Diligence Before Buying or Selling an Accounting Practice
2005 - Many think that due diligence is the first step before
negotiating the purchase or sale of a professional practice.
This is not necessarily correct. The due diligence process
reveals significant confidential information, is very time
consuming, and increases the risk that employees, and potentially
clients, will find out that change is in the works.
to investing time in due diligence, the buyer and the seller
should have at least the framework of a deal crafted. The
parties should exchange generic (no names of actual clients)
but specific, detailed information about their respective
businesses. If an agreement can be reached based on this
information, it is then appropriate to commence a due diligence
to starting the due diligence, both parties should enter
into a formal confidentiality agreement. This document should
include language that prohibits each firm from contacting
the other’s clients for a reasonable amount of time,
penalties for doing so, and a nondisclosure aspect that
prevents either party from sharing confidential information
with third parties.
the Buyer Should Review
terms of the deal frequently dictate the level of due diligence
the buyer should do. If the buyer is required to place significant
cash down at the closing, or will be entering into a deal
that has little to no retention period for the seller’s
clients, the buyer will need to perform detailed due diligence.
Conversely, should the buyer be acquiring a practice with
little to nothing down at the closing, and the balance of
the purchase price is based on a contingency relating to
client retention and fees collected over the payout period,
a less detailed review will be needed.
following are basic items to be reviewed in a typical deal.
versus collections, age analysis of receivables, and seasonal
cash flow. These areas must be compared to
expenses, which should include the payments made over time
to purchase the practice. These help determine a business’
ability to fund acquisition costs and generate a return
on the acquirer’s investment of time and money. The
buyer should review the amount and frequency of write-downs
and any other collection problems. If it is determined that
some of the clients are very slow payers, the buyer should
consider the following issues:
Can the buyer afford to carry the practice until the business
begins collecting its own receivables? It may be necessary
to retain cash from the seller’s receivables and
work-in-progress and then pay it back separately.
Does the buyer need to protect its cash flow by reducing
down payments, deferring or delaying the first note payments,
or making smaller payments initially and larger ones in
the future? One method of accomplishing this would be
to reduce the down payment but arrange for a balloon payment
when the cash flow increases.
Does the buyer need to provide for the seller’s
slow-paying clients by sharing receivables? For example,
once a client is 30 days late to the buyer on current
work and still owes the seller money, future collections
could be evenly split between the buyer and the seller
until the seller is paid off. The seller would not lose
its accounts receivable, but would allow the buyer to
participate in revenues while delinquent clients catch
flow and profitability. If a business’
revenues are highly seasonal (as with a tax practice), the
buyer must be aware of the possible need to financially
carry the practice if it is bought after the busy season.
The buyer may need to adjust the monthly or quarterly payments
to the seller to match a seasonal cash flow. Such adjustments
are automatic in collection-oriented deals or earn-outs,
because the payments made to the seller are actually based
on a percentage of collections received from the original
clients acquired over a period of time.
of the client base. The longer the seller
has serviced a client, the greater the existing loyalty.
If a transition is done correctly—for example, the
sale is promoted not as the loss of the seller but the addition
of the buyer—postacquisition retention should be excellent
for loyal clients. Clients that have been with the seller
for years may be more loyal than newer clients. Why have
clients left? An accounting firm that has a recent record
of losing clients to a rival firm should make the buyer
nervous and indicate a longer retention period.
does the work, and where? If the seller physically
visits certain clients and works there, the buyer will have
a tough time replacing the seller with its own staff. In
many clients’ minds, the seller’s fee may be
partially justified based on the time an accountant is dedicating
to the client while in their facility. The buyer should
be prepared, at least during the transition, to handle clients
the same way the seller had, thereby mitigating the risk
seller’s billing rates. Billing rates
constitute one of the great mysteries of accounting and
tax work. If the seller does the work manually and the buyer
computerizes it, the billing rate can be doubled without
raising the fee. The buyer’s focus should be on determining
the time, effort, and level of staff that will be needed
to complete the work, and the subsequent billing rate and
client fees, as compared to the seller’s current capabilities.
