With the pending retirement of roughly 78 million Baby Boomers, and nearly 60 percent of equity partners in CPA firms over the age of 50, the succession crisis only promises to get worse. Each year, an abundance of grim statistics regarding lack of succession planning foreshadows the looming catastrophe awaiting many accounting practices.
According to the AICPA's Private Companies Practice Section, some 80 percent of firm owners predict that succession planning will impact their firms in a critical way over the next decade, while less than 30 percent of firms with 15 people or less have any semblance of a formal succession plan in place. For larger firms, less than half have put pen to paper and addressed their succession needs in a document.
These grim realities are in effect rewriting the future for CPA firms caught unprepared. But it doesn't have to be that way.
There are a number of strategies available to practitioners, who may be six years or less from stepping away from a full time role and don't necessarily have adequate "bench" strength to complete an internal succession.
However, when faced with the prospect of a merger to ensure an orderly succession two fears ultimately come into play:
Loss of Income
Transitioning firm or book of business translates into "selling my firm" in the minds of many practitioners. And that is often misunderstood as a partial or substantial loss of income. Firm owners who are, for example, three or more years away from stepping down cannot justify in their own minds giving up what in many cases is a lucrative income stream. For many, succession is perceived as a goal for the longer term in lieu of a pressing dilemma that needs to be addressed far sooner.
Loss of Control
Change is often a dirty word to practitioners, especially when it comes to the way they run their firms. The majority of firm owners believe they are the" master of their own domain," and to many of them, the thought of a merger is frequently accompanied by thoughts of a loss of control. That often is enough to prompt them to put off their succession plans for another year as opposed to affiliating with a firm and experiencing the dreaded "C" word – change.
The Two-Stage Deal
To help overcome these fears, firm owners need an option that allows them to transition relationships with both clients and staff – often the basis for the valuation of an accounting firm – without surrendering both their income and loss of control.
That's where a strategy known as the "two-stage deal" comes into play, and one that has helped hundreds of our clients ensure succession. The two-stage deal is tailored specifically for practitioners who are six years or less from trimming down their time commitment and involves merging with a successor firm now while maintaining both autonomy and income.
Here's a recent case study of a deal we consulted on employing the two-stage deal:
"Bob" was a $500,000-a-year sole practitioner whose clients were "partner" loyal as opposed to "brand" loyal – and who had decided he wanted to work three more years full time before assuming a part-time role. Bob had one full-time senior professional and one clerical and netted roughly 40 percent to the bottom line including all perks and benefits. Bob agreed to affiliate with a larger buyer firm under the two-stage deal structure.
The buyer firm had three partners, operates under a similar fee structure and generates in the neighborhood of $2 million in annual revenues.
Both parties agreed that stage one was to be a maximum of three years. Once the two practices combined, the successor firm provided Bob with the same amount of labor and support as he had enjoyed before and assumed most of the administration duties as well. The deal was held out as a merger to the public and Bob's clients.
Under that structure, Bob was able to operate his practice through the successor firm's infrastructure and in the process, continue to enjoy autonomy and control, while still netting his 40 percent, providing his time commitment and labor requirements remained the same.
The end of the third year triggered Stage Two – Bob's buyout, which is traditionally predicated on a percentage of collections over an agreed-upon period.
The two-stage deal structure also offers a number of advantages to the seller firm among them is reduced liability in case of a client loss.
The two-stage deal structure also offers a number of advantages to the seller firm among them:
Reduced liability in case of a client loss: If Bob had ultimately decided not to merge and suffered the unforeseen loss of a $25,000 client, he would have been forced to absorb 100 percent of that loss because his overhead costs remained fixed. Under the compensation formula the two firms worked out in the two-stage deal example cited above, Bob would now have to incur only 40 percent of that adjustment to his income (or $10,000) in lieu of full 100 percent.
Higher labor requirements or redirecting time allocation: If the transitioning owner suddenly required more labor than he/she used in the past, they now have the resources available to them and their compensation would be adjusted accordingly. Also, without the burden of administration, they can potentially redirect some of their hours toward more profitable avenues such as business development or client service.
Client niches: This is a benefit for both the seller and successor firms, particularly during stage one, as both can focus on cross-selling services to their respective client lists and/or developing new clients.
The two-stage deal works with larger firms as well
Perhaps most importantly to remember is that a two-stage deal is not relegated to helping overcome the succession problems of sole practitioners or very small firms.
For example, we recently finished consulting with a firm that generated some $4 million in annual revenues and which presented a number of succession challenges.
One partner was seeking to slow down quickly, another in five years or less while the last two were young and had decades before they sought to retire.
We helped them merge into a regional firm that bought out the partner seeking an immediate role reduction (although they stayed on in an ongoing part-time role), completed a two stage deal with the partners seeking to work five more years or less and structured a merger with the younger two partners wherein they exchanged equity in their firm for equity in the combined successor firm.
In summary, the two-stage deal can be an excellent solution to the problem of chronic succession procrastination, provided the chemistry and culture are a good fit as well.
Bill Carlino joined Transition Advisors as Managing Director of National Consulting Services in 2012 after serving for nearly 12 years as editor-in-chief and editorial director of Accounting Today and AccountingToday.com, where he was responsible for all content both in print and online. During his tenure as editor, Accounting Today won a number of financial journalism awards including Excellence in Financial Journalism from the New York State Society of CPAs and was a two-time finalist for the Jesse R. Neal Award, the premier publishing accolade among business-to-business publications. In his new role as managing director of consulting, he helps match Transition Advisors’ array of services such as succession readiness evaluations, new partner admissions, partner retirement and exit support, partner retreats and owner agreement evaluations and design, to the strategic transition and succession needs of CPA firms across the country. He has been a frequent industry speaker, presenter and panel moderator and has appeared as an expert commentator on such business channels as CNBC, Reuters, Bloomberg, CNN as well as National Public Radio.