Brannon Poe of Poe Group Advisors talks about how the current landscape of acquisition — particularly the entrance of private equity into the field — is impacting firms below $10 million.
Transcription:
Dan Hood (00:03):
Welcome to On the Air with Accounting. Today I'm editor in Chief Dan Hood. When we talk about the m and a market for accounting firms, most of us sort of have a bias to thinking about deals among the big and the midsized firm, the sort of top 500 deals that get mentioned in the media, but there are literally tens of thousands of other firms that may be looking for or considering a deal, and that market is changing just as rapidly, if not more rapidly than the market for among the bigger firms here to talk about all of that is Brannon Poe. He's the founder of Poe Group Advisors. He's been advising firms on m and a and sales for more than two decades. Brannon, thanks for joining us.
Brannon Poe :
Thank you, Dan. Nice to be here. Yeah, I had the pleasure of being on your podcast. At the end of it, I was like, wow, this guy knows what he's doing.
He should be on more podcasts, he should be on our podcast. And we got into this topic because it is not one that people talk enough about because there's so many thousands of firms for whom it's probably more relevant than some of the talk about larger firm m and a might be. Maybe a good place to start would be to talk about what is a traditional small firm deal or the small firm m and a market looked like in the past? Was it small firms merging up? Was it two small firms combining? How would you characterize it?
Brannon Poe (01:09):
Yeah, so I would say we've always had a variety of different types of buyers looking at deals. So you have from the individual buyer who's like maybe one or two people who are leaving a firm, maybe there are managers who really want to be on their own, don't want to wait for partner. Those were good buyers for smaller firms. Then you'd have other firms that wanted to grow through acquisition. That's always gone on. I mean, those are the main types of buyers. And then you'd have large firms, I mean, we've even sold to KPMG, so you'd have large firms buying small firms in certain situations where it's a very strategic purchase and now we have private equity in the mix. So we've kind of divided that into the four major buyer types.
Dan Hood (01:59):
Right. Well, and they're all brand new. That's brand new for everything to the field.
Brannon Poe (02:04):
They are, and they've made a lot of difference. So what we used to see is as firms like went from say, $1 to $10 million, which is our primary market in revenue, and what we used to see is that the multiple, as the firm grew would actually the multiple and the terms would get weaker as the firm got larger. Now that has flipped, and now as firms get larger up into that four, five and up, there's more interest from consolidators. So that has driven those multiples up. And those terms have improved as firms get bigger.
Dan Hood (02:46):
And is that most of that change being driven by private equity coming in? Are they the ones who are buying those four and 5 million firms or?
Brannon Poe (02:55):
Well, we still have a lot of different types of buyers, but the private equity, that's where private equity kind of starts. I would say when you get to $3 million, there are even consolidators that'll look at deals that are under 3 million in revenue. We've seen as small as a million in revenue be at least on the radar of private equity if they already have a home base in that metro area. So I call 'em so they could tuck in, but when you get up in that $5 million range and higher, there's a lot of private equity interest and the private equity firms are very, you've got small ones and you've got larger ones. So it's not dissimilar in terms of the buyer, the way buyers operate in this market. You've got consolidators that won't look at anything less than $5 million. You've got some that won't look at anything less than 20 and so on.
Dan Hood (04:00):
But there are some key differences. I mean, in terms of how PE firms are going about buying things that are, I mean, one of the things we talked about is they put a lot of cash that you didn't used to see, or at least that's my impression. Maybe I should clarify that. Right. The previous, a traditional, put it this way, a traditional accounting firm acquisition, whether it was of a small firm or a large firm, didn't involve a lot of cash on the table and involved, yeah, you'll join us, you'll become a partner kind of thing. And it seems like that's changed a lot. Is that changing at the smaller level as well?
Brannon Poe (04:31):
It is, and we've often seen cash deals. We've been kind of a proponent of cash deals for smaller firms for years, but when firms got larger, the terms tend to be more buyer favorable. And I do think that has shifted with private equity as there's a lot of demand. So it's like any market, if you've got higher demand, the price and terms are going to strengthen. It's just a supply and demand equation.
