Earmark Podcast | Earn Free Accounting CPE | How to Sell Your Accounting Firm

Thinking of selling your practice? Join us as serial acquirer Michael Ly shares an insider’s guide to preparing, pricing & selling your accounting firm. Learn how to value your firm for maximum sale price, find the right buyer, negotiate win-wins, protect clients through transition, and structure creative deals - whether nearing retirement or just exploring options. Get practical tips from an active buyer on ensuring a smooth exit on your terms.

(Originally recorded on March 26, 2024, on Earmark Webinars+)

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Chapters

(01:34) - The Evolution of Reconciled: A Modern Accounting Firm
(03:48) - Insights on Buying and Selling Accounting Firms
(04:19) - Determining the Right Time to Sell Your Accounting Firm
(09:44) - Maximizing Your Firm's Value Before Selling
(16:53) - Adopting Modern Technology and Billing Models
(23:04) - Understanding Firm Valuation and Buyer Insights
(28:32) - Strategies for Enhancing Firm Valuation
(30:24) - Evaluating Potential Buyers: What to Look For
(32:11) - Client Retention and Revenue Strategies Post-Acquisition
(36:32) - Valuation Insights: Navigating Firm Sales
(41:19) - Optimizing Earn-Out Structures for Sellers
(43:44) - Non-Compete Agreements: Protecting Your Business Post-Sale
(46:11) - Common Mistakes Sellers Make and How to Avoid Them
(50:20) - Tax Optimization Strategies for Selling Your Firm
(54:03) - The Future of Accounting M&A Market
(56:33) - Closing Remarks and Resources for CPE

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Connect with Our Guest, Michael Ly
LinkedIn: https://www.linkedin.com/in/michaelly
Twitter: https://twitter.com/michael_ly_?lang=en

Learn more about Reconciled
Website: https://www.reconciled.com/about

Connect with Blake Oliver, CPA

LinkedIn: https://www.linkedin.com/in/blaketoliver
Twitter: https://twitter.com/blaketoliver/

Creators & Guests

Host

Blake Oliver, CPA

Founder and CEO of Earmark CPE

Guest

Michael Ly

Accounting & Fintech Entrepreneur, Co-Founder @punchpay_ & Founder @getreconciled

What is Earmark Podcast | Earn Free Accounting CPE?

This show is brought to you by Earmark, your source for podcast-based continuing education for accounting and tax professionals. You can earn CPE by listening to the episodes on this podcast and more! Sign up for our mobile app to earn free CPE whenever you want, wherever you go. Learn more at https://earmarkcpe.com.

EAP 69 - How to Sell Your Accounting Firm [Final]

Blake Oliver: [00:00:00] Is your accounting firm ready to deliver a modern client experience while improving your staff’s efficiency? ShareFile wants to help your business grow with user-friendly workflows and world-class security. You’ll find new ways to exceed client expectations during tax, audit, and advisory engagements. Stay tuned to hear more from our sponsor, ShareFile, later in the episode.

If you'd like to earn CPE credit for listening to this episode, visit Earmark Cpcomm. Download the app, take a short quiz, and get your CPE certificate. Continuing education has never been so easy. And now on to the episode. Hello, everyone, and welcome back to Earmark. I'm Blake Oliver, and today I'm joined by my good friend Michael Ly of Reconciled for How to Sell Your Accounting Firm. Michael, welcome to the show.

Michael Ly: [00:00:32] Thanks for having me on, Blake. Great to see you.

Blake Oliver: [00:00:34] We are recording live on the Earmark webinars platform, so please do ask your questions. Michael is a wealth of knowledge as a serial entrepreneur, serial acquirer of accounting firms, I should say. Uh, Michael has. Well, how many firms have you, uh, integrated into Reconciled now?

Michael Ly: [00:00:55] Three so far.

Blake Oliver: [00:00:56] Three. All right. And how have those how have those gone? Have they all been just fantastic successes?

Michael Ly: [00:01:02] Well, it depends on how you define success. But yeah, they've all been great learning experiences, uh, with both challenges, failures and wins. So it's been great. I'm excited to share more about it.

Blake Oliver: [00:01:14] Yeah. Um, tell us a little bit about reconcile. Where are you at now?

Michael Ly: [00:01:19] So yeah, Reconciled is a national, you know, online bookkeeping and advisory practice. We serve small businesses throughout the US. Started about eight years ago. We got team members throughout the US and about a dozen states. We serve customers in half the states in the country. And then we also have, um, about ten team members in Argentina as well.

Blake Oliver: [00:01:45] And how is reconcile different than a traditional accounting firm?

Michael Ly: [00:01:50] Well, there's probably a lot of different aspects to that or a lot of ways to answer that question. One is we don't have a central office that we all work from, so we're not based in one local community. We're not serving one major metro. All of our staff works from home or from a satellite office, and they work remotely, uh, serving customers throughout the US. So we basically see none of our customers in person. All of our services are done online and remotely, and we also are charging on a fixed monthly fee pricing model. So although that is not necessarily a new phenomenon in our industry compared to the percentage of accounting firms doing it in the country or in the world, it's a small we're still in the small percentage of firms that are billing on a SaaS revenue model or a recurring revenue model. So that makes some of the, you know, the intangibles unique. We also are very focused on our brand Reconciled as a brand. You'll notice that the company is not named Michael Ly consulting or Lee CPA services or Tax Services. So we're really focused on the brand where I really want myself, my face, my name to be removed from the brand identity. And I really want it focused on who is Reconciled and who. What do you get when you come to work with Reconciled as a customer?

Blake Oliver: [00:03:10] Jonathan in the live stream says, watch your video on how to buy an accounting firm last night. Loved it. If you haven't heard that episode or watched that video on YouTube, go check it out. Just search for how to buy an accounting firm with Michael Ly. And um, wait, is this one how to buy? This one's how to Sell. How to buy was the last episode. So Michael talks about everything you need to know as a buyer. And now he's going to talk about everything you need to know as a seller, having been a buyer so eager to get into that with you, Michael. So let's talk about like, timing. When is the right time to sell your accounting firm? What do you need to consider?

