Selling a CPA Firm or Small Business
These 10 essential steps will prove a handy guide to any M&A transaction, whether you’re a founder looking for an exit strategy or a CPA advising on another deal.
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Whether it’s the chaos of the pandemic, the elapsing of your succession plan milestones, or just a voice inside of you that says, “It’s time,” you’re ready to sell your CPA firm. So, what’s the game plan? Answer: “It depends. Each seller’s situation is unique. The outcome of a seller’s plan depends on the facts and circumstances. Also, a plan that works for one seller may not necessarily work for another.”
Now substitute “taxpayer” for “seller” and read again. You’ve given this advice hundreds of times in your career and it coincidentally now applies to your practice sale. There’s no single foolproof plan that’ll work for everyone; however, you simply need to educate yourself on the relevant considerations, get help as needed, and then apply the strategies that’ll logically get you the desired outcome.
Step 1: Planning
If you can avoid it, don’t leave planning until the twilight of your career. It took me about nine months to complete the purchase of my first firm. On the first day of my 15-year career as an owner, I started planning to groom my successors. I’m now in the fourth year of ownership and some of those plans have already failed. Most importantly, more than one has also already succeeded, and I’m fortunate that time to tweak and refine the planning is still on my side.
Step 2: Prepare the Buyer Information Package
Fundamentally, buyers simply want to know: (1) how much is the business worth, and (2) what is it exactly that you’re selling? For the first, in a Nov. 1, 2013, Journal of Accountancy article
, the authors stated that “small firms sell for as high as 1.25 times billings, even occasionally more in cities such as New York, but [they] have seen firms in more remote areas struggle to get 1 times billings.” This eight-year-old advice still has some merit, but only as a baseline gauge. There are many other elements that need to be factored in when determining pricing, such as the circumstances surrounding the sale, market conditions, potential strategic value, working capital, and prevailing buyer financing terms, to name a few.
For the second, you should start by including quantitative items, such as the last three years of tax returns and/or financial statements, fixed asset listing, projections, informal valuation, etc. However, you also just spent most of your career as an owner developing intangible assets in the form of personal goodwill, client lists, and public accounting processes. In addition, given the current labor challenges in the market, I’d pivot on that phenomenon and give the prospective buyer visibility to the potential labor resources they’re acquiring. Therefore, I recommend including a practice profile with qualitative items that includes a one-page biography of owners, client demographics, software, process descriptions, and key employee biographies.
Step 3: Start Advertising and Getting the Word Out—but Stay Quiet
If you try to sell on your own, leverage your network of professional colleagues, whether over drinks at a networking event or at a CPE lunch table. When having discussions with these colleagues, ask about their future plans and touch on the subject of them becoming a firm owner when the time seems right. You may also send a letter confidentially to let your banker referral partners and other select CPA colleagues know of your intention to retire in the next few years and request that they keep an eye out for any other CPA firms that they think might be interested in expanding.
For some anonymous outreach, first, obtain a listing of CPA firms in the area and send a letter or email to the managing partners of the firms that are similar in size to yours. Initially, introduce your firm anonymously with an invitation to respond to a Gmail, Yahoo, or Outlook account. Second, you can post classified advertisements in state society publications using the same anonymous email. In both strategies, you can let them know you’ll respond with additional details once they’ve returned your signed nondisclosure agreement (NDA).
The general recommendation of all professionals I’ve interacted with in my M&A activity is that internally you “stay quiet” until a few days before closing when there’s relative certainty that the deal will be completed (i.e., when financing is certain). At that point, you notify key personnel first and then all other team members within a few days. When the announcement is made to the entire office, you should have a follow-up firm-wide meeting to introduce the new owners on the same day. This overall approach avoids unnecessary panic, allowing employees the opportunity to ask questions freely.
Step 4: Either (1) Buyer Found or (2) Evaluate Your Results to Date
At this point, you should’ve found a buyer. If not, it might be time to hire a broker or consultant to assist.
Step 5: Engage Specialists
The main advantage of a CPA consultant with M&A expertise is to fill the gaps in the deficiencies of the other providers. It’s very unlikely that they’ve maneuvered through all facets of M&A deals for small businesses in the capacities of both buyer and seller, and even less likely that they’ve done so with tax and accounting expertise. Having someone who speaks your language to get advice from and have technical discussions with is the value proposition.
Now, while it’s true that you’ll lose some of the selling price for a broker’s commission, there are many benefits to hiring a business broker. Be careful though as all are not equal: Some merely facilitate an introduction and do absolutely nothing else, while others provide solid support by assisting both buyer and seller in completing the deal. The best brokers that I know prepare a detailed memorandum on each practice, assist buyers in finding attorneys and financiers, connect clients to CPA consultants when they run into technical issues, and aspire to create a partnership between the buyer and seller rather than a quick deal.