Dan Hood (05:02):
That's interesting. I hadn't realized that they would sit there with cash involved for a lot of the smaller deals. I guess there's smaller deals, it's easier to put up a smaller amount of cash. If you're buying a hundred million dollar firm, that's a different chunk of change than if you're buying a million dollar firm say, or a $600,000 practice or that sort of thing.
Brannon Poe (05:16):
Right. Well, there's a lot of good financing for CPA firms. So the SBA program works great under $5 million, and so a lot of times sellers can get a significant cash at closing that's kind of helped by that SBA program.
Dan Hood (05:34):
Sure. Now, are those, but are the prices now changing a lot? Are the terms changing because of pe? How is that all impacting the market?
Brannon Poe (05:42):
We're definitely seeing upward price pressure on the market as a whole, and we've been kind of testing over the last two or three years. We keep testing those boundaries and we keep seeing upward movement. So it's a little bit of the wild west right now. This whole market has really, it's still very much a moving, changing marketplace. And I mean, I just saw Baker Tilly made a big announcement. I just saw that I was in the Wall Street Journal this morning. I mean, so it's national news and this market, and they're talking about maybe taking that public one day. So can you imagine if there's a public market for large CPA firms that's just going to pull everything into that private equity world even more so?
Dan Hood (06:40):
Well, you were talking about private equity firms having, oh, we won't go below 5 million or we won't go below 20 million, or we won't go below 50 million. There's some people who talk about, well, in the end, what's just going to happen is if you're, you're accumulating firms, you're consolidating firms below 5 billion, what eventually is going to happen is your collective consolidated firms, your collection of consolidated firms is going to get big enough that one of those bigger PE firms comes along and buys you. Right? You're really just serving to package it up for a larger PE acquirer
Brannon Poe (07:07):
That is exactly their strategy. That is their whole, I mean, not their whole strategy, but that is a big part of where their profit comes from because as the entity gets larger, and I see this with small firms, even as you get larger, the firm becomes more stable, the revenue becomes more predictable. If you lose a staff member, you've got other people that can easily fill in. So it just becomes more stable as it gets larger.
Dan Hood (07:34):
Gotcha. I want to talk a lot, there's a lot of details I think in terms of how this is going to impact how small firms think about what m and a might look for them, what a transition strategy might look for them. But I want to start, and there's a lot of different ways to approach that, but maybe we could start, one way to approach it would be to say, how much does smaller firms need to rethink their transition or do they need to rethink their transition plan if it involved some kind of sale or m and a or that sort of thing? Is it really a completely upending how firms are going to transition, how owners are going to transition from active careers to retirement?
Brannon Poe (08:13):
Yeah, it's a good question. I wish I had a really clear answer. I think private equity is going to be a cycle. If you look at how private equity has moved through other industries, typically it'll be a five to 15 year cycle. So we don't know how long the cycle will be. I think the smart strategy, if you own a firm and you're thinking about exiting, I think it's smart to plan as soon as possible. And usually that plan means a couple of things. One, you got to make sure there's partner. There's a way for partners to exit that want to exit. Unfortunately, in small firms, that's not always the case. Their partnership agreements or shareholder agreements don't fully cover that exit scenario. And then you've got the whole governance, however small firms, how is that decision made? And that's usually not as well covered in agreements that as I would like to see. But the other part of the exit strategy is just building a good firm. So if you want to make your firm easy to sell or easy for you to exit, just if it's profitable, if it's a healthy firm with a good team, you're probably not going to have that much trouble exiting when you want to.
Dan Hood (09:37):
Well, let me pin you down on that. I think for a long time there were a lot of accounting firms, a lot of accountants, and I say a long time, I mean for 30, 40 years, there was a lot of accounting firms who just, well, when I retire, I'll just sell my practice on the assumption that there would always be someone to sell it to. And we certainly had, there's been such a frenzy of m and a activity over the past 15 years at the very least, and then even gotten even crazier with the last five with PE that I think there is a general assumption that, yeah, I'm pretty much going to always be able to sell my firm. Is that really true? I mean, obviously unless you're bankrupt and falling apart and have no clients and there's rats wandering around in your printers. Yeah. I think that is, apart from those, right, apart from obviously unsellable, is it pretty much true that anyone can sell their firm?