Michael Ly: [00:03:50] Yeah, I think there I think there's a lot of different ways to answer that question. And it really depends on the firm owner and when they're ready to sell. Now I'm going to make first the conversation really about the most of this conversation is going to be very focused on a single firm owner. Uh, but this also can pertain to a firm owned by multiple partners, because I've actually purchased both types. I've purchased firms that were owned by a single owner, and I've purchased firms owned by multiple people where I bought the whole firm from those partners. But really, it's a matter of is, is the firm ready to sell? And do you believe that you're ready to retire? For most firm owners in our industry, it's about retirement. And when they're ready to exit the industry, the accounting industry and I would recommend for most sellers is if you're going to sell your firm, sell it, sell it, and begin the conversation several years in advance and make sure that you're actually ready to exit the industry. There are firm owners that want to sell, and they're not ready to exit the industry. They're actually going to continue in the industry in some capacity or another. And I'll tell you, that limits your buyer pool. Most buyers don't want to buy it from a firm owner that's going to stay in the industry. There's a variety of reasons for that. One of them is they're going to be afraid, or assume that you'll go after the same customer base that they just purchased from you. And so. Why would you sell your firm as an accounting firm owner, if you're going to continue to do accounting work, that that's a strange idea to a buyer. So if you don't want to limit your buying pool, you definitely want to be able to to sell or prepare to sell when you're ready to exit the actual industry.

Michael Ly: [00:05:36] Another key sign of of of indicator of wanting to sell is there might be market timing, right? The market might be a ripe time to sell at the highest value. So there's certain times in the market where accounting firms are very attractive to purchase. I would say right now it's a very attractive time to purchase, because we're not yet at the height of all of the accounting firm owners selling their firms yet. So we're not at the largest peak yet. I would say that peak is going to be in another 5 to 10 years, where the majority or the largest number of accounting firms are going to be sold. So it's a very attractive time to sell where you can maximize valuation. So that's another. And I'd say the last one is you're at a place in life where you're tired. You're not showing up every day as your best self, as a leader. You're not willing to grow the firm anymore, or you just don't want to do accounting work anymore. That's probably a sign that you're ready to sell the firm. But I would encourage you before you get to that spot. If you're accounting firm owner out there, before you get to the place where you're tired and you're willing to sell your firm for anything. I would begin the conversation a couple of years before that, and I know that's hard to tell. When am I going to be tired? Because anything could happen and make you that you that spot. But it's good to start early in the conversation, right?

Blake Oliver: [00:06:59] It's like when you're selling your house, it's better to sell your house when you don't really, really need to do it right. When you have options, um, sell it before you're in contract under contract on another one. Right?

Michael Ly: [00:07:14] Right. Exactly. Yeah. And same with the firm is you don't want to sell it when you're in the middle of tax season and you're tired and you're upset at customers and you're upset at your staff, or you don't want to sell it, then because you're desperate and you'll you'll make decisions in desperation. You want to sell it when you're actually the happiest with your firm, and you want to sell it when you know the value of the firm, it's at its peak. And you you can get the best seller. You want to sell it. When people are really attracted to the firm right now, you don't want to sell it when it can barely function and staff are leaving and customers are leaving. That's a bad time to be selling your firm.

Blake Oliver: [00:07:54] It's a bad time because you're going to get a low valuation, because your people are unhappy, your clients are unhappy. It gives a bad vibe, for lack of a better term, to the to the buyer.

Michael Ly: [00:08:08] Yeah. And I also sell too. I would not wait until I would not wait until the, uh, the, the last possible age that you think you could work that would that would honestly be also a bad time because likely a buyer is going to ask you to at least stay on for six months, minimum, if not a year or two season, two tax seasons. If you're a tax accountant, they're likely going to ask you to go through a couple of tax seasons just to help retain the clients. And if you're in your final tax season and then you put this firm for sale, you're not going to want to be involved with that process. So I would I would not wait until the last final year that you that you want to do a final tax year. I would do 2 or 3 seasons before that. Put your firm up for sale and begin having the conversations.

Blake Oliver: [00:08:54] Robin says, love that. Sell when you are happiest. Counterintuitive, but it makes a lot of sense the way you've explained it. Michael. Buy low and sell high. Um, well, let's talk about the value. How do we. In advance. Make sure that we get the most value for our firm. Let's say, well, ideally, like how far ahead should I start planning on this, Michael? Like at least a few years, right?

Michael Ly: [00:09:22] I'd say a couple years at least. And I would begin talking to, uh, brokers if you were wanting a broker to represent you. And frankly, for most firm owners, I would highly recommend that a broker represents Brant represents the firm owner. The reason why is it's a full time job to sell, just like it's a full time job to buy a firm. Yeah, it's a full time job to sell. And remember, you still got to run the practice while you're selling. You can't let the practice fall apart in the midst of the selling. Just like having a house, you can't let the maintenance stop. You can't just stop mowing the lawn and taking care of the yard and taking care of the pool. Because you're in contract, you got to keep it going. Otherwise the pool will be green colored and the grass will be grown. And the, you know, the the buyers will come by and go, ooh, what happened to the house? I don't want that house anymore. So you got to keep it going. So I recommend that for most firm owners that that they get a broker or at least some advisors involved that can be a part of prospecting potential buyers. And then I would be talking to potential buyers a couple of years in advance, even if you're, you know, you're going to sell in a year or two, talk to buyers and say, hey, I'm going to be putting up for sale. And I want you to know that and I want to be in conversation with you to talk about what will you find attractive about the firm, what do you want the firm to be in the next couple of years in order for for you to want to buy it? And so you also have to then be ready for some transformation in that time, but again, a couple of years in advance so that you can get you can understand what the buyers out there are going to want from your firm.

Blake Oliver: [00:10:59] How do you get in touch with those buyers? How do you find those buyers? I imagine if it's a few years before you're going to sell, like, would a broker be interested in connecting you with buyers if it's that far out in the future?

