For CPA tax practitioners, two general concerns weigh upon the minds of those nearing the time for an exit to retirement: tax season and the landscape for mergers and acquisitions (M&A). These two disparate concerns may not be as separate as they might seem. One can affect the other. But how? That’s the question we asked Ira Rosenbloom, chief operating executive for Optimum Strategies LLC in West Caldwell, N.J. He explains in-depth some of the tax season metrics both parties should be looking at during M&A negotiations, and what CPA firm leaders should be focusing on in the 2019 tax season if they are considering an exit in the near future.

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By: Bill Hayes, Pennsylvania CPA Journal Managing Editor

Podcast Transcript
Two things that have a significant impact on CPAs are the idea of business succession plan and especially tax season. But how does one affect the other? To get an idea about this as we ramp up for the quickly approaching 2019 tax season, today we are with Ira Rosenbloom, chief operating executive for Optimum Strategies LLC.

When it comes to mergers and acquisitions, has an organization's tax season operations always been a major factor to consider, and has it increased over recent years? And if it has, why do you think it has?

Well, tax season has always been vitally important to any succession plan because most accounting firms make their real money during tax season. And over the last number of years, we now see that there are actually two tax seasons. There's the traditional tax season of the winter months which affects a number of individuals and a number of small businesses, and then you have the secondary tax season in September and October, which affects traditionally higher net worth and larger entities. So the ability to make your way successfully to your tax season is all about the inner fiber of your firm. And if you're considering doing a merger, you need to know that whoever you are going to merge into has the infrastructure to make your season hum.

And at the same token, if I'm considering as the successor bringing somebody in and I've got my own shop running at full blast, how much more can I take on during my high season to make it work? And tax season now has become increasingly more important for several reasons. One, we live in a digital world. And years ago, people would have much more contact with their clients throughout the year. But now we can put a great emphasis on the efficiency and utilization of electronics, so there's not as much dialogue and communication, but the tax season meeting seems to be a tradition that continues.

This is the opportunity for both firms to speak with their clients and to get their arms around what the future could be. So the ability to not only confer with your client from the standpoint of your strategy, but the ability to actually spend the time with the client during tax season. Getting back to that opening issue, this is where we make our money. Are we going to have the people power to spend properly on communicating with clients? That's becoming more and more important because it's one of the fewer opportunities to actually have a conversation. Secondarily, because of technology, one firm may be much more advanced than another. You need to see how far apart those technologies are because, again, we drive so much throughput in that engine during that busy season, tax season puts a big stress on it. And if we're talking about a group that is behind the curve, how quickly can we get you to the curve? And if we're talking about a group that's beyond the curve, well, that could be a very exciting transition to bring both parties into a much more efficient and effective world. And this is where we put everybody under the test. It's all about what can you do during your utmost stress?

There's four types of issues that need to be considered during mergers and acquisitions that get magnified around tax season. We're talking about operational, client, performance, and financial matters. Let's take a look at those one by one. What are the operational issues that need to be considered?

[Rosenbloom] Well, the operational issues are all about do we have the right system to move the work through the office or through that practice? And the system is not just about people, but people are very important to it. But it's the support mechanisms that go into it. Technology becoming increasingly vital toward reducing the stress on people. So operationally, we need to be sure that you're going to have a system that will get you through this particular season. And at the same token, it's the system that you're alert to that may tell you that to get to the next level, it's going to require a significant investment. And at a certain stage in practice, you're reluctant to make that investment. So you've got to look at it from the standpoint of “I am potentially exploring finding my successor, whether it be internally or externally. What are the innovations that may be required to move this practice forward?”

Operationally, it's a huge issue that has to be focused upon, and tax season again is where we're putting everybody under that test. All of these systems have to perform, and we need to see whether or not there needs to be tinkering or whether this is the indication that if I'm the successor, I'm really ready, my system can take on more. And if I am looking for success, I see that to continue to prosper, there's some innovations that I may or may not be prepared to make, but I recognize that I have a good business, and I want that business to be there. That potentially is that green light to move through, but you'd need to be alert through that season as to where you see your system/operations going, and do I need a different type of person? Is it an infrastructure in terms of my administrative support? Or is it something at the accounting side? That is very relevant, and, again, this is where we see everything happening sometimes 24/7.

What about the client issues? Obviously those have to be pretty important.

