Out-of-the-box thinking for CPA firms seeking new growth strategies.
By Bill Carlino
The accounting profession has traditionally had three strategies for growth.
- Organic growth – adding one client at a time.
- Beginning a new client service line that was not previously offered.
- Merging with another CPA firm.
But that was then and this is now.
With technologies such as blockchain, AI and robotics promising to revamp the accounting process there will be significant changes afoot – whether the profession is ready or not.
For one, within five-to-seven years, the audit process will likely be automated, sending the folks who normally perform that “Type A” audit or tax work, seeking assignments in other areas such as high end consulting and advisory services.
As a result, the past few years have seen a number of firms adopting a fourth option toward achieving their respective growth targets – that of merging in “non-traditional” businesses.
In lieu of conventional CPA unions, more practices are targeting entities such as IT/cybersecurity concerns, HR firms, or other growth-generating specialty companies such as financial planning, engineering, marketing and medical consulting.
As examples, Top 100 firms Eide Bailly recently acquired Spring2 Technologies, a Utah-based IT consultant specializing in NetSuite, while Nashville, Tenn.-based LBMC added W Squared, an outsourcing company offering finance, payroll and procurement services to its widening portfolio. Earlier this year super-regional New Jersey firm Withum acquire digital services provider Portal Solutions, while Chicago-area firm Sikich LLP – one of the early adopters of the non-traditional merger strategy – purchased Evolution Retirement Services a Milwaukee-based provider of employee benefits.
Meanwhile, Seattle-based Moss Adams, acquired Transacction Partners, a firm that specializes in outsourced finance and accounting services, while RSM agreed to become one of the founding partners of Silicon Valley-based startup accelerator Plug and Play to boost its cyber-security vertical.
Plug and Play typically invest in 150 companies a year, and some of its past investments include PayPal, Dropbox and Lending Club. Under the terms of the partnership, RSM will earn board seats on Plug and Play’s investment startups, which will give the firm access to those technologies and be able to offer those technologies to their clients.
Finding the Right Fit
Naturally, any merger whether it be traditional or non-traditional has to make sense for both the buyer and the seller. While it’s often difficult to discover the proverbial “round peg in the round hole” in terms of an ideal fit, non-traditional deals should complement each other in terms of synergies as opposed to being counter-productive. For example, a financial planning firm specializing in high net worth individuals and trust work would likely not make a good merger partner to a firm that pumps out reams of $300 tax returns.
Ditto for a firm that may not have made the transition to a paperless culture but who is courting an IT practice specializing in sophisticated services such as SOC audits or financial stress tests. Conversely, an engineering or construction firm might appeal to a practice that has a thriving cost segregation business.
Structuring the Non-Traditional Merger Deal
This is where it gets a bit complicated.
The reason why accounting firms tend to be valued similarly compared to each other is that they tend to be structured and operated similarly. Not necessarily for consulting companies.
For instance, some consulting firms have extremely high staff leverage, i.e. 40-50 employees per owner, while others boast high growth potential. Some will have higher profit margins for the owner; some margins will be far lower. It often depends on the type of firm and the specific firm in question.
The structure of the deal itself is also critical.
If you are buying the consulting firm outright you must come up with a sales price. That implies the current selling owner of the non-traditional entity will not be the long-term operator of the firm. If you are merging, are you merging it into the core accounting firm? If so, then just like in a merger of an accounting firm your owner agreement will dictate the value. If you are setting it up as a separate entity, then you have to draft a separate owner agreement with the principals of the consulting firm.
For example, if a consulting firm is generating $5 million in annual revenue, the merger agreement may stipulate that the first $5 million they make after the deal is closed they receive the same net profit, but anything over that is shared between them and the CPA firm.
Some consulting professions have rules of thumb on value like accounting firms do. Wealth management firms currently tend to value in the 2 to 3 times fees’ range. Payroll companies lie somewhere in the range of .75 to 1.5 times. Software companies tend to command values that can be very high.
It’s critical to remember that this is not your father’s accounting firm. You can’t operate a practice in 2018 like you did in 1975. With the advent of new technologies coupled with burgeoning growth trends such as non-traditional mergers, those that embrace those changes will prosper, while the ones who don’t are likely to create client and real estate opportunities down the road for those who do.