Michael Ly: [00:11:09] Oh, totally. Brokers would love to. The best brokers would love to talk to you early. One is because then they can advise you on what the market's looking like. A broker might tell you, hey, actually don't wait two years. Let's start now because the highest prices I'm seeing are happening right now. And you've got a six month window or a one year window. Let's get you prepped right now. A broker may also be able to advise you, hey, what you thought was valuable with your firm, you're going to have to change. Or here's some here's some changes on service line or in software that all of the buyers we see today are asking for from our sellers. So they may be asking you to you to implement a specific workflow tool or a specific tax software. Maybe you're on an old tax software that's not cloud based or cloud hosted yet. Maybe they're going to ask you to transition to that over the next two tax seasons. Or maybe they're going to ask you to leave QuickBooks desktop hosted and go to QuickBooks online. Maybe they're going to ask you to shift from hourly billing time and material billing. The amount of firms still doing that, it's still 90 plus percent of the market is time and material billing, right? Well, they're the broker.

Michael Ly: [00:12:17] If they're smart is going to say, hey, can you convert? Start converting your customers in the next two years to a recurring revenue model? I'm going to be able to sell your firm for a higher value. So talking to the broker early is great. On the buyer side, that's that's there's a lot of ways to start that process. One is if you're in introvert right. And you haven't been outreaching to fellow peers in the industry, we'll start going to the CPA, the local CPA society meetings. Reach out to the CPA. If you're a member, go to the engage conference, go to the digital CPA conference, go to some of the bigger conferences that QuickBooks puts on or Xero puts on, and start meeting other firm owners. Contact your local regional, regional, big firm, CPA firm player. See who's out there in your market buying. Ask the brokers who's buying in this market right now. There's actually a lot of buyers right now. Both current accounting firm owners and non accounting firm owners are yeah are buying right now. So reach out.

Blake Oliver: [00:13:16] So that's a really interesting point is there are a lot of non accountants non CPAs such as yourself getting into the accounting services business. Um turning it into an industry. And how do we find those people I was talking with uh Eric friend of your part time controller. They're a top 100 firm, and they just sold to private equity. He just sold. He owned, like, 100% of the firm. Yeah, a top 100 firm, right? He sold to private equity. And he was telling me that, you know, the offers they were getting from the CPA firms in the space of similar size were just terrible compared to what he was getting from private equity. Yeah. So, like you're saying, go to the societies and meet the other CPA firms. But maybe that's not the best option for selling your firm. How do you find the other buyers?

Michael Ly: [00:14:05] For most firm owners, they're not going to be at a size where. Where private equity or outside private capital, outside of the accounting industry is going to be attractive for a lot of people. So there's probably two buckets. One is if you have a firm, a small firm, between half 1 million to $2 million a year in revenue, and you're doing decent margins, decent EBITDA on that, the buying pool is going to be other ferm, other ferm owners, other accountants that want to leave the practice they're working at to buy their first practice. And then there's also non-accountants somebody like myself, you know, somebody like myself or some grad, an MBA graduate from from Harvard, Stanford, think of the MBA program or somebody in corporate that's thinking about buying their first accounting practice. And now you ask them the question. You might ask the question, why would somebody that's non accountant want to buy an accounting practice. Oh I know. Yeah. Yeah. There's actually very profitable highly profitable. The businesses are highly profitable. It's considered one of the most profitable businesses in the US. And so the the the buying market is going to be pooled around individuals, generally buyers that are going to be owner operators of the business.

Blake Oliver: [00:15:16] Got it.

Michael Ly: [00:15:17] Once you get to 5 million and above, and especially with, you know, somebody like your part time controller or other brands that have a strong brand in the market, and they're growing rapidly and they have a strong presence nationally, you're going to then be a a potential candidate for a larger strategic buyer or a PE group, right? A financing group. And there are there are dozens of PE groups right now looking for their first accounting firm to buy. But generally the the low end criteria is going to be around 5 million minimum in revenue before they even talk to you, but ideally 10 million in revenue and usually 2 million in EBITDA or higher before they even talk to you. And that's frankly not most firms. Most firms are fairly small, hovering around really under $1 million a year in revenue. So they're likely going to have to sell to somebody else that's a practitioner in the space.

Blake Oliver: [00:16:15] So you mentioned two ways to increase the value of your firm. One was adopting modern technology and the other was adopting fixed fee recurring billing and moving away from hourly. Right. Of those two, which one do you think is the most important?

Michael Ly: [00:16:34] I think the revenue model is the biggest importance, mainly because getting the transition of your customer base from time of material billing to recurring revenue model, that's the hard. That's actually some hard work. You. You have a customer base that's so used to getting billed to you hourly. And that means that you as a practitioner haven't sold them the reasons why and the value of transitioning to a recurring revenue model. The reality is the market likes recurring revenue contracts, especially recurring revenue contracts that have a term like one year, two years, or three years. It's synonymous to a software software agreements where they have recurring revenue terms or enterprise software agreements. So that's actually a hard work technology transformation. A lot of a lot of younger owners and a lot of new buyers are willing to go through the headache of a technology transformation instead of the recurring revenue pricing. Right, because a technology transformation, a lot of your customers actually don't see any of that right behind the scenes. And you don't have to get you never have to get a customer's permission to do technology transformation. You have to you say, we're updating our own internal systems, we're doing movements. And so it's rarely that you have to ask a customer. They're going to be like, oh yeah, that sounds great. I've actually wanted you to update the technology for a long time. That's an easier transformation to incur than getting most of your customers to go, hey, will you will you sign this agreement and commit to paying me monthly for the next year or two years? Three years? And that's a lot of work that a buyer would like to see done before they buy.

Blake Oliver: [00:18:16] Stephanie on the live stream said, what kind of impact does the contract length have on enterprise value for fixed fee firms, for example, six months versus one year, etc.?