[Rosenbloom] Well, the client issues are maximum importance. If you don't have clients, you don't have to worry about your staffing and your system. So, again, this is the opportunity during tax season to spend quality time with your clients. And there are some clients who will express to their accountant that they have the curiosity as to what the future of that accounting firm is going to be. And they would never do that in a way with which they can't have the face-to-face conversation. No one's going to do that via email. The importance of being able to share with a client and understand where they're coming from, what the future would be, and how to support that future is something that is mutual in priority. The clients need to know that they'll be taken care of, and you need to understand in what fashion they want to be taken care of if you're the person or persons looking for succession. And that, again, could be internal or external.

There could be a wonderful bench internally, but some of your clients may not realize that that bench is there, and it's your chance to articulate that and to prop up that group of professionals in front of the client so that this year they're spending more time with whoever it is you've determined internally is going to be the right person, or test to see whether that is the right person, and putting the right emphasis on responsibilities for that internal group is exactly what you want to do during the season. You want to set up a series of goals and objectives so that your client is being properly served, but your staff understands what's expected of them so there isn't going to be a mismatch on that level of expectation. That's the importance, if you're looking to potentially find your successor.

If you're the firm looking to grow because you feel more comfortable in acquiring versus being a huge business developer or an organic growth specialist, then you need to be sure that your clients won't feel that they're going to become second-class citizens because you're now bringing in a whole group of other clients, and you've invested so much in the relationship with those clients. Most accountants have their clients for an extended period of time because most accountants are phenomenal, trusted advisors. You don't want to let your client down and give them the impression that you can't be there for them. The ability for both sides to get a sense of where the mindset is, again, it's all about conversation. It's all about interaction, and tax season is when that happens.

Just before we move on to the performance issues, just something when we were talking in the lead up to our discussion today, something that I found really fascinating when you're thinking about the people who are moving toward retiring, that if they're two years out from retirement or exiting, they might have the opportunity to have two conversations with the clients. You think of it as being that you're in touch with the client all the time, but when you have a lot of clients, it's maybe once per year and so the time that you have to figure this stuff out isn't as copious as you would think.

[Rosenbloom] It is a very, very challenging process. Even if you can overcome your own personal emotions about the change, which is a challenge in and of itself, we do have limited time period, and the limited availability of your client to be part of that limited exchange is precious. You've got to put that to good use, and sometimes it's three years ahead of time that you really need to push that process for three tax seasons, which could be three meetings or four meetings. That's the world we live in.

What are the performance issues? What else should be kept in mind there?

[Rosenbloom] Well, performance is all about the expectations of your personnel and the turnaround process. Clients expect to get their tax returns or their financial statements, or their advice within a given period of time. And to the extent that you're experiencing challenges with that, that's going to create a crisis of confidence between the client and the firm. We need to be able to set criteria which will be the standard for turnaround time, and the standard for which we communicate. And everybody in your organization needs to be held accountable within reason. There's going to be crisis and there's going to be errors, and there's going to be mistakes that come about. This is not about perfection. But if we don't have clear and well articulated goals, both metric as well as tangible product, we are going to have a really big problem on our hands in terms of the ability to successfully pursue any type of merger.

If I'm the successor coming in, I don't want to come into a mess. I might be able to acquire your practice at a significantly lower number because there are things that are in need of significant improvement. But, by and large, accounting firms are not looking for fixer-uppers. They're looking for more turnkey opportunities where new services can be added, but not corrections of the old. So performance is vitally important so that when you have your conversations after tax season, the people who you're talking with will look at a very healthy or strong set of results. But if you don't program your own people to understand the expectations, you're taking a huge gamble on what those results are going to be. Recognizing that many things are out of our control. We may be waiting for information from clients, but how are we going to use our time when we're still waiting?

How are we going to be as efficient and as responsive as we should be because we want to be there for our clients? And this is all about perpetuity. This is not about just saying we're ending this and it's somebody else's problem.

And moving onto the final one, the financial issues. How do those affect matters, especially around tax season?

[Rosenbloom] Well, here we live in a world, and it's not unique to Pennsylvania, it's really a world of a national focus. Much more so on business clients than individual clients. Now, of course the first tax season is heavily oriented toward individual tax returns.

The focus is going to be on the number of individual returns and the average fee for those individual returns, because there is much more upside on a business return than potentially on a common individual return. High-net-worth individual returns are always in demand. But a very simplistic return is something that is not in demand. So the need to have an average rate on 1040s and on all types of what I'll call basic compliance is something that is very relevant, because the business of accounting is moving heavily toward return on investment. How much production can I get out of a given person? We're moving further away from the charge-hour goal and as much as the production per person. So if I can get $300,000 of production from someone and not need to have 1,500 hours to do that, I'll have a happy employee, and I'll be the happy boss by getting that.

