Preparing Your Firm for an Upstream

Merger

November 10, 2016

Terrence Putney, CPA

CEO-Transition Advisors

NASBA CPE Earned Credit Guidelines

Transition Advisors, LLC is a sponsor on the NationalRegistry of CPA Sponsors per the National Association of State Boards

of Accountancy (NASBA).

In order to receive your 1.2 CPE credit – You must complete two requirements:

1) Participate in all four polling questions during the presentation.

2) Complete an online evaluation after the webinar.

Attendee Control Panel

Take a moment to familiarize yourself with your Go To Webinar

control panel on the right hand side of your screen.

The orange arrow on the top of the control panel is to minimize the control panel.

All participants are muted during the presentation, but you can

communicate with us using the question box towards the bottom of communicate with us using the question box towards the bottom of

your control panel.

Just type your question in the box and click send.

The presenter will answer all your questions during our presentation

and we welcome your participation.

Upcoming Webinars

Transition Advisors, LLC offers FREE monthly CPE courses

Upcoming Webinars:

December 15 – The Urge to Merge: How, Why, When and With Whom

January 12, 2017 – Back to the Future: A look back at what happened in 2016

and what we can expect for the New Yearand what we can expect for the New Year

Visit transitionadvisors.com/upcoming-courses.php for more information.

Transition Advisors, LLC

National consulting firm working exclusively with accounting firms on issues related to ownership transition

Polling Question

How many equity partners do you have in your

firm?

1) 1

2) 2 to 42) 2 to 4

3) 5 to 9

4) 10 to 19

5) 20+

Case Study

Selling/Merging Firm• 3 partners, $2.4M in fees, $800k in capital

• Frank, 63 yrs old– 70% of the equity

– Manages $1.3M of fees

– Comp is $450k

• Alice, 55 yrs old, indefinite retirement plans• Alice, 55 yrs old, indefinite retirement plans– 25% of the equity

– Manages $800k of fees

– Comp is $275k

• Dan, 42 years old– 5% of the equity

– Manages $300k of fees

– Comp is $150k

Case Study

• Buy-sell agreement requires

– Capital paid in first year

– Goodwill value paid over 5 years at 1X plus 6% interest on

total revenue times equity

• Alice and Dan believe• Alice and Dan believe

– They can’t afford the payments to Frank

– They don’t have talent on the bench to replace Frank

– They can’t manage the firm and clients on their own

Standard Goals for Merge Up/Sell

Risk Avoidance

• Liabilities to former and soon to retire

partners

• Specialized services that may be

unsustainable

• Lease renewals• Lease renewals

• Potential loss of key employees

• Potential loss of key clients

Case Study

Acquiring Firm

• 6 partners, $7M in fees

• 2 partners will be retiring in 4 and 6 years

respectivelyrespectively

• 4 partners-in-waiting on the bench

• Firm knows it needs to promote the partner

candidates but is concerned about diluting the profit

pool

Alternative Deal Types

• Outright sales

• Two Stage Deals

• Cull out sales• Cull out sales

• Sale vs merger

Polling Question

What issues do you see affecting your practice

most in next year?

