In the intricate dance of buying and selling accounting firms, due diligence is the rhythm that ensures both parties move in harmony, avoiding missteps that could lead to future disputes or financial losses.
We will explain the importance of due diligence in accounting firm sales and provide a comprehensive overview of the process. Buying the legal entity means you have to conclude a normal, proper due diligence, and, as a person skilled in that field, this is the easy part for you, and we are not going to focus on that. Buying the privilege to service clients, the revenue associated with that, and the staff to achieve that is the focus of this article.
Therefore, we are providing a checklist. This list is not meant to be exhaustive or static in any way. As due diligence is a dynamic process, circumstances may arise that may require additional, supplementary, or varying forms of information. Some of this information may also not be required, as many Practice Buyers, having the comfort of a Turnover Warranty, are only really assessing basic information as the risk still resides to a large degree with the Seller.
The Checklist
General and Financial Information
Financial Statements
Review the firm's financial statements for the preceding three years. This will give you a snapshot of its financial health.
Management Accounts
Current year-to-date management accounts can provide more timely insights into the business’s financial condition; this must link back to the clients you are buying. Be careful that some high-fee clients that have left are included in these numbers.
Seller Discretionary Earnings
Understanding Seller Discretionary Earnings (SDE) and EBITDA is crucial for determining the firm's profitability.
Budget Forecasts
Examine the budget for the next financial year, especially the projected cash-flow movements. It is linked to the Clients currently being serviced, not new clients that you may get to bolster the revenue.
Contracts
Contracts for items, such as hire purchase, lease, and advertising contracts, must be considered. However, also look at service agreements with Clients.
Pending Litigations
Lastly, be vigilant about any pending litigations or indemnity claims. In some cases, it may be prudent to require the seller’s indemnity insurance to remain active post-acquisition as a safety net.
Clients
Invoice Analysis
Analyze the total billings per client for the last 12 months to assess the revenue streams. This is to be sure you know what work you will do and for what billing.
Client Plans
Review the current year's client plan to understand the firm's workflow and responsibilities.
Catch-up Work
Identify clients that are not up-to-date with accounting, audits, or taxes.
Client Base
Evaluate the composition of the client base, including the types of clients and their numbers.
Top Clients
Consider the percentage of fees coming from the top 10 clients to assess revenue concentration.
Tax Returns
Check the number of tax returns filed per year and the staff's competence in handling them.
Work-in-Progress and Debtors
WIP Ageing
Analyze the age of the work-in-progress to evaluate how efficiently work is being completed.
Expected Write-offs
Understand the expected write-off percentages on WIP.
Debtors Ageing
Check the age of the accounts receivable to gauge cash flow.
Work Processes and Operations
This section deals with everything from accounting software used, to audit file samples, to staff productivity reports. The goal is to gauge the internal operations and whether they align with your expectations. Here are two samples of questions asked here:
Listing of the current year client plan and who is responsible for this. This document should contain when which client is being done to allow the purchaser to do the planning.
A list of capacity and skill shortfalls foreseen if you sell and no longer perform the work, to ensure the Purchaser can provide the capacity and skills to meet the work to be done.
What is important in this section are all the relevant questions you need to know to plan and understand technically what will be expected from you and by when as the purchaser.
Don’t underestimate the importance of the software used. The learning curve for you may be steep, and you cannot move clients to a new platform at will during the warranty period without impact.
Staff
From staff matrices to performance measurement tools, this section will help you understand the firm's human resources and their productivity. Here are two samples of questions asked here:
Staff productivity report for the current year - This report shows billable vs non-billable hours as well as time that is written off. What are staff members' target Production and acceptable write-off limits?
Do you use a performance measurement tool/matrix - if so, please provide this.
So this is more than just ticking off a checklist, although that forms part of this section. What is very important is the skill level of the staff, their work ethics, and their cultural fit with your way of doing things. If you have a formal office structure and working hours and the seller has a remote working environment with a flexible output-driven culture, you must understand this is not going to work.
Regulatory Compliance
Review the most recent regulatory inspection results and understand the limitations and allowances regarding trainees. The firm may be a training centre with a specific allocation, and you are only buying the clients and staff; the training capacity you have, if you are a training centre, will impact the transaction. The deal structure may solve the issue and we have done so in some transactions to accommodate the transition of staff.
Take careful note of limitations or undertaking given after regulatory inspections and what will become the purchasers' responsibility if relevant?
Premises and Assets
This section is about understanding the physical and technological assets that come with the purchase, including maintenance requirements and software licenses. If you are taking the property lease over, request a copy of the lease.
Here are two samples of questions asked here:
Details of all software platforms used in business (e.g. Caseware, Pastel, MS Office, etc.). Licences for software and computers used.
Any copiers under finance lease/instalment sale - what are the terms, when does this expire, etc?
Conclusion
Due diligence is a dynamic, exhaustive process. While the checklist serves as a comprehensive guide, always be prepared to adapt it based on any emerging circumstances. The better your due diligence, the more informed your purchase decision will be, ultimately setting the stage for the successful acquisition of an accounting firm.
Remember, due diligence is not just a checklist—it's a critical evaluation process that can make or break your investment. Exercise it wisely. For sellers, due diligence presents an opportunity to substantiate the value of their firm, highlighting strengths and addressing any areas of concern upfront. For buyers, it's a critical step in assessing risks, understanding the firm's financial health, and making an informed decision. This dual benefit fosters transparency and trust, pivotal in closing deals that meet everyone's expectations.
By following this guide, you'll be well-prepared for the intricate process of acquiring an accounting firm, mitigating risks, and setting yourself up for success.