Brannon Poe (10:27):
I think that is a safe assumption right now in today's market. With one exception, I believe that rural firms where they're not highly profitable are getting more and more difficult to sell, and they take longer to sell. So if you're in a small town and you have a traditional firm in contrast to a virtual, fully remote team type of firm, and if you're not profitable and doing some things that are really to make your firm highly desirable, it can be very difficult and it can take a long time to find a good buyer,
Dan Hood (11:04):
Not excellent. Sorry. I mean, it's a fascinating point. I shouldn't have said excellent, that's terrible. But it's precisely the interesting stuff that I think they need to know to hear about, and I want to hear more about it, and I want to dive more into what it means to make yourself an attractive m and a target then all sort of stuff. But we're going to take a quick break before that, and we're back. We're talking with Brandon Poe Poe group advisors. We're talking about the market for m and a, particularly for small firms. As I say, it's an angle in the market, an aspect of the market that doesn't often get talked about. And given the number of firms in this sort of what we will call it, the 42,500 firms that are below the top 500 or top thousand, it's pretty important because a lot of people are hinging their retirements on it.
(11:50):
We were talking about what firms might have difficulty selling. You mentioned rural firms that aren't necessarily shining stars haven't made themselves as profitable as possible. I want to look into a bunch of different things about what a small firm can and should do and how it should be looking at the market. But before do that, I want to ask a quick question. How much do you think small firms should be expecting a private equity firm specifically as a private equity firm to come knocking on their doors? Do you expect a lot of small firms to see that or should that not even be something they're expecting, they should be looking in a different
Brannon Poe (12:23):
Way? I think most of the people listening to this have probably been approached. I would say that there is a pretty aggressive marketing effort by a lot of firms to send emails and letters to firms. So I wouldn't be surprised to hear that people are getting approached. A lot of those would be sellers I think are a little reluctant to reach out to private equity or to respond to some of those outreaches. But they're a funny animal. As I mentioned earlier. It's a little bit of the wild west, and we see some really good firms that are consolidating and they're doing a good job, and they have the staff and the leadership to do a good job with it. And then there are others that are really, they're not so ethical. They're not so trustworthy in deal making. They do some kind of funny things as deals go through. So we're seeing a real big effort on our part to kind of help filter those and try to find out who's going to be good to deal with and who's not.
Dan Hood (13:47):
Right. Obviously, without naming any names, can you give an example of a trick Simmons trying to put into a contract or that kind of questionable deal making, as you said, again, not looking for names, but just a sample of what that might look like firm company. Well, one
Brannon Poe (14:02):
Thing I see a lot is the hook will be really attractive. Say, Hey, we can give you this crazy high multiple and we can do this two stage deal. And the second bite at the apple might be they'll throw out a big number. And then when you get the contract and you start reading the fine print, you realize like, oh, well, if the stars completely line up and we hit it's
Dan Hood (14:27):
During a hailstorm in July
Brannon Poe (14:29):
On the fourth of the fine print can be really where those istic payouts are. Very unlikely to happen,
Dan Hood (14:43):
But a standard oversell hype kind of thing.
Brannon Poe (14:45):
Yeah. And another thing that I've seen happen too is they're really trying to beat the practice up during due diligence. So they're not coming in with a number that's ATS firm at all. Some of them, they just want to get you involved, get you locked into an exclusive negotiation, and then kind of beat the practice up and beat it down. And
Dan Hood (15:14):
That's interesting. I've heard something similar, but my understanding, someone was telling me I can't remember someone from a PE firm, which would've made sense, but someone was telling me that that was a standard PE thing, but they got you involved and then did their absolutely brutal due diligence, a due diligence that for standard accounting firm m and a seems really invasive and intrusive and like you said, beating the firm up. But someone said, like you said, someone had mentioned to me that that was a standard m and a standard PE thing that it wasn't.