Michael Ly: [00:18:28] Yeah, that's a great question, Stephanie. Um, I would I would argue that it's too early to tell at a mass scale. I would say that you're likely going to move your firm value up by, you know, a 10th of a point or even 20th of a or a 2/10 of a point. Um, mainly because the amount of firms that are still at time of material is so massive that most of the firms you're going to see on, on, on the market are going to be in time of material phase. So the other question, the bigger question is what is the pricing difference between a firm billing time and material versus fixed monthly fee? That is what you're going to see in the majority of the time. What is it? And I would say you're going to move from you know, I've seen firms at time of material sell for 0.5 revenue valuation, half of revenue valuation and then jump up to 1.25 or 1.5 in revenue valuation. So it's going to be a it's a massive swing. But imagine even firms doing 0.8. I've bought firms at 0.8 to 1 times. Yeah. And I will tell you at fixed monthly fee I'm willing to pay 1.25 to 1.5 times revenue because I've already done that work. Right. Okay. So it's a big jump. That's a.

Blake Oliver: [00:19:43] Lot. That's a that's that is the financial reason to make this change is you could get $0.80 on the dollar for your firm, or you could get a buck 25 to a buck 50 on the dollar for your firm. And we're talking top line revenue there correct? Correct. All you have to do is change to a recurring revenue model.

Michael Ly: [00:20:02] Yeah. Well, that's we say that we say that it sounds easy, except, you know, for firm owners, it's a very difficult transition for most firm owners because they never thought that way. They haven't had the education around it. And all of their systems is built around tracking time and expenses and.

Blake Oliver: [00:20:18] Billing for the time.

Michael Ly: [00:20:19] After the fact. Right. Yeah. And and then hoping that the customer pays and hoping that the customer doesn't, doesn't, uh, you know, have any have any disagreements with that that, that time, time and material billing. So all the systems are built around that, even the tools that they're paying subscription. It's funny, the tools they're paying subscriptions for, for the systems to track time is on subscription basis and it hasn't clicked for them that they're that they could go out and do subscription based.

Blake Oliver: [00:20:50] You're not paying for the software based on the number of hours that you build a clients. That would be that would be an interesting strategy, right?

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Blake Oliver: [00:22:46] Any other surprising, any other surprising insights? Anything else you've learned from buying selling you know that that about valuation with firms.

Michael Ly: [00:21:08] So there's two things. One is most firm owners have it have a misunderstanding of what their firm is actually valued at today in the market. What is the market willing to buy them. So that's why talking to a broker, talking to other people who have sold and have talked to buyers and have sold their firm, it's going to help you level set. What is your firm actually valued at? And secondly, and surprisingly, most firm owners, the number one reason they're selling their firm the one criteria is not the firm valuation. So I would tell you that for most of the people I bought from, they did not put valuation as the top reason. It was probably the third or fourth or fifth reason. The top reasons for them were how you're going to treat my staff. What's the opportunity for them, for growth, for a job, for longevity? How are you going to onboard my clients? What are the, you know, how are you going to serve those clients? Because like I said in the beginning, most firms are based in a local community. They're serving community members. So they're serving people they they know at their church or religious place.

Michael Ly: [00:22:20] They know from their local, you know, uh, school, the nonprofit they've served at. Um, they, they, they go shop there or, or purchase products or services from those, from those customers. They golf with them. They know them from the country club or from the chamber. So you as the buyer are now to the seller's perception are going to impact. The reputation of that seller in their local community. So that's that's actually in the top is the how you're going to treat the employees, how you can treat the customers. And then what is the transition plan look like for the seller? Are they going to get how much cash are they going to get up front? How long is the seller going to have to be involved with the firm and the transition? And then what what is the seller going to have to do to either earn or ensure that they get paid? The remaining consideration of, of the of the price purchase price that you offered. So those were actually the majority or the criteria. That was the most important. The valuation was actually not the most important in the process.

Blake Oliver: [00:23:24] And I want to dig in more to those other factors with you as we go through this. Kathy says we are currently on fixed monthly fee for the majority of our clients and have been for a long time, but our contracts aren't for specific time frames. Would that affect it?

Michael Ly: [00:23:42] So. So for Kathy's sake and for anybody that has a similar situation like Kathy, where you have basically a monthly recurring contract, it recurs every month, but it's still monthly. A customer can cancel at any time. Then what's really going to be important is your churn rate, right, or your retention rate. So what a buyer is going to look at is how often do your customers leave you? How often are they leaving you from the moment they sign up? How long are they staying with you, and how are you able to increase their pricing over the time with you? Now those three things matter, right? They matter to a sophisticated buyer. One is how you know how fast. How fast does a customer leave you? That means our customer is happy with you in general, especially if you're if you're in the bookkeeping or CAS space and you're doing fixed monthly fees, how fast are they leaving you? Are they signing up for just the first six months? Because that means they're probably like a clean up client, likely, or they're doing a one time tax return or tax planning. Retention is how long are they staying with you or how often, how likely are you to going to keep them for how long. So you want that to be really high and you want the churn rate to be really low, right. And then you want upsells. How how likely are you to increase your average over time? That means you can you can increase or get the same customer to buy more services from you. That is a sign that you're the type of firm that obviously is good at selling the value and getting your customers to buy more.

Blake Oliver: [00:25:14] And I would encourage everyone to get a basic familiarity with SAS metrics software as a service metrics. Michael mentioned one of the really critical ones, which is churn. Um, there's also cost to acquire a customer. There's lifetime value of a customer, and you can actually compute the lifetime value of a customer. If you know your average contract value, you know what your typical customer pays you and you know your churn rate. So those two things, right. What is the average customer pay you every month and what is your churn rate. Divide that by your churn rate and you get your average customer lifetime value. And that is really useful information for a buyer. Because even if your month to month, they can say, well, based on the churn rate, these customers are sticking with this firm for ten years.

Michael Ly: [00:26:04] Yeah. Yeah, exactly.

Blake Oliver: [00:26:05] You can project it out, right. If you lose 1% of your customers every month, then we know that a typical customer will stay with you for 100 months. That's like, you know what, eight years?

