the marketplace buys bigger is better, there is no better time than now to capitalize on the opportunities. a word of caution, however. i implore you – no matter how tempting it may be – don’t do a merger combination if 1 + 1 doesn’t at least = 3.

posted on august 10, 2017

one response to “m&a candidates: valuations and vetting”

frank stitely
august 11, 2017
great advice and exactly what i’m seeing. prices go down as everyone heads for the exits at the same time.

dom esposito

about the author

domenick j. esposito was the ceo of grant thornton, vice-chair of bdo, and national growth director at cohnreznick.

he is the author of "8 steps to great: the eight essential strategies driving success at the world's largest cpa firms. and how to apply the lessons at firms of all sizes," published by 卡塔尔世界杯常规比赛时间.

a life in public accounting

in 2016, esposito, then a former ceo of bdo, moved from a 46-year career in public accounting into the next phase of his professional life – consulting to cpa firms, launching a boutique advisory firm, esposito ceo2ceo, that provides advice to ceos, managing partners and other senior partners of cpa firms focused on the mid-market throughout the u.s.

with the launch, esposito authored “8 steps to great," a guide for ceos, managing partners, and other senior partners on how to move their firm to the next level.

cohnreznick national growth director

esposito was one of the most qualified individuals in the country to advise cpa firms on growth and profitability. through 2015, he was national practice & growth director and an executive board member of cohnreznick, llp, a mid-market sustainable brand and the tenth-largest cpa firm in the united states. he oversaw cohnreznick’s go-to-market industry specialization and consulting and advisory service lines. he was also intimately involved in the firm’s mergers and acquisitions and strategic and tactical activities for its public company and capital markets initiatives. dom joined the predecessor firm of j.h. cohn in 2002 as the chief operating officer and executive board member.

dom was also an independent director of ethan allen interiors inc. for several years (through 2014), dom was a member of the nasdaq listing and qualifications committee to the organization’s board of directors. he formerly served as the leader of the new york state society of cpas committee for large and medium-sized firms practice management. he also was an adjunct accounting professor at c.w. post/long island university.

bdo and grant thornton

through october 2002, dom was vice chairman at bdo, a mid-market sustainable brand and the seventh-largest international accounting and consulting firm in the u.s., with almost 50 offices and 3,400 employees. during his brief time with bdo, he was responsible for the alliance distribution network (at the time consisting of over 80 cpa firms, 10 law firms, and 25 consulting firms). he was also responsible for attracting and servicing a number of clients.

from 1979 through 2001, dom was with grant thornton, another mid-market sustainable brand and the sixth-largest international accounting and consulting firm in the u.s., with over 50 offices and 4,500 employees. he joined grant as an audit manager, became a partner in 1981, led the long island office from 1984 to 1986, became assistant managing partner of the new york office in 1986, and from 1988 to 1999, led the new york office. in 1999, esposito became a regional managing partner and for two years, through 2001, was the firm’s chief executive officer.

cpa, partner, mba, leader, influencer, media celebrity

between 1996 and 1998, and while he was ceo, esposito was on the partner board and was also on the board of grant thornton international – the worldwide umbrella organization. in these capacities, he developed strong experience in strategic thinking and execution, international relationships, corporate governance, partnership matters, branding, expense control, client relationships, and new business development.

as ceo, he took grant thornton to record earnings, consummated the largest line-of-business sale in the firm’s history, developed a major joint venture with axa financial, and made the largest practice acquisition in the firm’s history. from 1969 to 1979, esposito was with price waterhouse (now pwc), servicing ibm when he was promoted to manager in 1976.

dom was a cpa, has been quoted in national and local media, and has appeared on radio and cable tv.

esposito also testified before the securities and exchange commission.

he received his m.b.a. from st. john’s university and his b.s. from ferris state university. accountingtoday, one of the leading trade journals for the accounting profession, named esposito one of the most influential people in the profession for two consecutive years.

he passed away in 2021 at the age of 74.

click here for more by dom esposito

one response to “m&a candidates: valuations and vetting”

frank stitely