Brannon Poe (15:44):
Well, I think the due diligence being difficult is pretty standard. The due diligence from PE is thorough, and it's almost always done by a third party. Not always, but often it's done by a third party. So they're following a really lengthy checklist, if you will, and it's pretty rough, but sometimes that can be some of those things they're templated and they're not relevant. And so sometimes when you cross out all that irrelevant stuff, it's not quite so bad. But it takes an effort to get to that point where they realize it's not important or not necessary.
Dan Hood (16:24):
So at the very least, firms ought to be aware that the initial promises may not be fulfilled or may not be, would only happen if, as you say, the stars aligned perfectly. And two, to be aware of that, there's a fairly serious due diligence process that's going to happen at some point, probably later in, as you said a little later in the process, I think that most people would expect, right, given we've been talking for months now is the time when you start going through everything with a fine tooth comb, I think is probably surprising for some folks.
Brannon Poe (16:55):
And I think too, a lot of times these deals, they'll start the deal making before they even really know who's going to operate the firm. They'll want the seller to stay in and operate, which is not ideal because someone who wants to sell usually wants to sell because they want to exit at some point in the near future. So a lot of times a buyer, I mean a seller, when they're evaluating a PE firm and they get into like, okay, who's going to operate this? How's it going to be operated? That's where the deal kind of falls apart because I would say the vast majority of CPAs, they really care a lot about their clients. They care a lot about their staff and their reputation. And sometimes it's a little late when they figure out like, wow, this really just isn't a fit. This is not good for the firm.
Dan Hood (17:50):
And as you say, at that point, you're sort of locked in. You've spent a long time building a relationship, building a negotiating platform with these people, and suddenly the pressure to not give up to walk away from the sun costs can be
Brannon Poe (18:04):
Sunk cost fallacy.
Dan Hood (18:05):
Exactly. Let's talked about, in sort of broad terms about what firms want to do, they want to make sure they're profitable and so on. Maybe we can go dive a little more deeply into what makes unattractive m and a candidate, not just for PE, but just in general and what firms, particularly small firms can and should be doing specifically to make sure that, hey, when people come looking, yes, as we said, they're reaching out to everybody, but let's be in the front row when they start reaching out.
Brannon Poe (18:39):
Well, I think I'll start with owner hours because high owner hours, not uncommon, but they tend to point to a firm that's owner centric, highly owner centric. So if your firm is that way, anything you can do to lessen that will make it more attractive. So when we're looking at practices, we're looking at two primary metrics. We want to see the profitability of the firm to be high, and we want to see the owner hours to be as low as possible. So a lot of people think, well, how does that match up? But it requires leadership and it requires, I mean all these things, Dan, it requires really strategic, you have to have a good pricing model. You have to have a good client selection process. You've got to have, I mean, there's a lot of different factors and different ways to get there, but I think it's hard to get there without a good pricing model. So if you're trying to get your firm attractive, sometimes that's the first place to look is look at your pricing model and go from there. So
Dan Hood (19:58):
Definitely it seems like when we talk to people who are experts in m and a and transitions and that sort of thing, one of the things that a lot of people say is it seems like when you add up all the different things they're saying, you want to sort of indicate that you're thinking about your firm, that you, you're thinking in a modern way about your firm. You're not just a traditional accounting firm, like you said, having talks or thought about your pricing models, right? Smart firms have been doing this or have been told to do this for a long time. Not all of them have done it, but more and more firms are doing it. But it's when you go into a firm and you look, say, wow, you haven't changed your pricing in 10 years, that tells me that's a good proxy for 10 other things that say you might not be a good fit for me. And similarly, technology is one where we hear from acquirers, look at a technology thing and say, if you're using technology from five years ago or four years ago, you're not fully on the cloud. That sort of thing. That tells me something philosophically and culturally about your firm that keeps me from, it makes, yeah, that's a red flag for me. Is that a fair assessment to say these things sort of indicate a backwardness on the part of a firm, even if you haven't done it to at least to a thought about it? It says something.
