Don’t Ask Me Again!

There are certain phrases I hear with alarming frequency that well, have me reaching for the antacid.

For example, “It’s not the heat, it’s the humidity.” I’m sure you can drum up many more.

But there’s also the most annoying business-related phrases. Again, for example: “At the end of the day.” “Let’s think outside the box” and perhaps my most loathsome – “Let’s get all our ducks in a row.”

If I had hair, I’d be tempted to tear a good portion of it out each time some mush wit utters one of these overused expressions.

I’d like to add one more to that.

“What’s the multiple?”

I can always count on repetitively being asked that question each time I’m counseling a firm that is contemplating a merger. To be somewhat fair they want to know how much their practice is worth. And many don’t stop until they get an answer.

“What’s the multiple?”

Please repeat that because I didn’t hear it the first two times.

“What’s the multiple?”

Okay for the last time, I’m going to explain the concept of CPA firm multiples.

Determining a firm’s multiple is should be viewed as cause and effect. It’s critical to remember that the multiple is the effect – determined in large part by several distinct variables, which we refer to as the cause. Let’s examine each in depth.

1.  Cash upfront: What a buyer is willing to pay in a down payment can be heavily influenced by operational issues. For example, closing on a tax-oriented practice just prior to tax season is more likely to warrant a down payment, compared to closing the same deal in May when most of the billings have been collected. In most deals, the buyer is already making a significant investment to fund working capital, integration, training, marketing, and IT upgrades.

2.  Duration of the Retention Period:  In nearly 30 years of consulting on CPA firm mergers and acquisitions, we have seen virtually no deals that were not contingent to some extent on post-closing client retention. Retention periods of less than two years are becoming increasingly rare.

3.  Profitability. This refers to the buyer’s expected profits from the deal, not the seller’s historical profit. If a buyer firm can absorb the practice with no incremental increase in overhead, capitalize on cost synergies such as savings in labor and rent, create revenue synergy through cross-selling other services, leverage work the selling owner was doing to lower-level staff, and pay the seller in a manner that provides the buyer a current deduction as opposed to long-term goodwill amortization, this increases the buyer’s profitability and hence the multiple

4.  Duration of the payout period. For small firms, most payout periods are typically five-to-seven years. Larger firms tend to be paid with longer payout periods, sometimes even in excess of 10 years. So, why does that make a difference? Buyers tend to evaluate the profitability of a purchase of a practice based on the cash flow that will be generated. The longer the payout period, the smaller the purchase payments, therefore, the greater the annual cash flow from the deal.

Got it? Again, the multiple is the effect the above variables are the cause. So, the next person who ask me about it or serenades me with something like “let’s see if this has bandwidth,” I may just hit them with my calculator.