So the revenue levels are very, very important. The turnaround time. Being sure that there are time sheets and a time recording system in place for tax season with very, very strong areas of functionality. Because the next firm may be technologically more advanced, so the time that it takes to input a return, which one firm may do highly on a manual basis, another form may do electronically. And when they do the due diligence on your firm, they don't want to just look at globally. It took 10 hours to do that return. Well, it took two hours to input that return? We could do that in 15 minutes. So the need to be very, very on top of the tasks within your firm is going to be relevant and understanding what the marketplace is for 1040s, tiering your practice to understand your A, B, and C clients.

These are things that both parties are going to discuss once they get into that discussion, and traditionally those discussions are hot-and-heavy coming May and June. So you need to have all kinds of data and all kinds of talking points – both sides – which you will uncover by delving into the right kind of metrics which support that process. What's my average fee? How long has that client been with us? All that kind of information, which is not hard to get because we have robust databases. But if you don't use your database, it's going to be very hard.

What sort of metrics should both parties be looking at and focusing on during those negotiations? You mentioned a couple there, but in particular what metrics are impacted by tax season?

[Rosenbloom] Well, clearly the average rate per hour. When we talk about the average tax return fee, we are looking at the end of the day about how much revenue per person. So to the extent that firms are still hour-based, which still many of them are, what is the average rate per hour? And we're going to see different rates per hour depending upon the different type of service. Tax services are generally at a higher rate per hour than test services or audit services, and bookkeeping services. So how much is that number and how far apart is it? And what's the concentration within your practice? The more upper-end type of revenues, the greater the interest will be in terms of going out into the marketplace. So that is a critical area, and the utilization. How well utilized are your people? That is critical as well, and it works both ways.

The firm that may be interested in being the successor may be doing a great job of growing, and even with technology helping them, they still need more people. Well, if you have the ability to provide personnel but your utilization is low, that's going to be meaningful. That utilization statistic is really important toward the process. At the end of the day, CPA firms are transacted on the basis of restated profit and the potential profit. The fact that, prior to a merger, I can operate in a certain fashion with a high profit margin doesn't mean that the successor is going to see the practice in the same way. As a matter of fact, the successor is going to actually have an overhead infrastructure that a smaller firm wouldn't have. If it's a smaller firm merging up. If it's a merger of equals, then there's going to be some economies of scales that's going to come out of that.

These are the kind of potential areas that the parties want to go into a conversation knowing – whether there are economies of scale, knowing whether there's going to need to be an investment, and knowing whether the potential to deliver new services is going to be there. Not to the nearest penny, but to the extent of range. Because no matter how good people do in integrating practices, there's always going to be fall-off. Some client is going to wake up and say, "I never expected that you would do that, and I'm not happy about that." So could there be other revenues that we could generate from another client that will far exceed it? Where are those services going to come from? The greater the potential for that, the better the transaction is going to be for both parties, and ultimately the more money will go into both party sides.

If the potential isn't there to have escalated revenues and escalated profitability, it's not going to be a transaction that's going to light people's excitement. But at the same token, people do strategic things. So if they're looking to have a greater concentration in a particular niche, they may not be turned off by the fact that there's compliance coming with it because they're looking to position themselves, because later on down the road something may happen. But the focus on profit today and the future is how transactions happen, and those firms that reflect a lower potential are firms that are valued at a more modest space.

You talked about the focus on financials. Let's see if we can focus on something that's a little more intangible here, but still heavily important: culture. Can the culture of an organization that is getting merged in effect these negotiations, or even the culture of the one doing the merging?

[Rosenbloom] It's tremendously significant. The easiest part of M&A activity is to figure out the formula and the finances. The hardest part is to generate an effective integration. An integration is not just about how the clients are going to feel. It's heavily about how are the people going to feel, what's their role, what is their level of input? Are they going to feel like they were lost now in a big sea or are they going to feel like they're part of the ocean with everybody else? And that's something that a lot of time has to go into focusing on where our comfort zones are. It is in some ways about the ability to be flexible, that larger organizations generally can provide greater flexibility. We have a tremendously increasing number of people who work virtually who can do things at their mutual convenience. Smaller firms find that to be difficult to implement.

Well, if a small firm is going to move into a firm that provides that, the leadership of the small firm may find it very hard to accept that transition. It doesn't mean that intellectually they don't get it and they're not supportive, but practically speaking, it's a very hard thing. So the culture is vitally important. Many transactions unwind not because of the finances, but because there is a very rocky integration, that people aren't made to feel at home, that there wasn't a sharing of the best practices. That one just dictated to the other and somebody might be more passive and the other may be more aggressive. But the staff didn't have a say. And that's why it's important at the right time once the deal has been negotiated to bring in the other levels within the firm to be a part of the due diligence process, to be a part of the conversation so that people can understand that there'll be more right than wrong.

