Earn Out Transactions on Accounting Practice Sales

Should earn out transactions be allowed in the deal? As a specialty broker for accounting practice sales and CPA practice sales, we get to look at each transaction and understand the impact from both sides. There is nothing more obvious in accounting practice sales than the fact that buyers and sellers are on opposite sides of the retention or earn out debate. Sellers want to sell for all cash and who can blame them? Buyers want to minimize cash down and create a highly retentive contract, lowering risk and leveraging cash. Can’t really blame them either. Both are using their heads to try to minimize risk and maximize return, so how and why should a retentive contract be used? Earn Out Transactions

I recently read an article from one of the national practice sales groups in which they indicated that principals should sell for all cash and they should not take any retentive based contracts. Spoken like a true sales machine, as they try to attract sellers of practices in this way. While it may be that a cash only deal can be attained, we believe there is more to it than that.

Savvy practice buyers and the best operators in the industry know better than to purchase a firm for all cash. They understand that no matter how low the risk of client attrition in a transaction is, there is still risk. There are simply too many unknowns as it relates to the relationships the current principal has, the relationships the current staff has with clients and many other nuances within the selling firm. Listing practices for all cash will do something for the selling firm. It will attract through “adverse selection”, the weakest buyers and the strongest buyers will move on to another firm. Practices listed for all cash send a message to savvy buyers and excellent operators. Whether you are trying to send that message or not is immaterial. The buyers will get the message that you are unwilling to negotiate in shared risk situations.

So, what does a seller do? We recommend that an actual assessment of retention risk be completed with the seller. Why? Because that is exactly what a buyer will do when they come to buy your firm. Depending on that assessment, we recommend a retention position. If conditions within a practice are such that attrition risk is minimized, the selling firm should offer minimal retentive components. On the other hand, if risk is high, savvy buyers will find it and a more lenient retention position should be considered. Otherwise, you lose your best buyers.

Recently, I had a discussion with a seller with a concentration problem. He had one customer that represented 33% of revenue and had only recently come into the firm (not a long-time client). Clearly a savvy buyer would not want to pay cash up front for this customer before he knew that this client would transfer to his new firm after sale. This one customer was removed from the traditional sale terms and the buyer paid cash for the rest of the firm but negotiated a buy out that was more reflective of retention risk for this one customer. There are hundreds of examples like this and a specialty broker should have the experience and know how to negotiate these kinds of solutions.

In a little different spin on this, I recently spoke with a multi-discipline firm specializing in wealth management, law and tax. Only the tax book was for sale, but the “team” of all three operate from the same location and the clients within have had amazing retentive tendencies. The clients are attracted to having this multi-discipline convenience. There is a very high likelihood that most, if not all these clients, would retain in the sale of the tax book because they have securities invested with the wealth management principal and legal matters with the attorney as well as bookkeeping and tax issues for the CPA principal. We recommended a very modest 10% retention agreement where the first 90% of the practice purchase price was fixed and some small downside protection was provided to the buyer pool.

Selling goals are incredibly important. To most, the highest price or all cash is not always the only goal. Usually price and terms are important but finding the “right” buyer is generally the most important. Finding the buyer that can continue building the value of the entity you spent so long developing is often the most important with principals that I talk to. A buyer that will take good care of your long-time clients and friends is often more important than getting all cash. Finding a buyer that has the right technical skills is also very high on the list of importance and often outweighs finding a buyer that will pay the highest price.

We believe, a firm should not list for all cash unless they simply do not care to attract the best buyers. Can you sell for all cash? Yes, you can as long as you are familiar with the concept of “adverse selection” and you understand the quality of the buyers attracted to these types of firms for sale.   Those willing to pay all cash for a firm in general will be your weakest operators with low levels of experience in this arena. We believe that negotiating a retentive deal that has documentable components to support the position is best. We also believe that the best way to get an all cash offer is to offer retentive variables up front that coincide with risk and focus on the true selling points of the firm to generate a competitive bidding process.   This way, you get to see the best possible buyers and make the decision yourself by weighing the benefits.

Before you choose a specialty broker that is telling you they can sell for all cash, consider talking to Berkshire Business Sales and Acquisitions (www.stepheno129.sg-host.com) and get the whole story. It may be that an all cash deal is appropriate, but it’s not likely good to list it this way.

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