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1 x Revenue: Valuation Rubber-Stamping

Post Date: 3/1/2019

Blog Archive/ Written by Derek Leroux, CPA
Contributor: Transition Consulting, Practice Value Management, Practice Acquisition & Sales 

    Several months ago, I was having a conversation with a long-time colleague and potential CPA practice buyer. He made a statement, similar to others I have fielded on several occasions through the years...His proverbial "line in the sand" was..."I will only pay 1 times annual revenue for a CPA practice".  My very probing response, which has been revealing and effective in the past, was simply: "Why?" 

 

My colleague offered a series of reasons, including:

  • I can find many articles supporting this approach.

  • My friend sold her practice like this 12 years ago.

  • If I spent "$XXXXXX" over the next 10 years in marketing, I could potentially add the same revenue to my practice.

  • I don't think a lender would finance a deal with a higher revenue valuation multiple. 

  • No one should pay more than this for a practice.

 

...For further discussion, I offered 2 questions for illustration: 

  • If Practice A & B both gross $100,000 annually, but Practice A nets $50,000 and Practice B nets $30,000, would you value both practices using the same revenue multiple? 

  • Would you sell your own practice this way?

"...A properly negotiated initial price between buyers and sellers should stand the test of time through a given deal with lenders, business appraisers and all vested parties to the transaction..."

    Without a doubt, there are benefits to having industry benchmarks, especially when it comes to appropriate pricing and valuation methods. Past housing market bubbles, unwarranted stock market inflation and the early Dotcom era crash are clear examples of pricing assets without appropriate underlying metrics. Conversely, practice valuation should allow for variation based on performance and other unique factors with industry benchmarks set as the boundaries. 

Over the years, we have seen many factors that contribute to practice value, including, but not limited to:

  • Overall buyer demand

  • Availability and terms of practice acquisition financing programs

  • Geography

  • Practice service mix

  •  Industry trends and regulation

  • Changes in technology 

 

So, an approach that uses "Multiples of Revenue" as a boundary, has proven to have more substance for our clients over the years. A properly negotiated initial price between buyers and sellers should stand the test of time through a given deal with lenders, business appraisers and all vested parties to the transaction. The price should factor in the types of variables listed above, while balancing intangibles like seller-incentive and buyer motivation level...but, most importantly, practice performance should be front and center. Here is a 3-Step Approach that has been effective for our clients over the years:

 

  • Step 1: Determine a mutually-agreeable Cash-Flow based valuation multiple range.

  • Step 2: Evaluate whether a price in this range will support the Buyer's ROI or Cash-Flow requirements. 

  • Step 3: Back into the Gross Revenue multiple that this price creates. This Gross Revenue multiple should not exceed the limits set by industry business appraisers and lenders.  

 

Although a practical valuation of any practice will never be an exact science, there are ways to balance the variables that drive buyers and sellers with industry benchmarks to produce a fairly calculated price...without the risk of "Rubber-Stamping".

1 x Revenue: Valuation Rubber-Stamping

Phone: 1-855-266-PLAN (7526)

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