The climate for mergers and acquisitions in the accounting industry was already a bit balmy before COVID-19, but the onset of the pandemic turned the temperatures up even higher. In this podcast, John Warrillow, author of The Art of Selling Your Business: Winning Strategies and Secret Hacks for Exiting on Top and president of The Value Builder System, delves into current merger and acquisition trends, the best ways for driving up the price, and determining the right time to notify your employees of a possible sale.
By: Bill Hayes, Pennsylvania CPA Journal Managing Editor
In his new book, The Art of Selling Your Business: Winning Strategies and Secret Hacks for Exiting on Top, John Warrillow, author and president of The Value Builder System, delves into trends for mergers and acquisitions, knowing when it's time to sell, and mistakes owners make during the sales process. Today, we have him with us to dive into his thoughts on these topics and more.
In your new book, you provide business owners with advice for getting their companies prepared for the sales process. Of course, there's always a decent amount of mergers and acquisitions activity swirling around the accounting industry. What selling trends do you see going on right now, especially due to some of the hardships experienced during COVID-19?
[Warrillow] The big one is more business owners are looking to sell than ever before. We've done research over at Value Builder. We have business owners go through and answer a questionnaire about their company. Before the pandemic, we found that most business owners will plan to hold their business for at least 10 more years. During the pandemic, the data has changed whereby the average business owner has brought forward their sell by date by about 20%. The pandemic has been really difficult for a lot of businesses, in particular service businesses. Many are throwing up their hands saying, "Enough is enough. I want out." This has been a trigger that's caused a lot of business owners to think about selling.
When you think about an owner of a CPA firm, how do you think they should know when it's time to sell? What are the signs?
[Warrillow] When you reach the freedom point. The freedom point is the point at which the sale of your practice would generate enough liquid wealth that you could live comfortably for the rest of your life. I think when your practice is that valuable, it's worth asking yourself the question, “Is now the time?” Now, for some people, they have inherent value in building their firm. They love serving clients and all those things are great.
I think the one question though is when you reach the freedom point where the sale of your practice would essentially create enough wealth that you could live for the rest of your life, it's worth at least asking the question. Every day you hold your firm beyond that point, you're effectively like a gambler at the blackjack table. You are effectively risking freedom for the next tranche, the next rung of the ladder that you may not aspire to or may not value. Again, I think most business owners I talk to, their highest aspiration is for freedom. When you reach that point, it's just worth asking the question.
What are the biggest mistakes CPA firm owners make during the sales process?
[Warrillow] Getting lured into a prop deal. EY or KPMG or BDO or any of the midsize firms call you up and say, "Hey, we love what you're doing. We want you to be part of the BDO family, or the Grant Thornton family." I don't mean to pick on any of those syndicates, but effectively what you're doing is getting lured into a prop deal. A prop deal is where the acquirer negotiates with you without competition. What gives you, as a CPA firm owner, more clout, more leverage, is multiple offers. They do that. They lure you into a prop deal in an effort to ensure there is no competition for your firm and that creates a whole sort of domino effect of negative outcome. The biggest mistake is being lured into that conversation without creating competitive tension first.
How can a CPA firm owner let potential buyers know that they're interested in selling without looking desperate, which would affect that idea of the firm being wanted by people?
[Warrillow] Dan Sullivan, founder of Strategic Coach, talks about this notion of most owners thinking about problems in terms of “how problems,” like how can I create my business? How can I find a buyer without looking desperate? That's a “how” way to think about the problem like “How do I do that?” What Dan Sullivan talks about is the best entrepreneurs think about problems as “who problems.”
In other words, who do I need to hire in order to sell my business to the point where it doesn't make me look desperate. I think selling your business is a “who problem,” not a “how problem.” I think you need to hire an outside firm, an M&A firm or a business broker, someone who can do that for you. That's their job is to create competitive tension and ensure that you can go through a process without looking desperate. Again, I think it's a “who problem,” not a “how problem.”
