Do you value your practice?

By Phil Shohet And Andrew Jenner, Directors, KATO CONSULTANCY

CA MAGAZINE - APRIL 2003

In the February issue of CA magazine we looked at the issue of retirement and succession; something that is causing sleepless nights for partners in practices throughout the UK. As well as examining the background to this situation and the problems it has caused, we looked at ways in which practices could improve the ‘health’ of their businesses though restructuring and the creation of added value services for clients. A healthier business will not simply provide greater profits, it will also enable partners to consider a much wider range of options when selecting their exit routes. But even firms with serious problems need not despair; they may have more to offer than they think.

The path to creating the partners’ exit routes will, to some extent, depend on the size of the practice, the profitability of the business, the nature and structure of the business and the number of retirements it is expecting to fund in the foreseeable future. A small practice where all the partners are close to retirement age may choose a different route from a larger, more balanced firm.

Although any practice with a fee income in excess of £1m could consider any of these solutions, larger firms might find it difficult to find a buyer for an outright sale. However, for a smaller practice whose partners wish to retire it could be the ideal solution. There are basically two types of sale. In the first the partners have limited further involvement with the business following the sale. In the second, the partners who are retiring may continue on a consultancy basis for a term period, and agree a slice of goodwill on an earn-out basis. The extent of the payment will be determined on the security of the client base going forward.

Both types of sale should be approached in exactly the same way as a merger. Goodwill should be viewed as a key element in the valuation of the practice and factored in as a multiple of superprofits (available after adjustment including after factoring in a notional salary for partners). In any sale it is also vital to secure on-going continuity within the firm’s client base and contacts, particularly if there is no earn-out agreement and partners will not be around following the sale to reassure clients with whom they may have had a business relationship for many years.

For the fiercely independent practice there is an option more usually associated with industry and commerce: management buy-out. In recent years several firms have successfully taken this route, but it is not for the faint-hearted. This will enable a retiring partner to get value out of the business, and is particularly relevant to a dominant partner with a large slice of the equity. If the retiring partner has always been the driving force behind the growth and development of the practice then they must be replaced with someone with the same strengths. Ambition and the appetite to generate profitability along with entrepreneurial skills are essential for the partners and senior managers who will be responsible for the future running of the business.

Where a practice wishes to pursue this option but lacks strong leadership they should consider bringing in an outside investor or specialist; someone who can see the potential of the business and has the necessary skills and enthusiasm to drive it forward. In essence, an accountancy practice is an OMB just like the companies that comprise part of its client base and it is surprising that many firms, although helping to steer those clients through an MBO, rarely consider it for themselves.

There is another route to realising value that is also often overlooked. Rather than disposing of the entire practice through sale or merger, it might be more profitable to parcel up individually the different service divisions and sell them off as separate entities. For a number of these service lines, this has the added advantage of broadening the range of potential purchasers outside the accountancy profession.

In addition to wealth management (which can also include linked specialist tax services) and corporate finance, bureau work such as payroll and accounts preparation (outsourced services) also lend themselves to this type of sale. Indeed, the core assurance-led business can also be an extremely attractive proposition as a stand-alone sale. The valuation of these service lines will vary markedly dependent upon their attractiveness to a potential purchaser. However, before firms launch their specialist services onto the market they should consider that there can also be an MBO element here if the incumbent specialists may wish to purchase their own departments.

A potential pitfall arises where specialist departments are highly dependent on the core business clients as a source of work or where the Pareto analysis shows that a small number of clients are responsible for generating a large proportion of the division’s income. Any department sold as a separate entity must be able to stand alone as a viable business. Any sale should also include the relevant management team or there is the likelihood of a diminishing base of work.

Now let us look at what has in recent years proved one of the most popular means of solving retirement and succession problems: a merger attracting goodwill. To a large extend such a merger can really be considered as a sale because, whilst the majority of the partners and the staff may remain within the merged practice, attracting goodwill requires a merger with a larger practice that will inevitably end up as the dominant partner.

A variety of options are available in this regard without losing sight of the prime driver for joining another practice.

A firm that can bring an industry specialisation or a high degree of skill in a niche area to the negotiating table can also expect to greatly improve their prospects and increase the level of goodwill.

The consolidator models that have recently appeared in the UK are similar in the way they treat acquisition/merger. Both attract an element of goodwill for retiring partners ( both now and in the future) but in this instance the goodwill is based on share value. The expectation of the attributed goodwill is determined by the market performance of the shares over the period of the lock-in which forms part of the consolidation agreement.

No matter how desperate firms may consider their succession problems to be, it is vital to fully explore all the options rather than grabbing the first available opportunity. Our experience shows that a little time spent weighing up the pros and cons of every exit route can pay dividends. It is also important to remember that, no matter what the final solution may be, it must strike a balance between the requirements of the retiring partners and the needs of those remaining. Ideally, those who are leaving will enjoy a comfortable retirement, those who are staying can look forward to enhanced career prospects, and the clients can benefit from improved levels of service.

Prime considerations are the balance of priorities of whatever arrangement the independent practice undertakes for the retiring partners, those who are to remain working within the merged deal (which includes staff) and with great consideration directed to the well-being of the clients.

And finally, a cautionary note: be aware of the cultural fit of the two businesses and do not be overwhelmed by synergy relating purely to the numbers. Caveat emptor!