Similarly, many attorneys have handled preparation and review of purchase sale agreements (PSAs) on a few occasions throughout their careers and are likely very capable of doing it for any CPA firm sale. Notwithstanding, the larger the deal or more complex the transaction, the more I would recommend employing a larger firm with M&A attorneys. I used M&A attorneys on all my transactions to date—each deal they found material errors of varying degrees of magnitude in the works of their non-M&A attorney counterparts.
Selecting the title company is usually the easiest part of this step. Where real estate is involved, you would likely want to select the company that worked on the last title change as this will save some fees. Otherwise, consultants, attorneys, brokers, and banks have a slew of title companies they can refer you to.
Step 6: Prepare NDA, Negotiate Terms, Prepare LOI, and Collect Buyer Deposit
With your buyer identified, they’ll need to sign an NDA so that your financial and firm information may be shared confidentially. Your attorney, broker, or consultant should be able to assist you in getting one drawn up.
With the NDA in place, negotiations begin and the material terms of the deal, such as purchase price, financing terms, post-deal employment, due diligence, and escrow deposit, are written into a non-binding letter of intent (LOI) usually prepared by the buyer. Although the LOI is non-binding, some of the terms may become binding after certain milestone dates elapse with nonperformance or noncompletion of actions.
Step 7: Get Buyer Proof of Financing, Establish Seller Carryback, and Have Attorneys Prepare the PSA and Other Agreements
With the signed LOI, the buyer will apply for a loan and the attorneys will begin preparation of the deal documents and agreements. Most financiers will require the seller to carry a portion of the debt through a note of their own. If approved, the financier would then issue a conditional offer letter wherein if certain conditions are satisfied (e.g., independent appraisal supports purchase price, financial information is documented and supported, etc.) then they’ll loan the buyer the funds. You should obtain a copy of this letter to get comfort that the buyer is prequalified by an independent financier and initially believed to be creditworthy enough to buy the business.
Step 8: Buyer Performs Due Diligence and Completes Studies and Appraisals
The level of due diligence is commensurate with the complexity of the deal and the sophistication of the buyer. Regardless, the seller merely needs to be transparent and deliver any and all information requested and answer questions when posed by the buyer. Experience has shown me that an online secured portal is the most convenient way to move documents between buyer and seller and to keep information private from staff.
The business appraisal is initiated, and if real estate is a part of the deal for owner-occupied offices, then a real estate appraisal (by the financier’s preferred appraiser) and environmental studies (Phase I and/or II) may be required as a condition of obtaining financing. The faster they can be requested, the faster they can be completed, and I’d estimate three weeks at a minimum for either appraisal or study.
Step 9: Finalize Loan, Post-Closing Employment Agreements, PSA, Tail Coverage, Loss Limits, Working Capital, and Due Diligence Findings
The sticking points on your practice sale are going to boil down to a handful of deal elements. The usual suspects are: (1) accounts receivable, its valuation, and legal nuances; (2) working capital adjustment to be included in purchase price; (3) tail coverage and loss limitations; and (4) post-transaction compensation arrangements where the seller continues working. These items aren’t always easy to resolve, and the PSA (and by extension the loan) documents cannot be completed until they are. Ultimately, it’ll hinge on both seller and buyer being realistic, making sacrifices, and compromising.
Step 10: Agreements Finalized; Bank, Lawyers, and Title Company Arrange Settlement and Closing
Once all terms are agreed to, the bank, title company, and attorneys on both sides will work together with the buyer and seller to arrange funding of the loan and signing of all finalized documents. A flow of funds statement and settlement sheet (both usually prepared by the buyer’s bank and attorney) are prepared for the seller, their attorney, and title company to review. Once all parties agree to the flow of funds to recipients and share their respective institutions’ routing and account numbers, wire transfers are initiated, and the transaction is completed.
The task of selling your CPA firm or small business isn’t an easy one. The old approach of automatically selling to someone within the firm is no longer guaranteed, and when available, it may not always be the best option. You must begin by taking your emotions out of the picture and commoditizing your business. After those deal documents are signed, someone else will be calling the shots and you need to be prepared to let it go. In addition, it’s never too early to start the process of planning your succession. Throughout your career, you’ll need to be on the lookout for items that may have an impact on your future sale. For example, during ownership, you wouldn’t want to enter into any employment agreements with your entity; otherwise, your goodwill will become a business asset. If the goodwill were personal instead, then it would be portable and may be domiciled in another taxpayer-friendly jurisdiction prior to your sale to save on capital gains and income taxes. With a little effort, and a bit of luck, the right person will be found, and then you can grab your bags and head off to that tropical beach for some well-deserved rest and relaxation.
Asif Muzaffarr, CPA, MBA, MS is the managing partner of Foster and Associates CPA LLC, in Portland, Ore. This article is reprinted with permission from the Oregon Society of CPAs.