1) Succession

2) Admitting new partners2) Admitting new partners

3) Client retention for retiring partners

4) Need for growth

5) All of the above

Outright Sale

• Purchase payments begin immediately

• If seller needs to keep working-what to pay

• Disadvantage: not a lot of time for transition

could lead to lower client retentioncould lead to lower client retention

Two Stage Deal

Stage One-usually up to 5 yrs

• Seller merges into buyer’s firm

• Starts the transition process

• Maintain reasonable control over • Maintain reasonable control over

clients

• Take on a principal’s or non-

equity partner role

• Maintains compensation level

Two Stage Deal

Stage Two-paying for the practice

• Seller transitions to a part-time or

retired role

• If working, comp @ a per diem rate

• Purchase is now based on a practice

that has ALREADY transitioned

Cull-out Sale

• Selling a part of the practice OR

• Retaining a part of the practice

such as

— Clients

— Services— Services

— Locations

• Breaking up the firm

Sale vs Merger

• Key difference is ownership

status

• Merger-sign onto successor firm’s

owner agreementowner agreement

Case Study

Deal Structure• Frank will bought out using a Two

Stage Deal

• Alice will be admitted as an

equity partner equity partner

• Dan will be admitted as an

income partner with a path to

equity if he can manage enough

business

Case Study

• Parties agree that Franks, Alice’s, and

Dan’s books of business are separate

and distinct, therefore

• Frank’s buyout will be tied to his book

and Alice’s equity will be tied to her and Alice’s equity will be tied to her

book

• Dan will either eventually be admitted

as an equity partner or be bought out

of his equity in his old firm

Frank’s Two Stage Deal

Stage One-

• Stage One contractually ends in 3 years

• Frank’s comp is tied to his historic comp by paying

him 35% of the collections from his clients in comp him 35% of the collections from his clients in comp

and benefits

• If he uses more labor than a historic base, comp is

adjusted accordingly (can happen due to growth or

Frank reducing client service hours)

Frank’s Two Stage Deal

Frank’s primary objectives in Stage One are:

• Transition

• Keep clients

• Introduce clients to his successor• Introduce clients to his successor

• Maintain personal income

Frank’s Two Stage Deal

Stage Two Deal Terms-

• Retained AR and WIP

• Buyout based on collections over six years

• New Business Bonus• New Business Bonus

Polling Question

Which best describes your personal situation

over the next five years?

1) Reduce my role and time in the practice

2) Having partners reducing their role2) Having partners reducing their role

3) Acquire another firm

4) None of the above

Principles of Value

Think about what creates value for a practice

An accounting firm practice value is primarily based on a seller’s ability

and that of the buyer to successfully get the seller’s clients to transfer

from the seller to the buyer

Terms-Five Primary Factors

1. Cash up front, if any

• Dependent on time of year

• The deal’s cash flow

• Accounts receivable

2. Retention clause2. Retention clause

• Collection deals

• Fixed deals

• Limited guarantees

Terms-Five Primary Factors

3. Profitability

• Seller’s current profitability

• Buyer’s anticipated profitability

• Tax ramifications of deal

structuresstructures

(goodwill vs current deduction)

4. Length of the payout period

Terms-Five Primary Factors

5. Multiple

• Terms are the cause

• Multiple is the effect• Multiple is the effect

• Basic rule:

• Lower down payment, longer payout period

• Higher profitability, longer guarantees = higher

multiple

Frank’s Buyout Terms

Frank was paid-• No down payment

• 16.67% of collections from his book for three years

• Price locked after three years and the remainder was paid • Price locked after three years and the remainder was paid

over three more years

• Treated 50% as an asset sale, and 50% as consulting

agreement

Frank was essentially paid 1X of his managed book of business-

the multiples will vary depending on the market and quality

considerations

Alice’s Merger

Alice signed the partner agreement and-• Was conditionally guaranteed $275,000 of comp and benefits

for two years

• She received her pro rata share of the equity based on

revenues (8%)revenues (8%)

• She contributed her AR and WIP as a capital contribution to

the new firm

• She became bound by all the terms and conditions of the new

firm’s agreement

Dan’s Merger

Dan signed an Income Partner agreement• His base compensation was pegged at $150,000 for two years

• He is eligible for bonuses consistent with other income

partners

• His share of the AR and WIP was retained by the successor • His share of the AR and WIP was retained by the successor

firm

• If he is not made an equity partner within three years he will

be paid for AR and WIP

• If he is made an equity partner, AR and WIP will be treated as

contributed capital

Polling Question

Your firm’s most likely succession plan looks like:

1) Find an external buyer or upstream merger

2) Internal solution-prefer not to sell or merge

3) I don’t know what my firm should do3) I don’t know what my firm should do

Identify What Defines the Right Successor Firm

Four C’s • Culture

• What’s it like to be a client, employee and partner in this firm?

• Chemistry• Chemistry

• How well do you get along with key people in this firm?

• Continuity

• How will changes in your operations affect retention of your clients/staff?

• Capacity

• Does this firm have the capacity to take this on including replacing you?

You Are What You Are

However…

However…..

