Merger and Acquisition Service examples include: Confidential Agreements Merger Checklists Books - Suggested Recommended Reading Pro and Con Analysis of Merging Upstream Facilitator for Financial Considerations As we enter 2006, merger activity will continue to increase as CPA Firms will evaluate their present position in the marketplace and explore joining a larger firm. R. J. Gallagher & Associates, Inc. can assist your firm in the decision-making process. LOOK BEFORE YOU LEAP - AN RX FOR CPAS CONSIDERING A MERGER THE PRACTICAL ACCOUNTANT "This article explores the key considerations in the successful merger of accounting firms." - Bob Gallagher Somewhere, as you read this article, an accounting firm will be joining forces with another firm. Many will have made a fatal mistake, finding out too late that the grass really isn't greener on the other side. Others will have successfully launched a new venture of enormous personal satisfaction. The difference usually lies in the quality of preparation and the effectiveness of the advice received. In recent years, accounting has changed dramatically from a technical profession with no marketing orientation to a service industry in which marketing strategies often determine the survivors. This increased competition has created an earnings erosion and other problems for many accounting firms. As a result, many firms are asking, "Should we merge with a comparable sized firm?" or, "Should we be acquired by a large regional or national firm?" THE MERGER SYNDROME What is responsible for this merger syndrome? The main reason, in a word, is deregulation-which has triggered many changes within the accounting profession. Competition has increased fiercely. Clients have come to view the audit as a price-sensitive commodity (at least until an accounting firm differentiates itself from other firms by providing sophisticated services, offering expert personnel in specialized areas, having a more convenient geographical location, etc.). Many firms have found themselves marketing their services and pushing for growth just for the sake of growth. In fact, many firms have become more interested in obtaining new clients than in effectively managing their practice. The merger syndrome has affected firms at all levels. Alexander Grant & Company and Fox and Company have merged. Price Waterhouse and Deloitte Haskins and Sells almost merged, although the merger was terminated at the last minute. Ernst and Whinney and Arthur Young were reported to have discussed merger. And other national firms are now discussing merger. Obviously, the large national firms establish trends, and if a merger between large firms is considered, what effect does this have on small-and medium-size firms? Does it influence small-and medium-size firms to consider a merger? This question is the center of a major debate within the accounting profession. THE PROS AND CONS OF MERGING There are many reasons that accounting firms consider merger. These include: 1. A lack of planning for partners' retirement benefits (a major reason, in past years, for small-and medium-size firms to merge into larger firms). 2. A substantial increase in professional liability premiums. 3. A lack of management continuity. 4. The potential for increased revenues. 5. The risk of losing a major client. 6. Conflict among the partners. 7. The potential dissolution of the firm. 8. The opportunity to complement a practice or to penetrate a new market or industry. 9. Anticipated cost savings (perhaps by consolidating departments). 10. The acquisition of new skills and/or personnel. 11. Inability to service complex engagements (e.g., SEC filings). 12. Just plain old "burnout" (looking for a chance to sit on the back porch). Indeed, the potential benefits of a sound merger can be substantial. However, a firm that thinks a merger is a panacea for its problems is not being realistic. It should attempt to correct its problems first, since the "organizational shock of a merger is sure to create more." Both partners to a merger must be strong, vigorous and optimistic. Synergy and mutual respect can occur only from strength, not weakness. So if it's broke, "fix it" now-not later. There are, of course, several reasons that firms might not want to merge. These include: 1. An established comfort zone may exist within the firm. 2. Profitability may be excellent. 3. There may be concern about differences in operating philosophies of the proposed merger candidates and about staff unrest in the event of a merger. 4. The partners of the smaller firm may fear that they will become "second-class citizens" after the merger (and possibly reduced in status from partner to manager). 5. The successful entrepreneur who started the firm may fear the loss of clients and of professional and support staff-particularly those that have contributed significantly to the practice. 6. A merger will also strain everyone's administrative capacities, and troubling questions of independence may possibly arise because of partner stock investments in clients of the other firm and/or relatives working for clients of the other firm. EXPLORATION AND NEGOTIATION The partners of a firm considering merger must come prepared to the bargaining table with a set agenda and a list of issues to be discussed. Exhibit 1 below provides a starting point to stimulate consideration of the salient issues that should be reviewed. Time is precious; exploration of a potential merger must be made immediately. If there is no real interest in the merger, the discussions should be discontinued so that the firm can get back to its regular business. Exhibit 2 below suggests some of the key documents that should be reviewed during negotiations. However, checklists can only go so far; a key to success is the personalities of the various partners-and personalities are hard to assess. Issues must be investigated and honestly dealt with, so that the firms understand the skeletons in each other's closets, the exposure to lawsuits, the potential loss of major clients, the possible departure of quality personnel and the "unwritten code" that underpins existing partnership agreements. Negotiating is not a one-way street. If a medium-size firm has been approached by a national firm, then