Selling accounting practices in today’s environment: Five things you can do so you never need clawbacks.

 

The past few years have seen some changes within the business sales industry, with a noticeable swing in favour of business buyers. Though is more true for certain industries, it couldn’t be less true for accounting practices. The increasing demand for accounting practices for sale has lead to a number of changes in the way that buyers are seeking these businesses, as well as the way in which they’re valued.

Historically, accounting practices were valued at between 50 – 120 cents in the dollar based on market value. So, for example, if the turnover was $1M and the business was valued at $0.70 to the dollar, the business would sell for $700k. This method, despite being used by most professional practices is not without its drawbacks. Being based heavily on the turnover, this method often does not take into account the efficiency of the practice in that higher profit margins are not necessarily rewarded. Furthermore, accounting practices are also hit with clawback clauses under this valuation method, with only 55-70% paid up front. The remaining percentage is usually paid after a 12-month period or similar, subject to the success of the business during that time. Clawback clauses can often be something of a problem for accountants wishing to sell their practice, particularly as once the business sells, the departing owner has no control over its success or failure, despite being financially tied to it.

Overall, this valuation method, though effective, has often left business owners out of pocket due to these clawbacks and a lack of reward to practices with higher profit margins. With an increase in demand for accounting practices however, and a newer generation of buyers entering the industry, it appears that this method is being phased out in favour of Return on Investement (ROI).

As it does with other business types, the ROI method of appraisal takes into account risk versus profit, as opposed to Market Value versus turnover. This shift heralds a substantial change in the way that accounting practices are valued and though there are a number of factors contributing to it, the reason for this change seems to largely be the result of the newer generation of buyers entering the market.

The newer generation of buyers are increasingly accepting ROI valuations for accounting practices. Being that it is the more common valuation method across all industries, these new buyers bring with them an expectation that they paying a price based on the potential future profits as opposed to the current turnover.

With this shift, comes a handful of advantages to well structured businesses. The immediate advantage is that well structured, more profitable practices will be rewarded under this valuation method. The secondary advantage is that it effectively removes the need for clawbacks as the risks that are usually associated with clawbacks (ie. loss of clients), are factored into calculating the ROI. This opens up accounting practice owners to higher immediate returns when it comes time to sell, but it also means that different approaches need to be used during the sale in order to take achieve those returns.

The main issue with circumventing the expectation for clawbacks is the culture of clawbacks associated with accounting practices. In almost no other field are these expected, and though there are good reasons why clawbacks are used in accounting practice sales, there are things that business owners can do to remove their necessity.

The primary reason that clawbacks are used is that there is minimal certainty in regards to which clients will remain with the practice one you have left. In order to address this uncertainty an appropriate handover method must be devised and more in-depth sales document needs to be prepared. The idea is to remove uncertainty through information.  Here are five tips to follow if you are considering selling your practice and want to avoid clawbacks all together.

1)   Be more transparent. Provide an in-depth break down of current clients.
Though this information is usually provided during the due diligence phase, a breakdown of client numbers is absolutely essential to lessening the need for clawbacks. This information is used by buyers to make their biggest purchasing decisions, and should be made as transparent as possible in order to reduce uncertainty in the purchase. You should endeavour to provide, to the best of your abilities, the following information: 

  • Breakup of clients per return type
  • Spread of fee Income
  • Geographical Location of clients
  • Client time with the practice
  • Taxable income per client

2)   Provide accurate descriptions of your relationships to your top clients.
There are two primary reasons why clients will leave a practice after a handover. The first is everyday reasons (change of situation, bankruptcy, death etc), the second is as a result of the handover.  Everyday reasons are addressed in point four of this list, but for the most part, these are just a part of the business. What buyers are really worried about is losing bigger clients as a result of the sale. It is for this reason that they need to be firstly made aware of your relationship to your biggest clients. This means a description of tasks you undertake for them, your history, primary points of contact and the steps you intent to take to enable the new owner to forge a new relationship with these clients. The types of steps you can take are as follows.

3)   Devise a handover period designed to help the incoming owner keep as many clients as possible.
The handover period begins prior to the conclusion of the sale and concludes after the sale has taken place. The primary outcome of a good handover period with accounting practices is to help the incoming owner retain as many clients as possible. It is also advisable that you arrange to call your biggest clients or even visit them with the new owner to facilitate the introduction.  This type of handover period will involve more work from your end, but you keep in mind that if you do it well, you will be significantly reducing the risk of loss of clients to the new owner. By reducing this loss, you are removing, or at the very least, lessening the need for clawbacks.

4)   Provide realistic projections of loss of clients based on history of lost clients.
With your client base protected to the best of your abilities, it may also be worth preparing a projection of client retention over an average year. Include, to the best of your knowledge, how many clients were lost/became inactive, how many clients were gained and the ways in which they were gained. It is important to be open and frank with your analysis. If the majority of your clients are gained through standard marketing then fantastic, however, if a notable portion of new clients are gained through professional referrals it is worth reporting. This type of warts and all approach will increase a buyer’s trust in you and the business, and allow them to make educated decisions rather than risky guesses.

5)   Prepare a sales document outlining the business to be given to enquirers. Make sure you cover the above four points.
Having prepared your clients as well as your business, the final piece of the puzzle is to present it. It’s important to remain frank and open in your sales document. Obviously, the primary purpose of a Sales Memorandum is to sell your business, but it must present the business realistically. Put yourself in the buyer’s shoes. Who’s opinion would you trust more: a mechanic who tells you all the good and bad about a car, or a used car salesmen who tells you it’s a ’dream to drive’? Don’t simply ‘sell’ your business to a buyer, but help them understand it from the inside out. The only reason for having clawbacks in the first place is to offset risk, and if you can remove the risk, you will not have to negate it. As part of this document you should also endeavour to provide, to the best of your abilities, the following information:

  • Full P&L for at least the last three years and YTD
  • Marketing breakup and explanation
  • Annual income month-by month for all three years
  • Skills and qualifications of all the staff within the practice
  • Skills and level of involvement of the owner.

You may find that you feel uncomfortable reporting negatively on your business in this fashion. This is absolutely understandable, and indeed, you should be painting the best possible picture of your business for prospective buyers. Consider this though: Clawbacks exist to protect against risk. If clients are lost during the clawback period you will not get paid for that portion of the business at the conclusion of that period anyway. During this time you have little to no control over any aspect of the business or economy in general and if, heaven forbid, the business suffers severely after you leave, you are held financially accountable despite having no input. The alternative offered here is that you provide a reasonable and honest opinion of the businesses future performance and factor that into your price today. This approach could be the difference between getting paid less later, or more today.

 


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