• Buyers hate inheriting problems and poorly

run practices

• Clean up your AR and WIP

• Present your partners and staff in a positive

light

• Consider jettisoning problem staff

• Clean up the physical office-eliminate

clutter

• Provide good time records

• Be willing to part with unprofitable clients

The 7 Steps in a Deal

1. Author a generic practice information including your goals

2. Organize your must haves

3. Identify what your merger partner should look like

4. Initial meetings

5. Narrow the field and obtain a non binding offer

6. Perform due diligence6. Perform due diligence

7. Contracts and close the deal

Author a generic practice information

including your goals

• Metrics: revenues, services rendered, rates, staff, profitability, etc…

• Add lease info, timing for partners who may be seeking role reductions

• Technology

• What the goals are for the deal• What the goals are for the deal

• Individual goals for some

partners if different

• Aging of the partners/staff

• What success looks like

Author a generic practice information

including your goals

• Determine the deal structure you are

seeking:

• Sale

• Merger (What type)

• Two Stage Deal• Two Stage Deal

• Combination

Organize your must haves

Items that are absolute breakers such as:

� Location

� Partner retention

� Compensation

Items you strongly prefer such as:

� Technology� Technology

� Staff retention

� Name

Items you are more flexible about such as:

� Software

� Perks

Limit your must haves as much as possible

Have your initial meetings

1) Share your firm

information, goals and

must haves upfront

2) Focus on Four C’s

3) Discuss what success

looks like

4) Narrow the playing

field into top choice(s),

bridesmaids and

forgetaboutit

Ask for a Non Binding Offer

• You have already told them what

you have and what you want

• Require a non binding offer that

shares with you what the deal

looks like philosophically and looks like philosophically and

financially, pending due diligence

• Make sure the terms are complete as to

must haves, deal structure and terms

• Do not negotiate in pieces

Perform Due Diligence

For the mergee/seller

* Prior track record of successor firm in M & A

* Background checks: professional, financial,

legal, malpractice, licenses, peer review

* Metrics

* Their own retention rates* Their own retention rates

* Technical skills

* In a merger a key document is the partnership

agreement of the successor firm

* Your practice special needs i.e. language, licenses, niches…

Close the Deal

• Now is the time to bring in lawyers

• What is the goal of a contract

• Lawyer that makes deal versus breaks deal

For More InformationVisit the AICPA Succession Planning Resource Center

http://www.aicpa.org/InterestAreas/PrivateCompaniesPracticeSection/StrategyPlanning/center/Pages/default.aspx

Articles

CPA Firm Succession Series

July, 2013 thru June, 2014

www.transitionadvisors.com/succession-planning.php

CPA Firm Valuation SeriesCPA Firm Valuation Series

October, 2014 thru December, 2014

www.transitionadvisors.com/valuing-accounting-firm.php

Roadblocks to Avoid in Accounting Firm M & A

September, 2015

www.transitionadvisors.com/succession-planning.php

• Gary Adamson, Adamson Advisory• Bonnie Buol Ruszczyk, bbr marketing• Sarah Dobek, Inovautus Consulting• Angie Grissom, The Rainmaker

Companies• Dustin Hostetler, Boomer Consulting

• Tamera Loerzel, ConvergenceCoaching

• Jeff Phillips. Accountingfly• Terry Putney, Transition Advisors• Carrie Steffen, The Whetstone Group• Sandra Wiley, Boomer Consulting

#SuperConf15

• Rita Keller, Keller Advisors• Roman Kepczyk, Xcentric

• Jennifer Wilson, ConvergenceCoaching

www.cpaconsultantsalliance.com

Bridging the Gap: Strengthening the Connection Between Current and Emerging Leaders in the

CPA Profession

Amazon.com

$49.97

Free White Papers on Industry Trends

• CPA Firm Leadership: Communication Drives New

Possibilities

• Measuring Happiness at Work: How Firms Can Win • Measuring Happiness at Work: How Firms Can Win

With a Happy Culture

• Top CPA Firms Succession Challenges

Download at: www.cpaconsultantsalliance.com

For More Information

Please visit our website for resources including

FREE reports, whitepapers and case studies.

tputney@transitionadvisors.com

1-866-279-8550

www.TransitionAdvisors.com