What’s Your Accounting Firm Worth?
Accountants all want to know what their firm is worth? There’s no short answer to that question because every firm is different and the value of your practice will depend on a number of factors.
The good news is, if you are contemplating selling, it’s a vendor’s market. In Melbourne alone there are several hundred firms looking to acquire fees ranging from $150k to $5M in fees.
Demand is at peak levels but supply is scarce as the baby boomer principals and partners ‘dig in’ and work well beyond the conventional retirement age.
It is a very difficult market for these hundreds of frustrated buyers.
Before we launch into all the factors that influence the value of an accounting practice, let’s calculate the actual level of fees you are selling. In essence, you are selling your ‘future maintainable fees’ from your client list.
To arrive at this critical figure, let’s assume you invoiced $700k in the 2020 financial year and you now need to estimate your 2020/21 ‘future maintainable fees’. Last year’s fees are a great starting point but you need to subtract fees for:
- clients for whom you did work for in 2020 but have left the firm, retired or died. You can add the casualties of COVID-19 to this list.
- Clients whose circumstances have changed (i.e. they may have sold their business so their fees will drop).
- Disbursements like shelf company purchases or SMSF set-ups because these are no recurring annual fees.
- one-off consulting assignments because they are not ‘maintainable’ (JobKeeper advice)
- multi-year returns you completed last year and the maintainable fee is only one year’s fee.
Your $700k in fees might now be only $630k of future maintainable costs.
On the other side of the coin, you can add expenses for:
- new clients who are on your lodgement programme and you can estimate their prices for next year.
- Clients who are expanding – may have bought a new business, set up another branch office or have a new SMSF in their structure.
- A slight inflation factor added to last year’s fee base.
Your ‘future maintainable fees’ might now end up at $670k for 2020/21.
I’m specifically focused on valuations for smaller firms with fees of less than $1M and generally speaking, these firms are valued on a ‘cents in the dollar’ basis. For larger firms with fees in excess of the $1M mark, the valuation method could shift towards a multiple of EBIT (Earnings Before Interest and Tax) after allowing a notional salary for the Principal or Partners.
Let’s now explore some of the factors that determine the value of an accounting firm.
Let me say right up front that the size of the fees for sale will impact the number of potential buyers. The sweet spot for most buyers is around the $500k mark and if you are a vendor in the south-eastern suburbs of Melbourne looking to sell around $500k of fees you would have a queue of buyers on your doorstep.
If you were selling $1M in fees, the queue would be substantially shorter. At the $2M level you would only have a handful of buyers.
The economics of supply and demand apply and a larger pool of buyers equates to higher prices. This generally means suburban firms get higher prices compared to regional areas.
Breakdown of Fees
The split of fees between individuals, businesses and super funds also has a big bearing on price. Individual returns are not flavour of the month (or decade) and if your firm was simply an ‘I Return Factory’ in the mould of an H & R Block branch or an ITP franchise then the valuation would probably be about half of a more traditional accounting firm that predominantly services business clients with a sprinkling of individual returns.
The demand for these return practices is very low.
Location also influences prices. The demand for fees is robust in the eastern states and particularly in the inner metropolitan areas. It falls away as you push towards the outer suburbs and there is simply not the same demand for accounting fees in regional towns.
Again, Economics 101 applies with the supply and demand equation. Having said that, nearly every accounting practice can be sold in this market.
Fundamentally, buyers are buying a list of clients on your lodgement programme.
If you have an over reliance on two or three large clients, then that poses a major risk for investors. Will these clients transition to the new owner? Will they see this change of ownership as an opportunity to change accountants?
If the buyer loses these clients in the handover, the value of their investment diminishes overnight.
The contract of sale will probably include a retention clause (e.g. 10% of price) to protect the buyer so if the fees don’t reach the ‘future maintainable fee’ level, you won’t receive the full retention amount 12 or 24 months after settlement. Buyers obviously want to minimise the risk so a price reduction or a higher retention amount could apply to this group of larger clients.
The age of your client base is also a very important aspect of the valuation.
Buyers will focus their due diligence on your top twenty or thirty fee paying clients, and if a high percentage of them are aged over 55, then there will be concerns that the practice could evaporate in the next few years.
Remember, they are buying future maintainable fees and clients moving into the twilight or pension years simply don’t attract the same value.
