Accounting Practice Sales Reviews: Key Metrics and Considerations
Explore essential factors in evaluating accounting practice sales, including financial health, client dynamics, staffing, and common deal structures.
Selling an accounting practice is a significant undertaking requiring thorough evaluation. Whether preparing to sell or considering a purchase, understanding the review process helps achieve a fair transaction. Buyers seek assurance of financial health, operational stability, and growth potential, while sellers aim to present their firm favorably.
This article outlines the elements typically assessed during an accounting practice sale review, providing clarity for navigating the process.
Financial Metrics Used in the Review
A detailed examination of financial health is central when reviewing an accounting practice for sale. Buyers analyze the firm’s historical performance and future potential using quantifiable data. This typically involves reviewing several years of financial statements, often three to five, to identify trends and stability. Key documents include the income statement and balance sheet.
Revenue analysis is a starting point. Reviewers assess gross revenue trends, noting growth, stability, or decline. Distinguishing between recurring revenue (from ongoing services like bookkeeping or payroll) and non-recurring revenue (from one-off projects) is common. A higher proportion of recurring revenue suggests greater predictability, which is attractive to buyers. Average revenue per client may also be calculated to understand client value.
Profitability analysis examines metrics like gross and net profit margins to gauge efficiency. For smaller practices, Seller’s Discretionary Earnings (SDE) is frequently used. SDE adjusts net income by adding back expenses unlikely to continue under new ownership, such as the current owner’s compensation, non-cash expenses like depreciation, interest, and certain non-recurring costs. This provides a clearer view of the cash flow available to a new owner before their own salary, debt service, and taxes.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) might be considered for larger firms, though SDE is often more relevant in smaller practice sales. Cash flow analysis assesses the firm’s ability to generate and manage cash. Other indicators include billing rates, realization rates (collected revenue versus billed time), and the aging of accounts receivable, reflecting collection effectiveness. These metrics collectively paint a detailed financial picture for assessing economic viability and informing valuation.
Analysis of Existing Client Base
Reviewing an accounting practice involves scrutinizing its client base to assess stability, risk, and potential. Buyers look beyond revenue figures to understand the security and sustainability of the firm’s client relationships.
Client concentration is a primary focus. Assessors evaluate the risk tied to revenue dependency on a few clients. Concerns may arise if a single client represents a large percentage (e.g., over 10-20%) of total revenue, as losing that client post-acquisition could significantly impact finances. A diversified client base generally presents lower risk.
The composition of the clientele is examined, including the mix of individual versus business clients, their industries, and geographic locations. Industry diversification can mitigate risks associated with sector-specific downturns. Client longevity offers insights into loyalty and satisfaction; high retention rates suggest stability, while high turnover might indicate underlying issues.
The nature of services provided is also relevant. Reviewers consider the balance between recurring compliance work (like tax preparation) and higher-value advisory services. A strong advisory portfolio may signal deeper relationships and growth potential. Fee structures—fixed, hourly, or value-based—are also noted.
Protecting client privacy during this review is essential. Sellers usually provide anonymized data initially (fees, service types, industry) without names. Specific files might be reviewed later under confidentiality agreements, possibly requiring client consent depending on engagement terms and privacy rules. This analysis helps determine the practice’s operational health and the likelihood of client retention post-sale, influencing perceived value.
Personnel Considerations During the Review
The team within an accounting practice contributes significantly to its value, making personnel a focus during reviews. Buyers examine the staff structure, including roles, qualifications, and experience. The assessment determines if the team can maintain service quality and client relationships after the acquisition. Skilled staff with specialized expertise are valuable assets.
Compensation and benefits packages are reviewed to understand costs and potential liabilities. This includes salaries, bonuses, paid time off, health insurance, and retirement plans. Buyers assess the financial impact of retaining staff and integrating benefits, considering compliance with employment regulations. The terms of employment agreements, including non-compete or non-solicitation clauses, are also examined, alongside potential liabilities for accrued leave.
Compliance with employment laws is verified. Reviewers may check adherence to regulations like the Fair Labor Standards Act (FLSA), particularly regarding employee classification (exempt vs. non-exempt).1U.S. Department of Labor. Fact Sheet 13: Employment Relationship Under the Fair Labor Standards Act (FLSA) Proper classification is important to avoid potential back pay liabilities. Adherence to rules regarding employment taxes and non-discrimination is also relevant.
Staff retention is often a concern, as continuity supports client relationships and stability. High turnover can be a negative signal. Buyers evaluate the likelihood of key employees staying post-transition, and retention strategies might be discussed. The seller’s planned role after the sale is also considered, with transition agreements typically negotiated, sometimes influenced by financing requirements like those from the Small Business Administration (SBA), which may limit seller involvement duration. A stable, skilled, and compliant workforce enhances the practice’s attractiveness.
Transaction Structures Commonly Reviewed
The structure of an accounting practice sale significantly impacts tax outcomes, liability assumption, and finances for both parties. Two main structures are common: asset sales and stock (or equity) sales. Each has distinct consequences evaluated during the review, often leading to negotiation as buyer and seller preferences may differ.
In an asset sale, the buyer acquires specific assets like client lists, equipment, and goodwill, potentially assuming certain liabilities.2Internal Revenue Service. Intangibles The selling entity remains, holding assets or liabilities not part of the deal. Buyers often prefer this structure to select desired assets and avoid unknown liabilities. An asset sale usually allows the buyer to “step-up” the tax basis of acquired assets to fair market value, generating future tax benefits through depreciation and amortization, especially for goodwill under Internal Revenue Code Section 197, generally amortized over 15 years.3Legal Information Institute (Cornell Law School). 26 U.S. Code § 197 – Amortization of Goodwill and Certain Other Intangibles
Sellers often favor a stock sale, where the buyer acquires the owner’s shares (corporation) or interests (partnership/LLC). The buyer takes over the entire legal entity, inheriting all assets and liabilities. For sellers, especially C corporations, this can result in a single level of tax, typically capital gains, avoiding potential double taxation seen in C corporation asset sales (corporate tax on asset sale gain, then shareholder tax on distribution). For S corporation or partnership sellers, a stock/interest sale usually yields mostly capital gains, often taxed at lower rates than ordinary income, though specific rules apply to certain assets like unrealized receivables or inventory.4Internal Revenue Service. Sale of a Partnership Interest – IRS Practice Unit
The selling entity’s legal structure influences options. A sole proprietorship sale is treated as an asset sale for tax purposes. Partnerships and S corporations allow either asset sales or sales of ownership interests. C corporations can do either, but asset sales face the double-taxation issue.
A variation exists for S corporations and certain subsidiaries: the Section 338(h)(10) election. If requirements are met (including a qualified stock purchase and a joint election), a legal stock sale can be treated as an asset sale for federal tax purposes. This gives the buyer a tax basis step-up while legally transferring ownership via stock, potentially preserving contracts. The review process analyzes the chosen structure, the purchase price allocation among assets (affecting taxes for both sides), and the transfer of liabilities and associated risks.