Brannon Poe (21:13):
It does. And if you're looking at it from the buyer's perspective, if your systems are really outdated, not only do you have to change the systems, but you've got to change all the mindsets on the team and you've got to train. And if you've got team members that are very change resistant because that's been the culture of that firm, then that could be problematic for a buyer who wants to consolidate or wants to just put the firm in a better direction. It's not always the case. You can have a great culture and a great firm with old systems. I have seen some pretty well run firms on old systems, but those do, it is an indicator to look a little deeper because it could be that it's just the culture is change resistant as
Dan Hood (22:07):
Well, right? So if you're looking on old systems, and when you say systems, I mean we were talking about technology, but you could think about any kind of processes. Pricing is a process in a system and your marketing and your business development or a process in a system, any one of those, if you haven't changed them in a while, people are going to come in and say, well, why haven't you, and maybe it's because you got it right the first time and it's perfect and we don't need to worry about it. But if I'm acquiring you, I'm probably going to double check that to make sure. Right,
Brannon Poe (22:34):
Exactly. And the cashflow, more often than not, I think a lot of this stuff shows up in the cashflow. If you've got really efficient systems, that's going to show up in the cashflow. If you've got a good culture, that's going to show up in the longevity of your team. So there are a lot of bottom line things that really kind of point to the whole entity at a larger scale. So if you've got a good pricing model, your profit's going to be good. Probably
Dan Hood (23:08):
Makes sense. Makes sense. There's one question, there's a million more things we could go on. This is a huge topic and we think we've only just started to peel back the outermost layer of it. But before we go, I want to talk a little bit about an aspect of m and a for smaller firms that I don't know that a lot of people think about, and that's the possibility of them going out and acquiring firms. Even if you're a million dollar firm, there's plenty of $600,000, $500,000 practices out there that you might be looking at. Do you see a lot of that or are there a lot of smaller firms out there acquiring even smaller firms? Is that something that happens on a regular?
Brannon Poe (23:45):
It does. It happens really all the time. And I think acquisition can be a great way to grow. I think scaling a company can be really hard. Scaling an accounting practice is really hard. At certain points we see there, there'd be kind of like Dan Sullivan calls it the ceiling of complexity. He's the founder of Strategic Coach. He calls it a ceiling of complexity where, and this is kind of normal in any business. It's like you grow and then all of a sudden everything just kind of becomes this major problem to break through. Your systems start to break, your processes don't work anymore, and you have to do something really different to break through. And an acquisition often can force that. And what is a problem for a two and a half million dollars firm kind of ceases to be a problem at a $5 million firm. So there's definitely the fat, the speed at which you're scaling the business, and it accelerates you through those growing pains. So those natural, when you grow organically, you're going to hit those ceilings and you're going to have to intentionally find a way to bust through those ceilings to get to the next level. Whereas when you're doing an acquisition, it just expedites that whole process.
Dan Hood (25:17):
Right. Well, if you're the frog in the boiling water, if the water's going up one degree at a time, you don't notice it. But if it jumps 10 degrees all at once, suddenly you're like, oh wait, this is a problem. I ought to jump. Of course, if it jumps 10 degrees, you're probably dead. Right? It's a terrible metaphor. It is. Is that appetite for small firm combinations, do you see it saying the same? Is it growing? Is it, I
Brannon Poe (25:43):
Think the talent shortage is sort of increasing that thirst for acquisitions because I, we've seeing a lot of, we call 'em "aqui-hires" — you're basically buying it for the talent. We had a 50-person firm in Canada that just recently got acquired, and it was primarily because it had a good team. The profitability wasn't all that great, but they had a good team and they had a lot of talented people on. And so we're seeing a lot of acquisitions that are talent focused. Very
Dan Hood (26:20):
Cool. We had a joke around here that the ideal acquisition candidate for a lot of firms had 50 employees and no clients. They didn't need the clients. They had plenty of their own clients, but they needed the staff.
(26:32):
Alright, well these is fascinating stuff, and as I say, we can spend a lot, lot more time on it, but we're running out of time. So for now, Brannon Poe, of Poe Group Advisors, thank you so much for joining us. It was great stuff.
Brannon Poe:
Thank you for having me on. It's been a pleasure.
Dan Hood:
And thank you all for listening. This episode of On the Air was produced by Accounting Today with audio production by Adnan Khan. Ready to review us on your favorite podcast platform and see the rest of our content on accounting today.com. Thanks again to our guest, and thank you for listening.