Almost every day, a CPA firm somewhere in this country asks us the same question: “How much is my firm worth”?
The first thing we do is defuse the question and explain that the starting point is 1 times revenue. Then, we follow up with, “Based on a large number of variables ranging from the number of 1040s, rates, size and type of clients, bench strength, desired continued work objectives, niches and other factors, the value varies.”
This is the easy part of the conversation. It gets complicated when they think their $2 million firm should be valued the same as another $2 million firm. This is where “every dollar is not equal” comes into play. The easiest example to start to explain this is real estate. Take three identical homes that each cost $1 million to build. Same blueprint, colors, shingles, landscaping, etc. Put one of them on an oceanfront, another in a smaller city, and the other one on a lake somewhere. Each of those $1 million houses will sell for a very different price.
It is the same for a CPA firm. There are items that add to and detract from firm value. This is where the deviation on the multiple enters the picture. Let’s break down some of the variables inside CPA firms.
What adds value? This is a condensed list, but a highly valued point in today’s market is a qualified bench of professionals. Firm culture is critical because it is difficult to retain and recruit staff. If a firm has a “pressure cooker” environment, it makes the firm less attractive and less valuable to an outside party. Niches are critical, and the size of the clients is another major element. In general, firms are seeking clients from $5 million in revenue on up and many prefer clients with $10 million and up. Pricing is another key variable. Value-based pricing is very desirable, along with higher-realized billing rates.
What detracts from value? Again, this is a condensed list, but a heavy 1040 practice is normally a significant problem. High numbers of billable hours by partners might be great for current profitability, but this is a major value detractor and can be a sign of the firm’s culture. A minimal professional bench or a bench that is too mature or too young creates a difficult transition. Lack of a niche and/or minimal advisory services also affects value. As a note, from our M&A perspective, we look at firms with minimal advisory services with a different lens. We view them as an opportunity to cross-sell more services, but on the surface, a lack of advisory services does diminish value.
Ask yourself a few questions about your firm.
- Would you buy your own firm?
- What would pay for your firm?
- Would you pay a fair price to buy a firm and also keep the seller on at almost full compensation for a few years?
- How much cash would you put down on the deal?
- How much risk would you be comfortable assuming?
- Would you take the same risks you are asking the buyer or seller to take?
Circle back to the original question: “How much is my firm worth?” The reality is that it varies by firm, and in the end a firm is worth what a buyer will pay for it. Another component is perceived value. The value of a practice to one person may be significantly different to another person.
How do you improve firm value? First, look at the items unique to your firm that add value. If you discover your firm does not have enough drivers that add value, step back and look at two simple items you can begin to implement immediately. Any action to refine value is like a dimmer switch. It can be a slow process, but eventually there will be a brighter light.
Now, look hard at the items that detract from value. How do you refine or eliminate these items? Are your value detractors also consuming valuable personnel resources and time managing clients that are a drain on your system? What actions can you take?
One of our biggest barometers when we assess a firm to acquire or merge upward is 1040s. Low-dollar and high-volume practices are hard to move. They tend to not have the culture a buyer is looking for and they use valuable talent on work that is not building firm value. The other element in a high-volume 1040 shop is that it is not attractive to recruits. Selectively raise those fees, but also refocus how you conduct your business development outreach.
The second is niche refinement. If you do not have an industry niche or a service niche outside of audit, tax or accounting, consider creating one, or expanding the niche or niches you have in place. Niches are highly desirable and profitable. They also allow you to differentiate your firm, so you are not competing for new clients on compliance work, which is not always valued by prospective new clients.
Highly desirable firms are ones with minimal 1040s, deep niches, and advisory services. Assess your position and then develop a simple, one-page blueprint on the firm’s top three strengths and its top three deficiencies. List actions to consider for all six areas and then identify which items are easiest to address and which can make the biggest impact. This will create your roadmap and allow you to begin making changes to continue building value.
It may only take one change to make a considerable impact on profitability, culture, or another benefit that can be highly desirable. Even if you never plan to sell or merge upward, you should be operating as if you are because it will add the most value to your firm and make the firm less dependent on you.