The buyer in any deal must review the seller’s
workpapers in order to do the following:
Learn what services have been provided, what new services
can be added, and if a significant amount of time needs
to be invested in order to improve the records.
Estimate the time, effort, and staff needed to complete
unfinished work and confirm profitability.
Review potential liability and malpractice issues.
Confirm that the seller is not taking unacceptable accounting
or tax risks.
The buyer should review the seller’s
profitability, but the focus should be on the likely profitability
after the acquisition is complete. The seller’s profit
should be a starting point, not an end in itself. Due diligence
should focus on both revenues and expenses. An acquisition
that enables the buyer to take over a practice with little
incremental increase in overhead can be tremendously profitable.`
and software. What, if any, of the seller’s
equipment and software is being purchased in the deal? What
condition are they in? What does the buyer need to handle
new clients? Are there any leases or liens on this equipment?
What staff does the seller have? What is the
role of the staff in the firm, and how much contact do they
have with clients? Do they have employment agreements that
include noncompete language? If some of the seller’s
employees are part of the acquisition, the buyer should
examine compensation and benefits, as well as the staff’s
strengths and weaknesses. How does all this compare with
the buyer’s staff?
provided (and not provided). The buyer should
have the skills, technology, licenses, and time to handle
the services currently provided to the seller’s clients.
In a business environment of growing niche services, the
buyer should determine what services the seller does not
provide now but the buyer could profitably add after the
facilities. The seller’s clients and
staff are generally accustomed to their current location.
If the buyer is not taking over the lease, adequate space
to house the practice and keep clients comfortable will
have to be provided. If the buyer is taking over the space,
a due diligence review of the current lease should be performed.
of the client base. Are the seller’s
clients, especially the larger ones, in good financial shape?
Are some of them aging and thus likely to be lost to sales,
relocations, or retirements?
What portion of the work is done at the office,
and how much is done at clients’ offices? How are
billing rates applied? If the seller drives two hours total
round trip and spends two hours at a client, are two or
four hours billed? The more clients visit the office, the
more sensitive they are to where the practice is located.
the Seller Should Review
seller should also cover a number of issues during due diligence.
The following are some of the basic areas to be reviewed.
clients. Do the partners of the successor
firm have the capacity to service the seller’s clients?
The seller’s hours—billable and nonbillable—and
commitment to the practice should be reviewed. The relative
time put in by staff versus principals should also be considered.
Can the buyer replace those hours and roles? If the seller
has niche practices, is the buyer capable of performing
of the successor. Bigger is not always better:
Small firms are frequently more attentive to a client’s
needs. But there are exceptions. Other sellers have clients
that are accustomed to dealing with large firms and need
that environment to retain clients.
rates. The seller should make sure the successor
firm will not have to dramatically change the fees charged
to clients and risk possible retention problems. Many practices
have clients that are sensitive to the fee they are paying,
rather than the billing rate.
To retain clients, many practices cannot be
relocated beyond a certain distance without suffering client
strength. The seller should run a credit report
on the buyer and make sure the buyer’s firm is financially
secure before going through with the deal.
It is typically more risky to affiliate with
a buyer whose partners have never been partners before or
have only been partners together for a short period of time.
While no guarantees exist that partners will stay together,
the longer a firm has been together, the less likely a surprise
culture. In some firms, linguistic, ethnic,
or cultural issues play a significant role in why clients
choose the firm. Should this be the case in the seller’s
practice, the buyer must be within the appropriate parameters
for client retention.
broadly, clients become accustomed to the style in which
they receive service: how phones are answered, how clients
are billed, how fees are collected. These and other items
can have a dramatic affect on retention.
and strategy. If the buyer cannot retain its
clients, it is unlikely to retain the seller’s clients
in an acquisition.
addition, the seller should be sure the buyer has a plan
for where the business is going. The seller should know
the buyer’s plan and how it relates to clients.
covenants on staff and partners. If current
partners or staff members leave the firm, they should be
prevented from taking clients with them. If there are no
such restrictions, the seller will need to include additional
language in the buyout contract protecting the firm from
Sinkin is president of J Sinkin Consulting Group
Ltd, Hauppauge, N.Y. He can be reached at email@example.com.