Michael Ly: [00:26:18] Yeah. It's amazing. It's and that's amazing stat right. And that's even hard in software right. Software churn rates and retention rates. Um, so yeah, as Blake said get to know those. Another thing around firm valuation if most like, it's really important for a buyer to know how much of the billing, how much of the revenue of your firm is being billed by your staff versus you as the owner. And one of the little dirty little secrets about accounting firms is the reason why accounting firms have such high net income or net margins, is because the firm owner is billing so much themselves as an owner. Yeah. So what happens when you leave? If the buyer themselves can't either do the billings themselves or replace you all your net income is basically gone. If you think about how much you contribute to the bottom line as cost.

Blake Oliver: [00:27:05] Of labor at the end, you've got to hire somebody to do it.

Michael Ly: [00:27:07] Exactly, exactly. So. So the the attractiveness as a firm of being higher valued is, has the owner figured out how to have all the staff do most or all of the work, and the owner themselves is just doing sales and running the firm. That makes your firm very attractive to a bigger buying pool, because now you don't have to sell it to CPA. You're not relying on a CPA, making sure that they send off my tax return or sign off on every audit. You as a you can get an owner that just has good business acumen and good selling selling principles, selling, uh, selling practices. And they can then come and run your practice and continue to grow it. That opens up a bigger buying pool.

Blake Oliver: [00:27:50] Benjamin asks as a seller of a firm, how can I get comfortable around selling to a buyer? Perhaps someone like yourself who doesn't have a CPA accounting experience? What did you do to convince them that you were a good buyer?

Michael Ly: [00:28:03] That's a that's a great question, Benjamin. So for myself, for example, I actually have an accounting background. I've done accounting inside companies, but I never worked or ran or did audit or tax inside public accounting firm or never done really tax preparation myself. So one to get a buyer to to get a buyer for you to be a seller, to be comfortable with buyers. One is what's the track record of the buyer? Has the buyer started a business before? Have they run businesses before? What was their experience in corporate? What is the motivation around that buyer to buy your firm? What's their plan to if you're the if you're a CPA, you do a lot of billing. What's their plan to replace you? Do they potentially have a candidate or two that they already have set aside that they're going to hire and bring into the practice? Do they have a potential business partner that's a CPA? So that's all that's all really important for me. Obviously, I had Reconciled. I had built Reconciled for five years before I even started talking to the first firms I was going to buy. So that was really, really helpful.

Michael Ly: [00:29:02] And they, you know, obviously the sellers were able to see the brand. I was able to to buy or to build in order to, to propose. Secondly, I came to the table with financing. So as a seller, if your buyer comes to the table with financing, all at the end of the day, like when they when you sign a letter of intent and you're giving a buyer a period of time to bring the funds in for purchase, it's important for you to for the seller to know, hey, what's the likelihood of this buyer to close? And so if a good buyer is going to have the right financing at the table and the right process to get you from from signing the Loi to the close date, right? Just like when selling a house, you want to know the person you're selling a house to. What's the likelihood of them getting the mortgage approved and getting you to close? That's really important, because you could lose another 60 to 90 days and start all over if that buyer isn't successful. So that's really, really important.

Blake Oliver: [00:29:58] Look for a record of success. That's why once you're in the housing market, it's a lot easier to buy a house.

Michael Ly: [00:30:04] Yes.

Blake Oliver: [00:30:06] Exactly. Uh, let's talk about protecting your clients during the transition. And we have a great question from Greg to get us there. Greg asks, is there a standard client attrition rate when firm ownership changes? Do you have a benchmark? Michael.

Michael Ly: [00:30:22] That's a great that's a great question. I don't I don't believe that there's I haven't seen a market out there where there's a standard rate. I don't see the studies out there or a science around it. But I will tell you that I, I, I'm not surprised and I expect and I plan for somewhere between 5 to 10% of the client numbers, that the quantity of the clients that go away. And there's a lot of reasons why. But one is, um, if when for us, when we buy a firm, our pricing is generally higher. Our average price is generally higher than the firms we buy because we've spent time iterating on pricing, continuing to increase it over time. So we expect that there are firm there are clients of the firms we buy where they're getting what they call the friends and family discount. And they've gotten that for years. It's it's the family member or the friend that, that, that that said, hey, we'll do your your tax returns, we'll do your bookkeeping services, but we're going to discount it heavily. Well, that can only last for so long. And the reality is when we when we come into the picture, they're likely going to leave because we're not a friend or family of them. And secondly, we're going to raise their prices fairly quickly over that time period. So we expect that now revenue wise that's that's client attrition in numbers. But the revenue I expect to say the same or increase because of her pricing increasing increases and because we're we're actually going to start implementing the value of selling value, right. The practice selling value, which is the firms we buy from, they're almost all of them have done time and material billing. So the fact that we switched the selling value now and converting them to fixed monthly fee actually increases the revenue over time. And there's a lot of reasons for that. And I can talk about that if you're interested. But I do expect generally 5 to 10% of the client base numbers to go away, but the revenue to stay the same or go up.

Blake Oliver: [00:32:17] What is your goal in terms of revenue.

Michael Ly: [00:32:21] In regards to when I buy a firm?

Blake Oliver: [00:32:23] Yeah. Increasing it. Right. So you said you expect clients to decrease 5 to 10%. Yeah. What do you aim to increase revenue by?

Michael Ly: [00:32:30] I want to try to shoot for in the first year to, to increase revenue at least by 10%. So and that's while losing customers in, in in quantity. Yep. Um, because the, the customers that do stay the 90% that do stay, you get them on fixed monthly fee and you sell them higher value. So. Therefore you're increasing their, their rates and that that, um, defaults into a ten or at least a 10% increase overall in revenue in the first year.

Blake Oliver: [00:32:59] And what kind of services are you adding to increase the value for them so they're willing to bear this higher price?

