When business climate changes or partners approach retirement age, accounting firms often find themselves in a position where merging makes the most sense. Some firms will benefit from filling talent gaps, and others enjoy expanding their reach into new geographic markets.
Whatever the reason for a CPA merger, firms need to tread lightly when acquiring or becoming acquired. A successful and lasting merger requires a combination of financial stability and cultural compatibility for both sides to overcome common pitfalls known for dooming CPA mergers.
In this article, we’re going to look at the seven risk factors to keep in mind during a CPA firm merger.
1. It’s all in the timing
Picking the best time to put a firm on the market can have a significant impact on the deal’s success. In a 2017 webinar on CPA firm merger and acquisition risks, Joseph Tarasco, CEO and senior consultant with Accountants Advisory Group emphasized the importance of striking when the market is hot, rather than waiting and having to sell in a slow market with fewer options.
2. Avoid delays
Make it a priority to get as much accomplished in the first few meetings between the merging firms. Both sides need to agree to the most important financial data and critical business details to avoid delays. The faster you get to the letter of intent/memo of understanding phase, the better.
Factors that take priority include:
- Partner compensation
- Equity calculation and allocation to the seller
- Voting rights
- Retirement buyout payments
- Firm name and location of offices
- Lease termination issues
- Non-equity partner arrangements
Create a calendar with strict deadlines to finish due diligence and sign formal letters of intent/memos of understanding.
3. Misaligned valuation expectations
Every buyer is looking for a bargain, while sellers want the maximum price. Often, partners in a CPA firm that’s been around for decades have unrealistic expectations about the market value of their business. At the same time, buyers may not always understand the full value they are attempting to acquire.
Misaligned valuation expectations can differ to the point of becoming a deal-breaker. After initial financial information is exchanged, valuations should be discussed and agreed upon quickly. The more time that passes, the more likely it is that friction will develop between the two parties.
4. Culture clash
Both sides of a CPA merger will have an opportunity to see who they will be working with during the initial meetings. Leaders should have their radars up and scan for potential cultural issues and personality conflicts that could interfere with the merger.
M&A attorney Russell Shapiro noted in an interview with AccountingWEB, “The most important factor is that the merging be culturally compatible.” He continued, “The partners have to be able to work things out and talk together on things. You have to see if the practice fits.”
Shapiro has structured some of the most significant U.S. CPA firm mergers in recent years. He cautions against assuming anything about a potential partner. Always asks questions
5. Lack of capacity post merger
Many larger firms acquire smaller firms with the expectation of taking on more work that will result in more revenue and profits.
If you are acquiring a firm, you need to make sure you have the appropriate capacity, or your client-service will suffer. A dip in results can lead to client losses and even critical staff losses.
The acquiring firm should beef up its management systems to ensure optimal efficiency, hire the talent they need, or even acquire a whole practice to provide all the gaps are filled.
6. Proper due diligence
Both sides of a CPA merger need to be aware of what they’re getting into. One of the most important considerations is the professional liability risk the can arise from a CPA merger. Proper due diligence is key to discovering liabilities.
A close examination of the following is critical:
- Personnel — Examine certifications, licenses, training, and work experience of all partners and managers.
- Clientele — Make sure you know which kind of accounts you’re bringing together — including when contracts start and end.
- Financials — Have a clear picture of both companies’ revenues, profitability, debts, leases, insurance policies, and financial risks.
- Quality Control — Make sure there’s a process for ensuring quality client service during and after the merger.
7. Avoid oversights
Insurance policies raise a lot of concerns when firms buy or sell. There are several key insurance issues to consider:
- Engagement letters — Agreements need special “successors and assigns” language to ensure they remain legally bound after the merger.
- Confidentiality — Client data must be protected to avoid the expense of privacy litigation.
- Conflicts of Interest — Merger deals need to eliminate conflicts of interest that can lead to litigation.
- Software — Mergers can create software incompatibilities that affect service delivery and even create the potential for litigation.
- Tail Coverage — This type of insurance covers gaps in standard liability coverage that might occur in a merger. Insurance carriers can explain how tail coverage works and why it’s so important.
If you have questions about the risks inherent to CAP mergers, contact us at McGowanPro today.