How do established accounting firms deal with the challenges of succession?

Exiting partners and business owners want to maximise value while ensuring their clients and staff continue to be looked after. At the same time, potential partners often don't have the capital to buy in. This article explores this conundrum.

As COVID restrictions are gradually lifted, Australians are facing ever-increasing property prices and a rapidly ageing population. In the next decade, many people will make important life decisions which may include exiting and selling their stake in their business. This phenomenon is not just being experienced by your clients but by accountants and advisers too.

In accounting firms, there has always been the natural conflict between the older retiring partner wanting to sell out for the best price and the new vibrant and motivated partner wanting to buy in, while juggling their own personal financial commitments, which includes purchasing their own residential home.

As housing prices skyrocket, many households are borrowing five to six times their annual salary, then some. With the likelihood of inflationary pressures pushing interest rates up in the next 12 months, how will firms manage the succession process?

The considerations and options that might be available in accounting firms going through a succession process include:

  • Can the younger partner afford to buy in to the practice when the traditional path of using equity in the house is no longer available?
  • Will the older partner be open to vendor financing knowing that it may take 10 to 15 years to be paid out rather than 5 years? And what happens if the older partner passes away, or the firm stops being profitable? How are these scenarios resolved?
  • What finance facilities are available in the market to fund such purchases, and will they remain in the market as we start to experience inflation and potential tightening of the lending market?
  • Has the exponential take up of technology, both by the business and their clients, seen a potential deterioration in the traditional fee base and can a firm providing limited service offerings survive?
  • How will the shift to working from home, which is key to retaining staff, impact productivity?
  • Will the expected war on talent, which has already commenced in certain fields of accounting, rapidly increase staff turnover thereby impacting the ability of the firm to properly service the client?
  • What has evolved over the last 18 months in the accounting industry that wields a permanent change to accounting practices both from an operational or value perspective?

Many accounting firms don't have a formal succession plan. Those that think they do often fail to give the succession process sufficient focus. They may have had past success in this area and take the attitude – "Well it worked like this in the past, why won't it work like this going forward?"

Businesses are now more paranoid than ever with upcoming "unknowns" and this feeling of the "unknown" also applies to accounting firms.

These issues are "food for thought" for business owners of accounting practices.

Rapid Technology reliance

Technology and accounting software systems are becoming more intuitive with automating certain aspects of tax advisory services that the accountant historically did before. The exponential increase in the adoption of technology has never been more apparent. Personal tax returns are already being lodged by individuals themselves and the Government is pushing to further simplify the lodgement process. This kind of adoption could move into business clients if continued improvements in intuitive accounting technology and the interactions between business, their customers and their suppliers becomes so effective that a significant majority of the work can be automated. This opens the door to the client asking for a fee reduction.

So how does all this impact value on the accounting firm? Surely, it pushes values down. How will the older partner feel about reducing his/her price because of this reality?

One option that might be considered is the introduction of the "third party investor". This is where the young partner teams up with a sophisticated investor to assist in buying out the older partner. Or, for a sole partner practice with no obvious succession options, the third party investor may find a younger partner to take over the business.

War on Talent

In 2022, businesses will start to experience serious competition for talent.

This skills shortage, coupled with working from home becoming the norm, will see a new hybrid work environment. The way firms train staff and service clients will evolve also.

When we look at how our daily approach to work has changed, I note the following observations:

  • The use of Microsoft Teams and Zoom technology is standard.
  • There has been a substantial increase in technology usage to perform tasks, and;
  • Businesses are under pressure to pay more to attract and retain talent.

In recent weeks, several large law firms implemented pay rises across the board due to widespread concern staff will head overseas to fill the talent shortage in other countries like the UK. These firms are typically across global trends that may be about to hit Australia.

Selling the Accounting Practice – do I use a third party investor to assist?

In selling a business, the older partner may engage in a process of vendor financing the younger partner into the practice. This has been a common approach by accounting firms in the past but it does have challenges due to the natural tension that exists between older partners wanting to get the best price and younger partners wanting to have control of the business but "feeling the pressure" because the vendor financing process may cause the older partner to continue to want to "have a say" in the business.

The COVID lockdown has exacerbated this tension in some cases.

For many partners, COVID has accelerated the retirement plans. They don't have the same level of patience to go through the vendor process.

It is these current challenges where a third party investor may be able to step in and assist with the sale of equity.

Barry McGee of AZ NGA has successfully executed over 50 transactions in the past 5 years. McGee expects more people to "knock on his door" and ask him to solve their succession woes.

"Our purpose is to invest in professional services SMEs and support business owners to achieve their goals, be that, succession planning including financing for future leaders; banking and debt solutions; or capital for growth.

"For those planning to sell in the medium-to-short term, there are opportunities to link up with an experienced capital partner to continue building on your legacy and ensure staff and clients are properly looked after."

What happens if the older partner has no one to sell to?

Another challenge that may exist for an accounting firm is that only one older partner may want to retire. Perhaps they have had difficulties attracting talent and retaining that talent in the past. They are now faced with the simple issue of having no succession plan whatsoever.

When that older partner is ready to retire they do not have an obvious person to sell their stake in the business to. Therefore they are searching for an option or an alternative solution to selling their share of the business and maximising value on their exit. It is here, where again, the third-party investor solution can become very attractive.

Barry McGee says:

"AZ NGA's offer is flexible, with the ability to take a minority or majority interest in businesses and provide long-term buy-out options for shareholders"

"We are patient long-term investors and we are willing to work with business owners to understand their needs and concerns, and structure a deal that is mutually-beneficial for all parties."

Valuing accounting firms

In the current market it appears that the value of accounting and business services firms are somewhere between three to five times Earnings Before Interest and Taxes (EBIT). Those firms that specialise in specific areas of accounting are valued at different multiples and it will depend on the type of service that they offer.

Final comment

In summary, we often see small accounting firms disappear from the landscape because the founding partner has been unable to identify a financial exit option.

In the years leading towards retirement, the firm bleeds their clients thereby destroying any enterprise value that may have existed at the time the partner is ready to retire.

It is for this reason, in the current market, we are seeing significant changes occurring in those progressive accounting practices in what they offer and how they service their clients.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.