Will it be perfect? Impossible. But those firms that are comfortable inviting their managers and their seniors into the dialogue are the firms that are going to be much more likely to have a healthy integration, and much more likely to make the right decision. People are nervous, on both sides. This is not a matter of the people on the smaller end feeling nervous that they're going to get fired. The same thing can be said for the people on the other side. "Oh my God, these people are now coming in. What's that going to be to my future?" Anxiety is a common element to both sides of the transaction, and not being clear as to where and how the integration is going to work. Even if culturally they're feeling really good about each other, they get along very well. The more that people can have buy-in, the more that they feel that they played a role in it, the greater the success factor is going to be.

Some people are not good at transparency. Some people are very guarded. That has to be broken down. Especially if it's a short-term integration. Sometimes it's a longer-term integration. There's a dramatic difference between somebody who is a year away from retirement who is going to merge into a firm and in one year everything has to happen, versus a merger of two firms where the leadership could be in place for the next five to 10 years. Very different things are going to unfold there, good and bad. But the need for the people who aren't owners to have a role in the conversation and to not be blindsided by it is a game changer.

I think that's so fascinating: the small things that need to be considered when you mention the idea of one firm's fine with people working out of the office and the other one isn't. Those are the little things that need to be negotiated that you don't always think about.

[Rosenbloom] There are so many little things that make a big impact.

For the person who's retiring or exiting, are there different tax season questions or just acquisition or merger questions in general that need to be asked by a successor depending on whether they're looking to sell with an external buyer versus an internal successor?

[Rosenbloom] I think there are differences in the worries that exist. If someone is looking to transfer their practice to a group of professionals who have run their firm for a number of years, the worry by the person looking for succession that the successor won't run a business effectively is diminished, because these are people who have run a business. When you're talking about an internal succession, how much opportunity have you given these people to really run a business? You've given these people great opportunity to learn how to be wonderful accountants, to have great relationships with their clients. But if it's internal, you have to sit back and say, "I can't do this a year before I'm going to stop. I’ve got to start three years ahead of time and get these people into some type of pathway to ownership where together, we're sure that we all have confidence that they are comfortable becoming an owner and an entrepreneur," which is different than being a business developer. Business development is vitally important, but that's only one part of running an accounting firm.

So my worry will be different, or my priorities of anxiety will be different depending if I'm looking at something internally. The advantage to somebody internally is they've been working on that claim for a number of years where if I merge with a stranger, these are strangers. I don't think my client is going to leave if I keep my succession internal, if I'm fortunate to have that. But even my internal succession, those people may say to me that they would be more comfortable if the firm merged with somebody else, and that can be a win-win. But will the other side be open to that? They shouldn't be, but, again, how does that all fit in? If a partner on the other firm has to have X amount of business and X amount of business development, and you're more liberal on your end, then you don't require that. Will they permit this person to be a partner in that next organization? Will they be called something less than that? And now will your clients have a crisis of confidence?

You have to be thinking about this as you're thinking through your exit. The worst thing you could do is say, "I’ve got one year to go and I'm going to do this with one year lead time." This is now a process that is a definitely two- to five-year lead time, especially if you're doing it internally. If you're doing it externally, you'd be on the shorter end of that side. But if it's internally, you need to test that. These people have to feel comfortable themselves. There's a high likelihood that years ago one practitioner would feel comfortable if he or she had two people in the bullpen. Today, given the different lifestyles and the work/life balance, you may have three people in the bullpen to get it done because people just don't want to put in as many hours.

Now, if you're willing to reduce the size of the practice and raise your rates, then you could do it with two people. But that's a transition in and of itself, and the internal successor has to feel comfortable that there's real profit there. The transparency of the financial information is vitally important. How transparent am I going to be as I'm preparing for my internal transition? It's not a comfortable place to be for either party. But when you're thinking that I'm doing this to put an end, you have to think about where the hot buttons are because they're on both sides. You've got to map it out for yourself, and ideally brainstorm with someone who is objective because you could get very dramatic about it, which is not going to be useful to the process, and you could also forget things, because you're so dramatic, that are very functionally important. That's something someone should start thinking about if they know two and three tax seasons ahead, that this is something they want to do. This is the right time of year to plan all that out so that they look and feel right, at the right time.

I guess the internal successor, you have to have that conversation pretty early to figure that out.