both should be accepted at the table as bringing value. The "seller" should be allowed to see as much information on the "buyer" as the "buyer" sees on the "seller". For example, a small firm that was just acquired by a large firm which had a major lawsuit files against it would be at risk, and should be entitled to all information needed to assess that risk. FINANCIAL CONSIDERATIONS What is the practice of an "acquired" firm worth? What up-front cash payment should it receive? It is critical that an experienced consultant-who has worked in or with the profession-be engaged to evaluate the firm's worth. This is indeed a difficult evaluation because of the different approaches that can be taken. A discussion of how to value an accounting practice is beyond the scope of this article. In fact, it is the subject of a separate article appearing in the next issue of The Practical Accountant. A firm that is considering merger into a larger firm should consider postponing the merger if it has experienced a few years of low profits but projects excellent earnings for the next year or so. This will allow it to benefit from the best profit experience. OTHER CONSIDERATIONS There are a number of additional considerations that a firm contemplating merger should keep in mind: 1. The merger must make sound economic sense for both parties. 2. The parties should have shared values as to the quality of service and professionalism. 3. A firm commitment by the parties to work extremely hard for at least two years is necessary to make the merger work. 4. Learning new procedures, protocol, checklists, etc., coupled with the blizzard of paperwork, will be extremely frustrating (but necessary). 5. The signing of the merger agreement is irrevocable (the end of one era and the beginning of another). 6. The merger should be reviewed by the firm's attorney and by an experienced consultant, who should evaluate the fairness of the merger. 7. The merger discussions should allow sufficient time to consider all issues (usually, at least six months). 8. The partners of the acquired firm should receive earnings guarantees and unit awards for the first two years (based on experience and earnings). 9. The partners in the acquired firm should receive full past-experience credit in the acquiring firm's retirement plan. 10. The staff and management of the acquired firm should receive extensive training during the first six months and be made aware of the opportunity for professional growth and promotion potential in the new firm. 11. A partner retreat should be held before any documents are executed by the partners. 12. All department heads should, if possible, be involved in the merger process. Although you will find that the exhibits highlight several important issues to consider, seeking objective, independent counsel is essential. Finally, remember that people are the key to making a merger work. Confidence, patience and enthusiasm are needed-along with a pinch of good luck. EXHIBIT 1. WHAT TO DO AT THE INITIAL MERGER MEETING The initial merger meeting (which preferably should be held for two days away from the office) should be attended by partners from both firms. During this meeting, each firm should take certain steps, obtain certain financial data and resolve certain issues: 1. Identify the partner best suited to conduct the merger discussion. 2. Explore the significance of any name change. 3. Identify the managing partner and department heads of the other firm. 4. Review the quality of the other firm's earnings by analyzing its financial statements. 5. Explore the major terms of the proposed merger (e.g., capital contribution, firm ownership, covenants not to compete). 6. Determine the other firm's average partner earnings for the past three years. 7. Examine the retirement and benefit programs of the other firm 8. Obtain information about the other firm's average hourly rate (net fees). 9. Explore the best tax treatment for the merger. 10. Determine the existence and extent of any current litigation. 11. Review client-retention prospects if the merger is consummated (e.g., determine which clients may object, whether to "guarantee" that fees and charges will not exceed previous years and whether to "guarantee" that the same professional staff will serve on the engagement). 12. Explore the question of office location. 13. Review personnel and related profile data. 14. Review audit programs and formats. 15. Discuss the handling of accounts receivable and work-in-progress. 16. Discuss long-term commitments. 17. Review the other firm's property accounts and determine which assets will be utilized and which may have to be sold. EXHIBIT 2. WHAT DOCUMENTS SHOULD BE REVIEWED A firm considering merger should review the following documents of the other firm: 1. Partnership agreement. 2. Tax returns for the last three years. 3. Financial statements for the last three years. 4. Financial projections for the next three years, including estimated charge hours for management and staff. 5. Summary of charged hours by partner, manager and staff accountants for the past three years. 6. Employee profiles (as to title, education, age, dates of employment, outside interests, basic compensation and bonus, fringe benefits, billing rate, total productive hours and/or dollars produced, and partner potential). 7. Employee benefit program. 8. Quality control document and the results of any peer review. 9. Credit and reference checks for all its partners or, if the firm is a large one, a questionnaire completed by each partner. 10. Insurance program, including a copy of the professional liability policy. 11. Lease (for occupancy and equipment). 12. List of the ten largest new clients in each of the three preceding years. 13. List of outstanding major proposals. 14. List of major clients lost during the last three years. 15. Marketing plan. 16. List of aged accounts receivable and payable. 17. List of managers and any partners that have resigned from the firm during the preceding three years. 18. The business plan for the next three years. R.J. GALLAGHER & ASSOCIATES, INC. Management, Marketing & Educational Consultants Chatham Tower, Suite 1-L   112 Washington Place Pittsburgh, PA 15219-3504 412/281-8559 - 412/281-2115 FAX Click for Email