Michael Ly: [00:33:06] Um, one, there's a technology upgrade. So you're doing a technology upgrade from something like QuickBooks desktop hosted to QuickBooks online. So you're giving now you're selling the value of real time reporting, right. And access for the client to to their financial reports in real time. The other thing is is advisory services. A lot of the firms we buy, they're not giving they're not doing true advisory services on a consistent monthly basis. So now we're going to sell that as a package on top. We're also going to add tax return services. If they're if they don't receive those from the firm yet. And also HR services as well. So HR services that we can add. Yeah.

Blake Oliver: [00:33:42] Yeah that's unusual HR services. Tell us more about that.

Michael Ly: [00:33:46] Yeah HR services would be at the at the administrative level. So think of um creating and administering an employee manual, creating an employee onboarding process, helping with employee screenings. Um employee onboarding process. Um, helping identify the difference between an employee and a contractor and defining that for the customer, creating a plan that financially that aligns with their growth plan. So there are all things around HR.

Blake Oliver: [00:34:15] That's interesting because those are things that we kind of do one off, we may advise reluctantly on that as CPAs or firm owners. And you formalized it into a an offering.

Michael Ly: [00:34:25] Right, right, right.

Blake Oliver: [00:34:27] Back to valuation. I knew that valuation would be a popular topic, which it always is. Stephanie wants to know what is the average revenue multiple when valuing a firm? Michael mentioned 0.8 to 1.5 times. Is that standard? Are there niches that are more attractive or higher value than others? For example, karst practices serving tech startups versus construction companies. Right. So multiple questions in there. So I'll let you.

Michael Ly: [00:34:55] Yeah. So the the remember as I said, I've said multiple times most of the industry is billing on time and material basis. So the average of most of the industry valuation is lower because of that reality. And so most firms you know, the average right now, if you look at any website, any broker website, and if you are in practice buying firms, most firms are selling around one times revenue. And I and I and I and I said that gives or take a few tenths of a point based on a variations of of reasons. Also the longevity of how how long it takes take to pay it gets to paid out. So one of the things that a seller doesn't realize is, okay, you can probably get a higher valuation from a buyer. But that buyer likely will string out the term, the payment term of when you're going to get that paid out, so that you can earn that out over time to prove the value the firm stays to and is connected to that higher multiple. So one of the things that I've done in my, in my negotiations is and buyers will do in negotiations is if I, if I want to pay out a buyer, a seller faster.

Michael Ly: [00:36:18] Right. If a seller says, hey, look, I want more cash up front and I want to get paid out sooner or faster, well, you can offer a lower valuation in order to get the payout done faster. Let's say .8.7.6. I've seen point five out there where it's like, okay, seller wants to sell and they want out quick. Okay, well, the buyer is taking a lot of risk getting you out quickly, not having to involved as long I'm going to pay you more cash up front and I'm going to pay you the rest faster within 12 months. But you're going to lower the valuation if you want a higher valuation, like 1.5 even two times. And I've, you know, I've heard of the market out there from selling for two times. They're getting that paid out over 4 or 5, six years. So imagine as a seller you having to be involved with the buyers business for a matter of 4 or 5 years or six years. Well, okay. Yeah, you're you might get that higher valuation. But the reality is things might change with the buyers business over that time frame. So when I sell.

Blake Oliver: [00:37:15] My firm that was my term was four years. And I got to say that when I got to like year three, I was like sitting there praying every month that the check came. Yeah, because I was away from the business. I had no idea at that point and I was really just relying on the, the buyers. Um, I mean, obviously there's like legal mechanisms to make sure you get paid, but if at that point it would have cost me more to exactly get the money legally right, I had to trust him. Yeah. And luckily it worked out. But yeah.

Michael Ly: [00:37:44] And so it's not it really. I think sellers need to realize this. It should not be based on just what's the highest value I can get, because value and terms are all negotiable. Right. And so would you rather I tell I tell sellers, look, assume whatever cash you're going to get up front, um, you've got to be happy with because there's a risk, there's always a risk that you may not get the remaining amount later on the remaining amount of your consideration. And will you really take the legal recourses to go and go after those? Because that also puts, think about it, the buyer that just bought you, it puts them at legal risk if you go and if they have financing involved and you sue. Well, the buyer's financing actually is is seniority to you in almost every situation. So you put them at legal risk of them having to report to their lender, report to their equity partners, and now you've got this big battle that you probably aren't, aren't willing to fight. And the cost is so high to win it that it's probably it's likely going to cost the same, um, than what you're going to get paid anyway. So you got to think about the reality of valuation should not be the only top reason you go. You go after selling your firm. There's got to be other reasons and negotiate what you can in the beginning and willing to compromise on some things in order to get what you want in the beginning.

Blake Oliver: [00:39:14] What's your favorite earnout structure? How long do you like to pay out the seller? Yeah.

Michael Ly: [00:39:20] My my personal favorite is getting the seller out as soon as possible. And the reason why is most sellers, once they've received their large chunk in the beginning, let's call it 40%, 30%, 50%, whatever it is. Large chunk of cash at close. There. They their incentive to want to make the deal work over the next period of time continues to go lower as time goes on. Because they got money in the bank now. Yeah, they got paid now. And of course they are compromising being paid the rest over time. But the reality is there's money in their bank and they're not hurting anymore. They're not financially. And the firm's gone out of their out of their control. Right. So they're not having to run the day to day. They're really having to help you with transition. Now thankfully, most of the sellers I've bought from have been really cooperative and have been great, and they want me to see me successful. But that's not going to necessarily be the case with every seller that you buy from. So my my preference is how do I get the seller out within a year. And then as we go throughout that year, how do I actually negotiate to get them out sooner than that? How do I give them an opportunity to get out sooner than that? Because remember, everything's negotiable, even even during the period of time that they're involved with your firm.

Blake Oliver: [00:40:40] So aiming for a year or less?

Michael Ly: [00:40:42] Yeah, a year or less. Now other buyers are going to be different. They want they might want you involved way longer than that. And some sellers may want they might be young, they may want to be involved in, uh, much longer because they're like, hey, I got nothing else to do. I'll happily be involved with you for a long time. So it's going to be different. There's no standard there, but for me it's a year or less. That's actually my preference.