[Rosenbloom] That is vitally important. And it has to be a willingness. Just the fact that I have the confidence in that person is not enough. The person has to feel that this is something that number one, they're confident in, and, number two, that they want to do, and that they will be able to do it in their way. If they have to continue it the way that you did it for 40 years, there's a high likelihood that they're going to say “No.” It has to become theirs. And the sooner you make it theirs and show an open-mindedness toward it, the better it is.

So are you going to make tax seasons easier or less intense as you work your way through? That's a real big sign to that next generation that you're working along with them to see that succession happen. Or if you're going to say to them, "You know what, in three years it's going to be yours. You may make changes, but until then it's my way." You're not going to have an internal successor.

Can the way an organization operates around tax season serve as a motivating factor for a buyer to close the deal? Obviously, it's an important part of any CPA firm or practice.

[Rosenbloom] It is hugely important, going back to our opening part of the conversation. The traditional accounting firm makes its money during its busy seasons. We have a growing level of nontraditional services. But unless you're a boutique firm, the vast majority of what you're doing comes from compliance and the consulting around the compliance.

To the extent that your tax season is efficient, robust, strongly profitable, practically profitable, it's not just about raising the fees, it's about getting the right value for what you do. And sometimes your fees are proper, but we have procedures that are clocking the system, and we need to fix that. You have to recognize that having a system that is highly functional is going to be to your benefit if you're merging in, and certainly to your benefit if you're going to be the successor. People looking for a succession externally have a tremendous level of expectation of the next firm. They put the bar very high. That succession needs to understand that, and the way that the firm is looking for succession, that firm potentially looking to exit, they look at it and say, "Where were we going to be during tax season? I'm doing this to have an easier tax season. I'm doing this so I don't have to worry about the FedEx man showing up and whether the envelopes were taken care of. I'm doing this because I don't want to worry about if we missed an extension. I need to have that sense of confidence that your system is better than my system."

But the other guy also needs to know that they're not walking into a war zone and that's what this is all about, improving yourself for the period of intensity. When you sit down right afterward, everybody complains. There is no such thing as a fun tax season. That doesn't happen. There's such thing as having fun when you look at the checkbook after tax season, and there's gratification from helping your clients. And you can have fun at moments during tax season, but this is a very hard time. It's like Christmas season in retail.

The good thing is people are happy when they get what they were looking for, but it's long hours and it's a lot of back and forth. It's important to have people functioning in prime fashion during prime time. The better that each party looks right after tax season, the opening question is “How is tax season?” And that's the opening part of that negotiation. You need to be able to talk about a lot of very significant factors which will be bold, hopefully bold to the positive. But sometimes they are bold to the negative, and that could be very compelling to somebody else.

It goes back to your statement: these firms are not looking for fixer-uppers. The profits could be there, but if they're having to pull from other areas to fix faulty procedures, it's going to drags things down.

[Rosenbloom] Sometimes during tax season, it's not uncommon for a client to sit with you and say, "I'm considering X, Y, and Z in my business," and you might say because there's no time, "Let's defer that conversation until after tax season," number one, because you didn't have any time and, number two, because it's not within your wheelhouse. The more that that pipeline of potential extra services is there or the more you tell the next party where we send out in a given year, X amount of valuation and X amount of due diligence and X amount of other consulting, the more attractive you're going to be to the next party, and that's something you’ve got to keep track of. And you've got to plant those seeds, but you also have to test – both sides have to test – and understand how their staff will feel about it and how their clients are going to feel about it. This is not a decision that's only based upon what the owners of the firm think amongst themselves. It's a very big decision, and it's a game changer. You want to change it for the better, not for the worse.

How should people who know they want this to be their last tax season, or they want it to be the last without a deal, put this tax season to good use as far as mergers and acquisitions?

[Rosenbloom] I think that to put the season to good use, you want to be sure that your A clients and B clients are properly taken care of. You've got to know who they are because they're the ones that are going to be the most in the radar screen for that merger conversation. That is crucial to how you map out how you're going to time the delivery of your work. There are many practitioners who will tell you that all their clients are A clients, or they treat everybody as A clients. It's great to know that they treat everybody as A clients, but nobody only has A clients. And sometimes delivering A service to a D client is a very poor place to be. The first thing you need to do is make sure you're taking care of your top-line clients. The thing is you need to be sure that you're taking care of your all-star employees, that you've got them on board. That they are going to be comfortable, that they're going to continue to be part of your team, and that they are not going to go off the deep end during this difficult time.

You've got to take care of your top assets. That's very crucial, and you've got to have data. You've got to know ahead of time what kind of data is going to be discussed, and make sure that you can deliver it promptly for those conversations. When accountants can't deliver data to other accountants, it sends a very bad message.