Show Me the Money: How Practices Are Sold
Sellers and buyers always want to know the value. But before we talk about value it might be helpful to know something about how accounting and tax practices are sold. When a house goes on the market the assumption is always that the seller will receive all cash at closing. Anything different from that requires early clarification.
In the sale of CPA or CA firms the situation has been almost the opposite. Practices have historically sold with a seller financing arrangement which usually includes some type of guarantee of client retention on the part of the seller. So, unlike houses, the assumption was, and still is quite widespread, that firms only sell one way. But the fact is that practices do sell today in different ways and on different terms. Sellers and buyers need to understand the reality of today’s marketplace and they need to be on the same page in their discussions with each other. There are four basic ways firms are sold.
With seller guarantees:
This is a type of seller financed transaction in which the seller receives payments based on what the buyer collects (or perhaps bills) over a period of time. The down payment, percentages and payout years can be adjusted. One example would have the buyer paying down 20% of the estimated final price and then paying 20% of receipts collected each year for the first 4 years. This particular scenario has been so ubiquitous that many buyers and sellers think it is the only way practices can be sold! Buyers like it because it gives them easy cash flow payments and puts almost all of the risk of client retention onto the seller. They particularly like to tout the possibility that the owner can receive even more if the practice should increase. Sellers do not like assuming most of the risk in a method that has them guaranteeing the work and abilities of the buyer years down the road. Sellers also complain of having to do the accounting and due diligence involved in the calculations. If such a method is used both buyers and sellers need to be sure everything is spelled out very clearly. For example, how are new clients to the business counted in the mix and how are collections applied and accounted for?
In this type of sale the buyer looks back after a period of time at how much has been collected (or, perhaps, billed) and the total sales price is then adjusted up or down. For example, a buyer agrees to pay AED 325K for a practice that grosses AED 300K with a price adjustment of one Dirham for each Dirham variation in actual collections the first year. In this example, if the practice actually collects AED 250K for year one then the final price becomes AED 275K; if the practice collects AED 330K the final price is AED 355K. One year is what is most often seen. Dirhams for Dirham adjustments are common but there can be variations like 50 cents for each Dirham increased or decreased. Sometimes no change in price is made if, for instance, the increase or decrease of collections is less than 10%. There can also be caps on the adjustment. There is room for creativity. This pricing is similar to collection pricing in that seller guarantees are involved but it can be used with both cash and seller financing. In the example above, the buyer could have paid all cash up front, paid half down and the rest after the first year or could have made traditional monthly payments. The key is that the price is adjusted over a period of time based on what is collected. Although not nearly as common as collection pricing, sellers are somewhat more comfortable because of a shorter period of time that they are at risk. The risk that is covered by the seller is essentially the risk that clients won’t give the buyer a chance rather than the risk of a bad buyer. The variations can be complicated so each party needs to be especially certain they understand the implications of various scenarios.
Without Seller Guarantees:
This would be a method with no guarantees from the seller and the seller receives the full price at closing. This refers to cash paid to the seller. The buyer may have obtained cash from personal funds or, more often, from an outside lender. The latter can really create a win-win for both parties-the seller receives cash and the buyer is able to obtain often favorable payout terms. Most owners are going to naturally prefer the all cash option not only because they are reluctant to guarantee the abilities and work of the buyer but also because it allows the owner to complete the deal and move on to other endeavors. This option has become more and more common especially with solid firms in desirable locations. Two things have contributed to this: there are more and more outside lenders looking to loan on accounting practices and brokers like Accounting Practice Sales are creating a more efficient market with a larger pool of buyers.
Fixed Seller Financed Pricing
This is defined as any fixed price without a guarantee on client retention that is paid out to the seller over a period of time. Interest is usually a part of the deal but not always. This type, while very common in our lives, is often misunderstood in the area of accounting practice sales. That is because seller guarantees have been so common in the past that even now when someone mentions seller financing they are often really talking about #1 or #2 above. Buyers would want seller financing for a number of reasons:
- It is much simpler than the outside financing process,
- They don’t qualify for outside financing,
- The perception persists that this keeps the seller in the game and motivates him or her to work harder in a good transition, or
- They might get favorable interest rates or tax benefits.
One reason they might not want it is that outside lenders can often offer better terms (lower downs, longer payout periods, working capital, etc.) than sellers will. Sellers are more favorable to fixed financing than the seller guarantee options but they still worry about collecting their funds. Sufficient down payments, a good credit on the part of the buyers, strong buyer experience and credentials can mitigate the fear. Sometimes sellers feel better if they stay involved somehow in operations, at least for a while.
Accounting and tax practices are sold today in all four ways. When a firm has factors, such as good location and a strong cash flow, that attract many buyers and ultimately more offers which then results in the seller getting terms favorable to him or her. Conversely, if a practice cannot attract many buyers then the terms will favor the buyer. Buyers need to understand the dynamics of each offering so they can make the deal work for them. Sellers need to offer their practice in such a way they can attract the largest number of quality buyers.