Blake Oliver: [00:41:04] Now, you mentioned this at the beginning. The idea of, um, staying in the industry or profession versus leaving it. You are looking for sellers who want to exit, retire, do something else, get out of accounting. Yes. And that's because you don't want them competing with you, right? Later. Right. Turning around and starting a new firm and taking back the clients. And that happens actually all too often, unfortunately, I've witnessed that happen in my own peer group recently. So and it does not end well for anyone. So let's talk about these non-compete agreements. How do you approach them with your sellers when you are buying?

Michael Ly: [00:41:43] Well, yeah, non-compete agreements you want to have for a length of time that that is reasonable. And also, um, the reality is different states have different rules around what is reasonable and what is enforceable. Right? So, um, you want to make sure that you have a non-compete agreement and a non-solicit agreement, right? That's actually the key is a non-solicit agreement, uh, which is more enforceable in most states than a non-compete agreement.

Blake Oliver: [00:42:10] And that means I'm not going to go and solicit the clients that you have bought. I'm not going to go talk to them and say, hey, come to my new firm. Correct?

Michael Ly: [00:42:19] Right. And a non-solicit agreement can, can, can, um, contain all types of solicitation. Right. So, for example, a non-solicitation agreement would say you will not solicit for any reason the employees, customers or vendors of this firm that you're selling.

Blake Oliver: [00:42:37] That's important.

Michael Ly: [00:42:38] So that's really important. So why is that important. Well if you have a firm you're selling and you have contractors that are doing tax work for you or advisory for you, they're technically not your employees. So if you don't lay out a non-solicit and you have a lot of different contractors that are vendors for your the firm you're buying, well, technically speaking, the seller can go and use them for other services for another firm or another business that they have. So you want to be able to say to the seller, hey, I want to use all of the relationships to my benefit because I'm buying your firm there. And when you're selling a firm, there's no hard assets. Generally, it's not like I'm buying a server or mainframe or IP. The IP is the relationships that they've built.

Blake Oliver: [00:43:21] The people. Yeah.

Michael Ly: [00:43:21] The people. Right. And that includes vendors and customers and employees. So the non-solicit says you you can't solicit them for any reason at all. And a non-citizen could go as far as saying you can't solicit them. Even if I don't decide to have a relationship with them after I buy your firm. Right. So because you could choose to let go of all the employees or all those employees could decide, I don't want to come work for you, right? There's also that risk. They could say, I don't want to come work for you. Or the vendors can say, I don't want to have a relationship with you, or the customers can too. Well, you don't want them. Then going back to the seller and saying, well, I'm just going to come work for you and start another firm or work with you. Start a new thing. So that's also part of a non-solicit that's actually the more important piece is a non-solicit agreement.

Blake Oliver: [00:44:07] What are the top mistakes that you see when people go to sell their practice as a buyer? I imagine you look at a lot of firms. How many firms did you look at to buy the three that you bought?

Michael Ly: [00:44:19] We probably looked at at least a dozen or more. Okay, right. And I probably had at least 50, 50 prospecting conversations with firm owners. So I've talked to a lot of firm owners over the past three years. Four years. Yeah.

Blake Oliver: [00:44:33] So I imagine during that due diligence, things came up, items came up that scared you away. Yeah. Uh, what are those red flags?

Michael Ly: [00:44:42] Yeah. So? So the top mistakes for sellers is one you don't want to be. You don't want to be involved with the firm after after the sale. So that's that's a big one. Like you're you're at your last tax season. You're not going to do anything any else anymore. You're done. That's a big red flag for me. Um, because because how do I then get you involved in transition? How do I how do I know that you are going to help really help with the customer transition. So that's a that's a big one. Um, another one is, um, you as the seller are doing most of the buildings. You haven't you haven't built a staff around you to do work and to hold the relationship with the customers. So my risk as a buyer is, well, if you leave even in a year, these customers are loyal to you. You have all the relationship right now. How am I going to get them to want to work with me? So it's a big red flag, uh, for me as well. Um, so and then the third is, uh, misrepresenting, obviously misrepresenting the, the actual size and the actual makeup of your, of your practice. So if you're going to list your practice, make sure what you list actually represents, you know, with 95% or 100% accuracy what the details say. Right? So if you say, hey, we're this percentage of tax, this percentage of of bookkeeping or advisory, make sure the details support that, um, don't don't. And or if you say we have 100% of our customers on contracts, make sure that's real because due diligence is going to find out a good person, a buyer with due diligence is going to find out if you only have 50% of your customers on contract.

Blake Oliver: [00:46:26] Has that happened to you?

Michael Ly: [00:46:27] Oh yeah. That's happened plenty of times. And then you go, hey, this is this isn't going to work because there's no contracts for me to buy in this process. So customers for me to buy. Yeah.

Blake Oliver: [00:46:37] What about the, you know, like personal expenses of the owner that are being run through the business?

Michael Ly: [00:46:42] Yes. That's really, really important to to understand. Now, most business owners obviously, because accountants are are tax professionals. They know how they know the appropriate personal expenses to run through the business. And why. Now, one of the things you're going to have to do in your presentation, um, for the seller, the mistake they do is they present their financials and they don't remember to add back all the personal expenses. They run through the business. Now, remember, when you sell your firm, that's all going to go away. So your car lease that you have the cell phone, the life insurance you're paying for, your own medical expenses, the kids or spouse that you have running through your business, that's all going to go away. So don't present the firm's financials as if those are going to stay. That's only going to lower the value of your firm, because the buyer is going to think, oh, why is your net income so low? Because you maximized having the least amount of taxes. You actually want to add all that back and show a high net income to the buyer. So they see how attractive your your business is. So a sophisticated a seller working with a good broker is going to get that education. But a seller I've seen sellers forget to do that. And I go, hey, what what are all what are all these other expenses that you have here? They don't make any sense. You go, oh, those are the travel that I pushed through or those are the I'm paying my spouse to do this or my kids do this. Okay. Well, you want to add that back?