You’ll also find ageing clients don’t refer new business clients like their 30 year old counterparts.
They aren’t buying investment properties or starting businesses and these services have driven growth in smaller firms for decades.
If most of your top 30 clients are aged over 50, you need to start planning your exit strategy now. Look at ways to rejuvenate your ageing client base, and it might be time to start looking at digital marketing tactics that focus on attracting younger clients.
Selling your practice involves transitioning your client relationships AND your staff. It’s natural for the team to build great relationships with clients, and your staff can be the glue that binds the sale together.
Buyers generally don’t want to ‘rock the boat’ in the early months after settlement and wish to retain productive staff or put them on a three-month probation period.
They also fear that staff might move on and take some clients with them so expect a grilling from a buyer about your staff before they make an offer to buy the business.
They will focus on each employee’s loyalty and productivity. Top quality, high performing staff add value to the business.
If your fees are flatlining or in freefall, this will impact buyer interest. Declining fees are a symptom and a warning sign of bigger issues.
If the practice is leaking clients due to an ageing client base, poor service or below par work, the writing is on the wall and no one wants to go board a leaky boat.
Most buyers are in the market to grow and a leaky boat is not going to solve their problem.
The declining practice is common, and typically the vendor took their foot off the marketing pedal years ago.
These firms are characterised by an outdated brand, a website that is just an ‘electronic brochure’, and they are almost invisible on social media channels. Your marketing could be the difference between boom, doom, and gloom in the digital and social age.
Buyers are investors looking for a return on their investment and if your profitability is headed south then you have a problem.
Technology and automation have decreased the value of many compliance-based services, while the cost of running a firm continues to rise.
Buyers will benchmark your firm against theirs and others they are looking to buy.
If the numbers don’t stack up they will want a discounted price or walk away.
For example, if you are only generating $100k per full-time employee and are doing $150k per full-time employee, your fees could be too ‘cheap’ or the firm is unproductive.
It makes sense, if a buyer is evaluating two practices with similar fees, the more profitable firm will win out in 99% of cases.
The keys to increasing profitability in your firm include:
- embrace technological advances in accounting as a way of saving time and money (i.e. create more efficiencies)
- provide value added and advisory services – premium priced services that deliver a higher return on your time
- Add on services that increase the fees and profit from each client (e.g. vehicle and equipment finance, audit insurance, mortgages, financial planning services.)
Technology has changed the accounting profession, and at a bare minimum, buyers will expect your firm to be virtually paperless with all records kept electronically.
Better still, they gravitate to firms who have moved their client bookkeeping into the cloud.
If your offices are furnished with dual screens and modern hardware, then you get a big tick because buyers don’t want to inherit archive boxes of files and dozens of filing cabinets.
They waste space and archaic filing systems are inefficient. The storage requirements add to the cost of rent and drag down the firm’s profitability.
On the point of technology, software systems can also help get a sale over the line. If you use the same software (general ledger or SMSF) as the buyer, this can create time savings when transitioning client files. It won’t devalue your practice, but it will make you more attractive to a buyer.
Increasingly, websites are being seen as digital assets that can lift the value of an accounting practice. If your firm’s website is simply an electronic brochure that lists the who, what and where of the firm, then it’s of no real value.
These websites are just billboards in the desert, and they don’t attract new business.
On the other hand, websites that consistently generate leads and new business on auto-pilot are precious.
There are other factors at play when valuing an accounting practice, but the critical thing to remember is, start preparing early. If you’re contemplating selling your accounting fees in the next few years, now is the time to address all eight of the valuation factors described above.
7 Reasons Why Buyers Won’t Buy Your Practice
The Deal Breakers
We all know from Economics 101 at university that price is determined by supply and demand. However, when selling your accounting practice, other price factors come into consideration, and in some cases, they are ‘deal breakers’ for prospective buyers.
Currently, demand for accounting practices and fees is at record levels. We have more than 250 registered buyers in Victoria, and when an approach lists for sale, it is a frenzy. The open market is being starved by baby boomers refusing to sell.
In some instances, they are selling internally or going ‘off market’ and dealing with friends or colleagues they have known for years in their discussion group, university days, or they worked with at another accounting firm in the past.
While prices hold firm because of the supply and demand imbalance, I’m noticing even the hungry buyers are baulking at some firms. Below I have listed some of the reasons why vendors can’t afford to get complacent, and this serves as a warning for baby boomers planning to sell over the next few years.
