Growth and Succession in Small to Midsize Accounting Practices

By Max T. Krotman

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Responding to the Shortfall

For the last 10 years, small and midsize firms with partners between the ages of 50 and 65 have responded to the shortfall with a variety of internal responses, such as the following:

• Bidding up the price of available talent;
• Intensely nurturing the talent available;
• Utilizing technology to leverage the time of partners and staff;
• Avoiding the provision of services that are less profitable or highly time consuming, such as payroll work and bookkeeping;
• Merging practices to increase the efficient use of talent, incorporating organizational efficiencies, and freeing partners from nonbillable administrative time;
• Retaining senior partners beyond their expected retirement age;
• Turning away new clients or shedding existing clients; and
• Lower-quality work.

The first alternative to solve the shortage of staff is internal: promote from within. If that fails to meet the needs, the firm must hire outside talent to ensure its survival, growth, and ability to pay out retiring partners. Because of market conditions, it is often necessary to use an executive search agency to find the right people.

Promoting from within provides hope and incentive to the next generation. Staff may be motivated to work harder because they see that good service is rewarded by advancement, and management gets to work with a known quantity. Among the advantages of importing outside talent are new skills and ideas and the possibility of expanding the business.

If neither method is satisfactory, then it is necessary to use external solutions.

Mergers and Acquisitions

Mergers and acquisitions have become more popular in recent years, partially because of the talent shortage but also because of the increasing realization of their benefits.

Acquisition or merger of partners. Usually, a firm seeks to acquire or merge-in a smaller firm. Ideally, the combined firm will have new equity partners that will be a minority in the combined firm, and fees brought in by the new equity partners will be less than half of those of the combined firm. Ideally, the revenues of the new partners will be closer to one-third of the total.

For example, a $2 million/four-partner firm would seek to merge with a $1 million/two-partner firm. A $6 million/six-partner firm would try to find a firm with less than $3 million in collections and fewer than three equity partners. If these ratios were to hold, all partners could add significantly to their books of business because they could take advantage of the larger firm’s administrative infrastructure.

By selecting a smaller firm, a larger firm seeks to maintain the preeminence of its partners. The goal is to acquire the staff and niches developed by the smaller firm and to use the expertise and billing rate of the larger firm to increase the income generated by the partners from the smaller firm.

The situation occasionally works in reverse. For example, an efficient, smaller firm might successfully acquire a firm with greater billings and more partners, but with far less profitability per partner because each partner manages a smaller book. Once the larger firm follows the model of the more efficient, more profitable company, the combined firm benefits from its addition of the partners.

Obtaining staff and future partners. Some larger firms purchase or merge a smaller firm in which the senior partners are approaching retirement but have developed an excellent staff. These employees can be not only a working asset in the combined firm, but may also supply future successor partners. In this scenario, the senior partners of the acquired firm may remain full- or part-time for a finite period.

Frequently, the partners in the acquired firm that are planning retirement are insecure about their original firm’s ability to pay them out. Often, they are willing to sell to obtain security. In the current market, this works well for the seller. They have avoided sharing their profits with junior partners and have not diverted their energies by nurturing talent.

These merger or buyouts work best when the staffs of the two firms are complementary or when the overpaid, long-term staff of the acquired firm can be retired, trimming payroll. Usually, some or all of the partners in the acquired firm want to work one to five more years after the merger, but their primary goal is to secure their retirement. On the other hand, there are scenarios where the acquiring firm may value a high-quality staff more than the clients purchased.

Securing succession. If a firm has not successfully developed younger partners, it can merge with a smaller, more youthful one whose partners can become the future successors. The larger firm should commence this program when a senior partner intends to retire within the next one to three years, even though retirement may be five to 10 years away for most of the partners.

In the short run, the merged partners of the smaller firm give up their preeminence to the senior partners of the larger firm. The larger the firm, the larger the constraints. These mergers are most successful when the smaller firm’s partners appreciate the increased earnings, security, and future opportunities they will enjoy with the bigger firm.

Joining a large firm. The Big Four and the other large accounting firms, with more than $20 million in revenues, offer another option to many firms and partners. These firms can easily absorb partners and their clients. The partners are not “bought out,” and they join the firm, contribute their clients, and receive the firm’s standard or “tweaked” retirement payout. This is very suitable to those satisfied with being a respected, well-remunerated professional within a large organization. Others grimace at this role change and loss of autonomy.

No firm is totally secure. The disintegration of Arthur Andersen and the demise of other leading firms in the past 30 years prove that size alone is no guarantee of safety. One could argue that a smaller, solid firm is a better source of security than a large firm whose financial health defies accurate analysis. The smaller firm, however, must constantly keep enough high-quality staff to maintain its status.

Ingredients of Successful Mergers

In all successful mergers, the increased financial rewards resulting from the economies of operating through one organization help to soothe egos. Some of the economies result from—

• shared technology expertise and expense;
• the affordability and availability of higher-level talent; and
• the ability to cross-sell clients through the additional support that a larger firm can offer its partners.

Staff synergies follow successful sales or mergers of practices. Some advantages are—

• complementary staffs (e.g., good junior partners from one firm and good senior partners from the other);
• the ability to eliminate overpaid people;
• the addition of staff with expertise useful to the firm; and
• complementary staff time (e.g., the merger of a firm specializing in tax services with a firm that has underutilized time during tax season).

These same factors apply to the skills and expertise of the partners, both professionally and administratively.

Technological differentials are beneficial to firms. Even if one firm is far more advanced than the other, it will take less than a year to bring the weaker firm up to pace. If reversed, the incremental cost to equip and train the new people is dwarfed by the additional time and efficiency recovered.

In addition, the personalities of the firms and the partners must work or the merger will not be successful. There must be basic agreement on moral issues, and the personalities cannot be abrasive or incompatible with each other.

Fortunately, these issues emerge quickly in the preliminary meetings between firms. They appear during the negotiation process, the due diligence, and the documentation. If problems arise, they can usually be settled if all parties are alert but not paranoid.

There are an increasing number of large firms, because an increasing number of professionals have seen the value in merging. There are proportionate benefits for firms at lower levels as well. The right sale, merger, or acquisition is truly a win–win proposition.