Buying and selling a tax practice

A typical tax practice acquisition requires a compromise between the buyer and the seller, who often have very different objectives. To mitigate these differences, the price is generally expressed as a multiple of annual revenue receipts and paid out over several years rather than in a lump sum. This approach reduces the buyer’s risk and allows for a more effective transition of the seller’s goodwill to the buyer’s practice. However, there’s also the condition of the proposed practice to consider. Let’s take a look.

Seller and buyer objectives

A successful client transition is crucial for long-term client retention. In most cases, the seller has two main goals:

1. Get the best price for their practice.
2.  Transition their clients to a firm that offers the same or better quality of service.

Ideally, a seller would get paid a lump sum upfront and spend minimal time on the transition. However, this kind of deal is rare because it poses a huge risk to the buyer.

Conversely, the buyer has two objectives:

1. Maximize new client billings at the best price, while retaining those clients over the long term.
2. Ensure the two merging practices “fit” in terms of geography and the type of tax service offered.

How a typical tax practice acquisition works

In a typical acquisition, the price is set as a multiple of the practice’s annual revenue receipts. The payment is usually made monthly over a period of three to five years, depending on the time needed to transfer goodwill. This method requires the seller to forgo a lump sum deal and accept the risk of a lower payoff, while the buyer agrees to pay the seller for additional revenues generated from the acquired clients.

For example, a tax practice with annual fees of $500,000 is sold with a multiple of 1.00, based on factors such as historical client retention and gross margins. A four-year payout is agreed upon because the seller isn’t staying on after the acquisition. Even with a drop in revenue during the first two years, the revenue returned to the $500,000 level and grew by 5% in the fourth year. The seller received an non-discounted total of $501,500 over the four years, which has a present value of $477,153 when discounted at a safe rate of 2.5%.

Valuing a tax practice

The valuation of a tax practice is subjective. However, a multiple of 1.00 of annual receipts is a good starting point for an average-sized practice. This multiple can then be adjusted up or down based on various attributes of the practice.

The following factors help determine the multiple to use for a valuation:

• Tax software: If the buyer and seller use the same software, it’s a positive factor.
• Office procedures: Excellent and sound office and review procedures increase the multiple.
• Tax notices and audits: A low number of tax notices and a high audit success rate are favorable.
• Location: A desired location with high growth potential is a positive factor.
• Employees: Highly trained employees with a long length of employment are valuable assets.
• Non-competition agreements: Having these agreements in place is a positive factor.
• Gross margins: High gross margins are a good sign.

For example, a multiple of 1.00 could be increased by 0.2 to 1.2 by factoring in these attributes. The longer the seller is active in the business, the better the transition of goodwill. A seller could even consider merging with a suitable firm one to three years before retiring to facilitate a better transition.

Bringing it all together

A typical tax practice acquisition is a compromise between the buyer and the seller, who often have different goals. The price is usually set as a multiple of the practice’s annual revenue and paid out over a period of three to five years. This method mitigates risk for the buyer while allowing for a smooth transition of the seller’s goodwill. The valuation of a practice is subjective, with a multiple of 1.00 of annual receipts being a common starting point that can be adjusted based on factors like tax software, office procedures, employee experience, and location. A seller can facilitate a better transition of goodwill by remaining active in the business after the sale or by merging with a suitable firm a few years before retirement.