For a CPA firm owner who is thinking of selling, at what point do they have to notify their employees that they have that idea in mind?
[Warrillow] When the check clears your bank account. You never want to tell your employees. What I would suggest is that most people listening to this, most CPA firm owners, are deeply loyal to their employees. Many of them hire family members, treat the ones they have as if they were family members, realize they would not even be in a position to sell their company if it were not for the employees that have brought them to the dance, so to speak. That loyalty is admirable and very deeply held.
However, if you share the fact that you are selling your business with your employees, they're going to take one or two actions. The first is going to be they'll brush up their resume. The second is to update their LinkedIn profile. They're going to shop their industry experience they've gotten with you as an associate or partner at your firm, and they are going to go to your competitors and say, "Look, Bob is thinking of selling. I'm a great associate. I know lots about" whatever specialty you have.
The industry is going to find out you're for sale. That lowers the negotiating leverage and ultimately can derail a sale. Look, you've got to obviously reveal to your partners that you are thinking of selling, but to your rank-and-file employees, your associates, your nonequity partners, I don't think they find out until the check clears your bank account.
As you mentioned earlier, one of the best ways to get bang for your buck on a CPA firm sale would be to have multiple buyers interested. Are there any tips that you'd offer for a CPA firm looking to create a bidding war of sorts?
[Warrillow] You're absolutely right. The bidding war gives you more leverage. You've essentially got to run a formal process. The formal process is where you start with a large swath of potential candidates to sell your firm to. Again, the biggest mistake most accounting firms make is they fall into the hands of the first firm that expresses interest. Whereas what you want to do is get a whiteboard out and think of all of the firms that would have a reason to buy yours.
Obviously, the big national firms, obviously the big super regional firms, the regional players. What you want to do is then scrutinize that list using something called the “5 to 20 rule,” and the 5 to 20 rule simply says that the natural acquirer for your CPA firm is going to be 5 to 20 times the size of your firm today. Let's just put round numbers on that.
If you've got a million dollar CPA firm, you generate a million dollars of revenue, the natural acquirer for that firm is going to be a firm varying between 5 and 20 million in annual revenue. Although you may want KPMG to buy your firm or EY or whoever, it's much more likely that it will be a regional player that buys a one million dollar firm to add some more revenue to their docket. Again, the 5 to 20 rule is a rule of thumb. It doesn't always hold true, but it's just a way for you to zero in on the most natural acquirers for your firm.
Are there instances when buying a CPA firm where a potential buyer might want to talk to current employees or customers? If so, how do you handle that? Is it something that's allowed?
[Warrillow] It's one of the trickiest parts of the sales process because, you're right, put yourself in the buyers' hats. They're going to want to scrutinize and talk to your customers and talk to your employees, yet both of those acts will undermine your leverage in negotiation. Because as soon as they've talked to your employees, they've talked to your customers, you are making yourself susceptible to something called retrading, where the acquirer makes up – in some cases, manufactures – a reason to lower the price they've agreed to pay for your business.
Retrading is one of the dirty little secrets of the world of M&A. It happens all the time. It happens because you give up negotiating leverage, in particular by letting them talk to your employees or customers, and so both of those things are to be avoided at all costs. What I would recommend is something called staged due diligence. When you sell a CPA firm, you agree to a letter of intent, where you've got an LOI, where it's non-binding, but you agree to primary terms. Then, there's due diligence and due diligence lasts usually 60 to 90 days. Then there's a closing, a share purchase agreement that is signed.
During that diligence phase is when they're going to want to talk to your employees and customers. What I would recommend is that is the very last gate they need to cross in order to close the share purchase agreement. It's not the first. You may ask why. The reason that is the case is because you want them to invest considerable amounts of time and money in the deal before you give them access to your employees. Because that way they've got a sunk cost effectively in the transaction.
They're going to hire third-party individuals to do that due diligence. They're probably in $50-$100,000 of due diligence fees before they start talking to your employees. It's a gating process. It ensures that you don't do that too early in the process.