Blake Oliver: [00:48:06] Let's, um. Let's zoom out a little bit. Well, actually, before we do that, I do want to talk about the broader M&A market where you see things going. But before we do that, um, let's talk about like tax optimization. Is there a is there a way to structure these deals so that it's better for the buyer and the seller from a tax perspective?

Michael Ly: [00:48:27] Yeah, for well, most of the time for a seller obviously doing a, a an entity or stock sale is going to be one of the one of the best optimizations. The problem with that is most firms are have been around for for too long. So a buyer is not going to want to carry the liabilities of that of that business by buying the entity itself. And that's a reality for for most firms. So the reality is most firms are going to sell, they're going to do an asset sale, which simply is they're going to be selling their customer lists, the right to their employees, the right to their vendors, and, and the brand name and the, you know, the, the website, all that stuff. And then whatever computers or other physical assets might that might be in the office. And most of the purchase is going to be then applied to goodwill value. That's going to be the reality. So then that goodwill is going to be amortized over the, you know, the tax life of goodwill. Um, that's generally how most deals are going to get structured. Um.

Blake Oliver: [00:49:25] Tell me about uh, like the best deal you've done so far. Like what worked about it. What did you like about it? Right.

Michael Ly: [00:49:31] So the best deal I've done is the is it was not in the deal structure itself. Although, you know, I was able to find a firm that was local to me, you know, and that was very, very helpful. And so I was able to meet with the owners in person. I was able to meet when I met the staff, I met the staff in person and be close to the reality of the firm and the transition, the changes. The other thing that was super helpful was giving the firm employees time, the selling firm employees time. So on my first my first purchase, I we we went way too fast on trying to transition the employees. And we tried to do that in a 90 day period and it was way too fast. So we and we we forgot to realize that the firm employees that we're buying, they had a day to day, they still had the day to day, they had to run with their customers, but they also had to transition and onboard to our systems and get used to the way we did things. That takes a long, longer time than you realize, especially if you're doing it during tax season. So the firm we purchased, we gave we we purchased it during tax season and then gave we we waited till after the tax season was over to make any changes of transition over to our to our firm. And that helped a lot with client retention and employee retention.

Blake Oliver: [00:50:51] That's interesting. Even though your firm is virtual and people work from home, it's still helpful to do an acquisition that is local because yes, you can be there. You're not just a face on a screen. You can build the relationships. That adds a lot of comfort, I imagine. Yeah.

Michael Ly: [00:51:11] Unless you're unless you're you're in the rare you have the rare opportunity to buy a firm that's already virtual, which the majority of firms are not. You're going to buy a firm with a brick and mortar presence, and likely they're leasing an office from the owner. I've seen a lot of firms, actually. Every firm I've bought, the owner has owned the building. The accounting firm owners have owned the building that they're leasing from. So so the the which is great for them. And it shows you the sophistication of accounting firm owners. They know how to maximize the value of their of their own cash flow. So they're paying themselves rent, which is great. Um, but the the reality is like, yeah, there's a brick and mortar presence. And being around that brick and mortar presence just obviously gives you a lot of benefits in the transition of that firm to virtual.

Blake Oliver: [00:51:58] As we wrap up here, let's zoom out a bit and talk about the evolution of the accounting M&A market. Where do you see things going? Is it going to get hotter or ferm valuation is going to increase? Are they going to decline as all the boomers desperately sell? Yeah. Who are left.

Michael Ly: [00:52:20] Yeah I think I think that there is going to be two routes for this market. One is one is there is going to be a the over time, over the next 5 to 10 years is going to be a slew of of firms and the count of firms up for sale. It's going to only increase because the firm owners are all aging out and they're all getting tired and they're ready to sell their firms. So the number of firms are going to go to go to market increase. And the firms that are basically doing under 1 million, under 2 million in revenue, those valuations are going to go down because there's because the market has so many of those firms, it makes up 90 plus percent of the market is firms that are doing under 1 million or 2 million in revenue. The firms that are above 2 million, but three above four, and and have these and have made these shifts of technology transformation and recurring revenue, those values are going to go up because the amount of buyers that want those firms are only going to increase. I've already seen it, um, myself this year. This year I've had more outreach from potential buyers than any other year so far. And in the first three months of this year, more outreach than all 12 months of last year.

Blake Oliver: [00:53:36] These are folks who want to buy Reconciled.

Michael Ly: [00:53:38] These are folks either on to buy Reconciled or get advice on how to buy a firm like Reconciled. Right. So I've seen more outreach than any other year so far. And so there the number of buyers entering the market is at an all time high, in my opinion, and the number of private equity groups looking for their first platform, like Reconciled, is at an all time high. So I see the firms that are at a minimum revenue level of two, three, 4 million and up. Their valuations are only going to go higher, especially the ones that have done the transformation already of technology and recurring revenue model.

Blake Oliver: [00:54:13] So it sounds like now is the time to get started on moving to fixed fee, recurring billing and modernizing your tech stack. If you want to maximize the valuation of your firm when you go to sell in a few years, that's the way to do it. Well, thank you everyone who has joined us live. This has been one of our most popular webinars so far. Michael, and I expect that the podcast version and the YouTube version will do just great, really valuable information. If people want to follow you online, keep abreast of what you're up to. Where should they do that?

Michael Ly: [00:54:49] Yeah, look me up on LinkedIn or on Twitter easily to find my name and I'm very active on both. So wonderful.

Blake Oliver: [00:54:57] Thanks everyone for joining us. Don't forget, you can earn CPE for attending these webinars or listening to the podcast. Download the free Earmark app and actually big news, you can now use it on the web. We just completely replatformed the app so you can go to Earmark Dot app. And in a few days when this, uh, episode has been turned into a course, you can take the quiz and get your one free CPE. Thanks everyone. See you around soon. Thank you. Michael.