“What is the fair market value of my firm?” is the largest question we receive when contacted by accounting and tax practitioners considering a sale. Taking firms to market over the last 15 years has given us an excellent understanding of demand, supply, and the algorithm that is used to value and sell firms.
In this article, we will explain a straightforward formula that, if employed, will give you an approximate firm value. We will also explain why this is an approximate firm value and what other factors add to and subtract from this value when attempting to market a firm for sale.
CPA and accounting firms historically sell for 1 times gross recurring revenue on average. The average multiple (1 times gross), however, will only tell you what an average firm sells for.
A better way to look at firm value is to consider a spectrum of multiples, generally between .75 -1.25 times gross recurring revenue and to understand where on this range of multiples your firm falls.
When considering this, there are two primary determining factors and many other factors that will ultimately give you an accurate look at your firm’s value. The two primary factors are supply and demand and profitability.
Secondary factors consider staffing, technology, types of revenue streams, and deal structure. For the purposes of this essential guide, we will only consider traditional practices, completing accounting work and tax work as their primary revenue streams.
Supply & Demand
The fair market value of an accounting practice is the price at which it would change hands between a willing and informed buyer and seller in an arm’s length transaction. The term is used throughout the Internal Revenue Code and in bankruptcy laws, state laws, and regulatory agencies.
In other words, supply and demand are primary factors in determining value. To go to an extreme, firms don’t sell if there is zero demand, and the ongoing enterprise’s fair market value is zero.
The merger and acquisition marketplace is constantly changing. The industry is entering into more of a buyers’ market due to the changing relationship between supply and demand. In this case, the aging baby boomer demographic is reaching retirement age and they want to retire. The sheer nature of the size of this demographic is affecting the supply and demand relationship (increasing supply) which will tend to soften multiples over time.
Any factor that will increase the supply or reduce the demand in practices for sale will cause a general lowing of the multiple. Consider small practices in rural America. If the population of the community is small and there are just one or two practitioners in town, demand is extremely low. The multiple range of .75-1 times gross revenue may be more appropriate for this supply/demand inversion.
In fact, in this situation, your multiple may be well below .75. Firms that fall into this category or firms with margins below 25% (to be discussed below) are likely to sell at or below 1 times revenue.
Margin (Profitability)
Assuming a solid balance of supply and demand (metro areas), a firm’s profitability will be primary in assessing a firm’s value. By looking at the cash flow margin of the firm, the principal can determine where on the range of pricing multiples (.75 -1.25) they fall.
We use SDE (seller discretionary earnings) as our cash flow metric. We see SDE ranges generally between 25% and 75% of revenue. We see the extremes on the flat part of the bell curve, meaning there are fewer companies that operate with these extremes. The bulk of the bell curve is more likely to have cash flow margins of 40%-60% of revenue.
In a more metropolitan setting (balanced supply and demand), a more appropriate range of multiples is 1-1.25 times gross revenue. If your firm has a 50% SDE margin and you operate with critical mass in a metropolitan area, you should find your multiple in the middle of this range on average. We do see firms trading outside of these ranges from time to time, but these can be caused by negotiation tactics or what we call “strategic value creation” between the parties.
Don’t make it more complicated than it is. If you understand these two items, you will be far ahead of most. While there are other factors that can increase or decrease the revenue multiples used for accounting firm valuation, supply and demand and the cash flow margin of the firm are the two primary metrics when setting a multiple.
Staffing
A full staffing complement with non-competes or non-solicit agreements within a firm can add to the multiple used-to-value firms in today’s marketplace. A staffing compliment that is well trained, age diversified, and credentialed most definitely will add to the demand for your firm and therefore put upward pressure on price. The demand for good quality, credentialed staff is at an all-time high within the accounting and tax industries and buyers will pay for it.
Technology
The use of modern technology is also a factor that buyers will pay for. Technology is generally used to make things more efficient and reduce the number of staff a firm needs to employ. The staff and the client base must be trained in the technology. If well trained, margins will improve over time and buyers will pay for rising margins and the use of robust technology within a firm.
Just one of many examples is self-scheduling software. Clients can decide if they want a tax appointment and schedule their own tax appointment with the software. The software populates the appropriate calendar with an appointment, the software sends a zoom link if a video meeting is preferred. The software reaches out and confirms the appointment as the appointment gets closer. Restaurants use this software regularly now. You book your own reservation, and the software reminds you and asks for your confirmation to hold the reservation.
This may save a full-time receptionist position. While this is just one example, the combination of great software can increase the price.
Revenue Streams
The type of revenue stream coming into the firm can affect price primarily because it alters the supply and demand portion of the pricing equation. Firms that complete assurance work or attest work will have a smaller buyer pool, for example. Fewer firms are completing audits and reviewing financials in today’s economy. If fewer firms are doing this work, then there are fewer buyers of practices that conduct this work.
Deal Structure
Deals that are structured with very little down payment will have an extensive buyer pool (increased demand) but at high levels of risk to the seller. We are not recommending this as the terms are critical in realizing the price set, but it’s a real factor in setting the price. You are much more likely to get a high multiple and price for your firm with no down payment, but how much of this price will you actually realize?
There are other factors that can impact price, but most of these other factors work to either change the cash flow within the firm and the ultimate profitability or the demand and supply relationship (both of which are primary in setting a price target). It’s good advice not to overthink all these existential factors when pricing your firm. Let an expert do it for you!
Berkshire Business Sales & Acquisitions is a specialist that values, packages, markets, and sells accounting and CPA firms. We have the tools, knowledge, and experience to address all these items to maximize your price and minimize risk.