This is particularly the case when supply starts to increase.
So what characteristics make buyers shy at a practice?
Age of the Client Base – as baby boomers hold on longer, their client database ages. Buyers generally focus on the top 20 or 30 fee-paying clients, and if they are all aged 55 plus, then buyers fear up to 40% of the practice will disintegrate within a few years.
This concern escalates if the top 3 clients form a significant percentage of total fees. Age aside, the dependence on these top clients means the risk is even higher for the buyer, and they might want to negotiate a reduced price, a higher retention amount or an extension of the retention period.
Declining Fees – if your fees are flat lining or in decline, the warning bells ring for buyers.
Who wants to pay top dollar for a practice that is in the fall and leaking clients? These firms often have an ageing client base (see above), and quite often, the principal is a baby boomer who has become somewhat complacent in their twilight years.
The practice has been in cruise mode for years, and they are often characterised by no marketing, website or financial planning services. In many cases, they could best be described as a ‘compliance sweatshop’.
You might think I’m cruel using these terms, but in the next few years, buyers will gravitate away from these firms because the target market for most buyers are Gen X and Y clients, and these firms have very few clients in that demographic.
Bookkeeping is fast becoming a commodity with outsourcing growing in popularity, and these clients aren’t interested in paying premium rates for bookkeeping services. They want to use and trust cloud-based solutions and want an accountant who does more than keep the score.
Declining Profitability – let’s face it, buyers want a return on their investment. If your fees are flat lining or in decline while your wages, software subscriptions and rent are creeping up, then profits are heading south. The majority of sole practitioners have total fees of between $400k and $500k. A prospective buyer is comparing similar fee parcels but one has a net profit of $225k, and the other has a net profit of $130k, then the decision is a ‘no brainer.
Staff – with quality staff in short supply, this variable has become even more critical. If you have employees producing three times their salary in fees, then they become a magnet. A buyer will grill a vendor about their staff and want to know all about their products and whether they will stay on.
Sometimes, the team is the glue that holds the sale and clients together, but obviously, a 63-year-old employee is not that appealing as a 28-year-old ‘young gun’.
Technology – are you paperless with dual screens and using the latest software and tools? If a buyer has to contend with paper, that probably means they inherit boxes of files and filing cabinets which may create storage issues and additional scanning costs.
As my teenage son says, ‘get with the program, dad’. Don’t procrastinate and think that technology will be the buyer’s problem when I sell in a few years. That complacency quickly leads to some of the issues I have mentioned above, including diminishing profitability.
Technology may well be a cost, but it is an investment in the future value of your business. The primary purpose of technological change is to drive efficiencies and better productivity that leads to improved profits.
Price Expectations – Some of the owners of practices identified earlier in this article expect to attract premium prices for their business on sale. While the supply and demand equation remains unbalanced, prices will hold up, but it won’t last.
Most suburban firms with fees under $800k sell between 80 cents and a dollar for every dollar in gross payments. However, standalone I returns are not worth that much, and if 30% of your practice is made up of I returns, expect a significant discount.
You are also selling future maintainable fees from your client list.
Hence, you need to look at last year’s gross costs, extract any disbursements and charges for company incorporations, SMSF and trust set up fees, fees charged for multi-year returns and remove fees for clients who have moved on to another accountant, sold their business or had one-off consulting engagements.
Remember, you are selling one year’s maintainable costs from a client list.
Also, don’t think your second-hand furniture is worth anything. It could be of value to a start-up or internal successor, but most buyers are mature businesses who are merging your fees into their practice, and they don’t want the 18-month-old server that you think is worth $20,000.
They simply wish to the data transferred across to their server, and the market for second-hand furniture is peanuts, according to e-Bay.
Take-Home Clients – buyers will shy at a vendor who just wants to take a ‘few’ clients home or a parcel of self-managed super funds. In other words, they’re retiring but just want to keep their hand in the tax game.
This just sends the wrong message, and you can’t have your cake and eat it too. If you plan to take a few family clients because they have never paid fees, think again. In a goodwill gesture, hand them over and add a notional value to the future maintainable costs of the practice, so you get some compensation for all the years you did their work at ‘mates’ rates.
Accountants are notorious for making more ‘comebacks’ than John Farnham, and buyers are becoming more insistent in your hand in your tax agent licence.