You want to sell your accounting firm, but do you know what it’s worth? In simplest terms, the value of a small business is some multiple of its revenue. The question is, what is that multiple? Is it one, two, or a higher number? In making this determination, several factors come into play.
The Terms of the Transaction
In theory, the multiplier method should assign similar prices to two companies that have the same revenues and costs. But that’s not always how it works out. For various reasons, one company might command a much higher or much lower price than the other. One reason involves the terms of the transaction.
Take the payment period, for instance. Are you asking for the full value of your business at the closing table? Or do you plan to allow the buyer to spread the payment over time? If you ask for the money up front, you might have to accept a lower multiple. But why? Because such a payment agreement places more risk on the buyer and puts it in a less-enviable cash flow position.
Then there is the matter of your current clients. They likely make up a significant part of your company’s intangible value. Prospective buyers might worry, understandably so, what happens if those clients jump ship once ownership changes.
To quell such buyer concerns, many sellers agree to a retention clause. This clause recalculates the sales price based on how many existing clients remain after a set time. Imagine that Firm ABC buys Firm XYZ. At the time of the sale, Firm XYZ is bringing in $1 million in revenue from its client base. The two firms agree to a sales price of $1 million (the multiple here would be one), payable over five years. They also agree to a retention clause that adjusts the sales price based on the percentage of existing clients remaining at the end of two years.
After two years, 80% of the yearly revenue from those clients is still coming in. Per the retention clause, Firm ABC must pay $800,000, or 80% of the initial sales price, for Firm XYZ.
If you include a retention clause, the terms can affect what buyers are willing to pay. A shorter retention period shifts more risk to the buyer, resulting in a lower multiplier and lower sales price. With a longer period, you shoulder more risk but can command a higher multiplier.
The Number of Interested Potential Purchasers
Supply and demand, the same dynamic that controls the price of everything, affects what you can get for your accounting firm. Owning a small firm confers a huge advantage here. Small firms can charge higher multipliers than large firms because they have more potential buyers.
The problem with large firms is twofold. One, the acquisition price of a large firm puts it out of reach for many prospective buyers. Two, large firms tend to have high overhead. The cost of absorbing a big company can be challenging to the buyer. It can take the buyer a long time to break even from a cash flow perspective.
For these reasons, many buyers shy away from big companies and seek to acquire small firms. With more potential suitors, you can put a higher premium on your firm.
The Nature of the Practice
The actual value of your business, measured in assets and liabilities, and revenues and expenses, represents only one part of the puzzle. You must also consider its perceived value. Or, more specifically, how prospective buyers judge its value. The nature of your business influences perceived value.
Certain aspects of a small business cause buyers to place a lower value on it. Is your business highly relationship-centred? A potential buyer might worry that it cannot replicate the connection you’ve forged with your clients. The buyer, therefore, might not be willing to pay as much as it would if your business were purely transaction-oriented.
Businesses with weak profit margins sell for lower multiples. If your company outsources many of its services and places a small markup on labour costs, a buyer might worry about scalability and income potential.
On the other hand, companies that cater to high-net-worth individuals command high multiples. Buyers love such companies and are usually willing to pay big for them. That’s because buyers recognize the opportunity to cross-sell and expand those profitable relationships.
Other Trends to Consider
Economic and political trends can also influence the valuation of your small accounting firm. Consider, for example, the retirement en masse of baby boomers. Many of these retirees have small businesses and, just like you, wish to sell them. This selling activity has put the supply and demand of small businesses into a state of flux. The number of sellers is even higher, but there’s little corresponding increase in buyers. The result is a buyer’s market in the business world and lower multiples.
If you’re ready to move on from your accounting business, you can cash out by selling your company to an interested party. By understanding small business valuation and the factors that affect it, you can make sure you get paid what your company is worth.