I often get asked questions on valuation methodology for accountancy firms or CPA practices. There are many variables that get considered in a valuation, attrition averages, operating margins, cash flow margins, work quality, book demographics such as AGI, work complexity, and average age but the size of the firm (the gross recurring revenue) needs to be considered up front. 
Firms with less than $150,000 of recurring gross revenue have traditionally traded with a multiple range of .75-1. Accountancy firms with gross between $151,000 and roughly $850 or $1,000,000 in gross recurring revenue carry multiple ranges of 1 – 1.25. Firms that are at, near $1,000,000, or above often trade in the 1.25-1.5 multiple ranges. Below, we will explore four factors that cause this to be true.
- The amount of sunk cost as it relates to gross revenue will consistently be higher in small firms. Rent, software and insurance just to name a few sunk costs will be higher as a percentage of revenue. This means there is a lower operating margin or cash flow margin in small firms because of their size. Clearly, the amount of cash flow to revenue should be a determining factor when pricing these firms. The buyer will have to accept lower returns on investment until more critical mass can be achieved.
- After the owner living expenses, there is often little cash flow left in the firm to redeploy to growth strategies or other endeavors the principal wants to engage upon. This forces new buyers to either reduce the level of income they are taking or not completing the critical growth and marketing tactics necessary to grow.
- Small firms also have smaller and less developed infrastructure and controls. For investors or even principals that want to buy some critical mass in order to grow the firm later will be forced to tackle the infrastructure and growth issues within the firm before the growth occurs. This comes at a cost. Cost to develop new systems and controls and costs to hire and train staff are just a couple of examples.
- In small firms, the owner does most of the daily work and carries with him the customer loyalty and all customer contact. The risk of concentration issues and the risk of retention issues after purchase, when all of the clients are tied to one individual are also concerns that buyers will have with small firms.
Size does matter in the valuation and sale of accountancy firms. There are a number of other issues as it relates to pricing and size, and plenty of contractual issues that will be negotiated in the purchase agreement partnership agreement. For a full understanding of these CPA or Accounting Practice valuation issues or if you would like to know where you stand on firm value, please feel free to discuss with a business intermediary that specializes in your industry.
