Magazine article The CPA Journal

Determining the Multiple for Buyouts of Retiring Partners in External Sales or Mergers

Magazine article The CPA Journal

Determining the Multiple for Buyouts of Retiring Partners in External Sales or Mergers

Article excerpt

Professionals seeking to sell their practice must ask themselves: "What is the multiple?" It is a simple question, but the only simple answer is: "That depends." There's no such thing as a universal multiple, because there are too many variables involved. By "multiple," accountants refer to the multiple of one year's collected billings that is used to compute the total payments made when buying and selling a practice. For example, if the seller receives one year's revenues for his practice, then the price is referred to as a "one-time multiple." The discussion below will cover the computation of payments for the acquisition and merger of external partners. Internal payouts raise a host of different issues and parameters.

The last two dozen deals this author closed in 2008 and 2009 had payouts between 1.0 and 1.5 times annual billings. That is an enormous range, half a million dollars on a million-douar practice. In many cases, the formula in place for a payout does not include a multiple, but it can still be analyzed to evaluate what multiple is embedded in the transaction.

In reality, the payout, including the multiple, is ultimately determined by the nature of the practice; the profitability of the practice to the buyer (not the seller); the terms of the payment; and the allocation of the risk of retention between the payer and the payee.

Professionals often believe that smaller, low-end practices are sold for higher multiples than larger, high-end practices. That apparent anomaly is often the case, but the author has recently seen multimillion-dollar practices with contractual payouts which are greater than a 1.5 times multiple and some $100,000 practices for which the payout equals a 1.0 time multiple. Computing the multiple can be sensibly done without regard to the size of the practice.

Measuring Post-Transaction Profits

What is the right amount of money to pay a retiring partner? There is a simple, accurate answer to that question, but applying it to a real-life situation requires care. That answer is: The payments per year should equal a fully deductible 50% of the profits that the successor firm will accrue after hiring or allocating replacement labor for the retiring partner. Making this computation correctly requires attention to detail.

Computing the annual payout. If a retiring partner is making $300,000 per year and the successor can replace his "time" with a senior making $90,000 per year (and all other expenses to produce collections remain the same), then the acquisition or merger would produce $210,000 in profit for the successor firm. In such an event, the successor firm could pay the retiring partner $ 1 05,000 per year and still net $105,000 per year on the transaction. This represents the return which the successor firm has earned for taking the time and energy to put the deal together, accepting the risk of taking over the business of the retiring professional, and contributing its management time to govern the practice absorbed. Often, the other expenses of the practice need to be recomputed also. For example, there may be a great rent savings, but there might also be a labor cost increase due to the need for additional levels of review for quality control purposes.

Computing the multiple. If the retiring partner is paid half the successor's profits for 6 years, the successor firm in this example would be paying $630,000. Once this profit number has been established, then die multiple can be computed based upon the retiring partner's gross receipts.

The partner's multiple for a practice netting $300,000/year would depend on the gross receipts needed to return this profit.

For successor firms keeping score by multiple: If the retiring partner above, who had been netting $300,000 on a $500,000 practice (60%), is paid $105,000 a year for 6 years, then he would be selling for a 1.26 multiple ($630,000 H- $500,000 = 1 .26). $105,000 represents 21% of annual collections. …

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