plus how to factor in rias.
by rory henry
the holistic guide to wealth management
why are accounting firms measured in revenue multiples while most other businesses are measured in ebitda multiples?
according to allan koltin, accounting industry transaction guru, there is no better reason than because that’s how we’ve always done it in the accounting profession.
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“accounting firms have zero ebitda; they clear out the register every year,” noted koltin. “when i talk to firms about private equity, i have to walk them back and explain how you’re going to create your own ebitda. and the biggest piece of it is what we call the ‘scrape of partner compensation.’ you’re making $1.2 million. can you live on $800,000 if we move that extra $400,000 into an ebitda category and put a multiple of 7x to 11x on that and get capital gain?” asked koltin.
“partners 55 and older love it. partners who are 35 are not so sure.”
according to bob lewis, president of the m&a advisory firm the visionary group, the reason accounting firms are typically valued on revenue instead of ebitda is because it can be difficult to adjust ebidta “when trying to replace a partner’s or owner’s work effort in relation to their compensation.” he said today’s accounting firm transactions are based on using both ebitda and a multiple of revenue calculations to determine value. “then you compare the results of both calculations,” said lewis, cautioning that other factors that make it hard to measure value in accounting firms may not be so obvious.
“one variable is the number of annual billable hours delivered by firm partners,” explained lewis. “firms whose leaders generate high billable leadership tend to have high profitability. but those billed hours conducted by professionals with 30-plus years of experience are difficult to replace under new ownership,” he added. “this impacts the firm’s ability to replicate its same profitability moving forward.”
lewis shared an example of a firm leader billing 2,000 hours annually at $400 per hour. that’s $800,000 in revenue. a key metric lewis looks at is “revenue per professional head,” which can be anywhere from $175,000 to $500,000 per professional on the high side. “the norm we use is $200,000 to $250,000 per professional head,” he explained. “so, replacing $800,000 of one professional’s revenue stream requires a lot of new labor and that tends to be costly. ideally, we see firms moving more into the $300,000 to $400,000 revenue per head range as technology, increased fees and value pricing continue to improve.”
according to lewis, other factors include the hourly rate, the size and type of the client, the volume of clients, and the services being delivered. “a key value impact item is the number of 1040s and their price,” he said. “while many 1040s may be simple to do, they do not build the long-term enterprise value of an accounting firm.”
what are the multiples for rias?
fidelity’s 2023 m&a valuation & deal structure survey of nearly 500 ria transactions completed between january of 2020 and march of 2023 found that the median ebitda multiple for rias is now 9x. firms with more than several billion dollars in assets under management that can demonstrate solid growth and good operating qualities can easily reach the high teens.
according to koltin, the multiples of rias trade substantially higher than those of pure cpa firms. “for a foundation firm in the accounting profession going the way of private equity, i’ve seen lows of 9x and highs of 12x,” said koltin. “if you’re a great wealth management firm, multiples could be 15x to 20x. wealth management simply drops more money to the bottom line than accounting does. some would also say wealth management is an annuity business for longer periods of time.”
what consolidation trends are you seeing?
phil whitman, ceo and president of whitman transition advisors llc, told me that the fragmented nature of the sector – “a cottage industry with an abundance of small and medium-sized firms – offers ample consolidation opportunities, allowing investors to realize synergies and efficiencies by acquiring and merging multiple firms.” he also said many accounting firms are expanding into lucrative areas such as financial advisory and wealth management, investment banking and recruiting services. “these broaden their appeal to investors,” added whitman.
koltin believes the “countries” are going to kill the “country clubs.” that’s because the co-called country clubs are bigger firms, in which everyone has autonomy and does their own thing. koltin said the countries are firms in which everyone, regardless of where they are located, does it the one right way. “that produces efficiency, which produces profitability. and when you look at the profitability of larger firms, the ones that are like a country with high levels of accountability have two to four times more profit than country club firms who love their autonomy,” he asserted.
charles paikert, u.s. correspondent for family wealth report and contributing writer at barron’s advisor and citywire, told me that consolidation is continuing for firms with approximately $500 million in aum, but volume is slowing down. more rias are being formed than are being bought, he maintained.
for the past quarter century, we’ve seen cpa firms trying to get into the wealth management business. “it was a one-way street,” noted koltin. “large accounting firms were buying small wealth management businesses, owning them outright or owning them 80/20 or 50/50 with varying degrees of success. about 10 percent of them did incredibly well; 70 percent did okay; for the remaining 20 percent it was a dud,” he said.
but when creative planning acquired bergenkdv in june 2023, “that was a game changer.” why would a wealth management firm ever buy an accounting firm? it seems counterintuitive, but koltin said when he posed that question to creative planning ceo peter mallouk, mallouk told him about the early days of his career in a small estate planning firm. mallouk noticed that time and time again, wealth advisors and others who provided value-added tax planning, wealth preservation and wealth management services were the ones who tended to hold on to clients. for everyone else, he said, ‘when the market goes up you are a hero, but when market goes down, goodbye,’” related koltin.
according to koltin, mallouk said he tried to hire tax people as needed, but when you get to be $220 billion of aum, you can’t scale it enough. so, the only way is to go by that expertise in bulk. same goes for audit, cybersecurity, forensic, business valuation, payroll, and client accounting services. “clearly the bigger you are the more competitive advantage you have because you’ve just gone from bricks and mortar to a virtual firm. in a virtual firm you can recruit talent anywhere, not just in the u.s.,” mallouk told koltin.
when koltin started his accounting career, he told me the client wanted to be down the block from their cpa in case they ever wanted to have breakfast to discuss something. “when you talk to today’s 20-, 30- and 40-year-olds, they could care less about meeting you in person,” he said. “they just want to know, ‘can you help me with my problem at a fair price? can you be responsive and maybe show me some love?’”
what types of firms are getting the biggest multiples?
from the ria perspective, paikert said buyers are looking for firms with steady growth. also, he said the demographics of the client base should skew toward younger households that are accumulating assets, not decumulating. the firm should be in the top three in their local market; have professional operations and leadership; have a state-of-the-art tech stack; have nextgen advisors who are capable of assuming leadership; and have marketing and social media expertise. it might be tough to check all of those boxes, but that’s the ideal acquisition candidate for buyers, asserted paikert.
when it comes to getting good multiples, koltin shared 10 key criteria:
- great leadership and decision making
- strong organic and profitable growth
- culture with strong ratings of trust, respect and connectivity
- successful track record of m&a
- destination place for talent; firms that can recruit, retain and grow talent will always succeed
- uber (very) profitable
- strong consulting and advisory niches
- industry specialization that can be scaled over a larger geography
- respected and admired by its peers in the profession
- exciting story of what the firm could aspire to become with a strategic and capital partner (pe firm)
whitman pointed to his own list of 11 key “levers” that can have the biggest impact on a firm’s multiple:
- gross revenues
- profitability
- geography
- partner demographics
- succession bench
- niche practice areas
- practice management support
- average collected per hour
- technology stack
- culture
- prior experience with m&a
according to koltin, pe firms are looking for top 50 firms that generate between $100 million and $700 million in revenue. from there, they can look for niche firms with specialized expertise to add to their fold, generally firms with $15 million to $100 million in revenue. koltin said pe firms are also looking for very profitable firms whose average partner compensation is at least $500,000. they know there’s excess cash in those firms – the partners can take a cut in pay and still make a very comfortable living.
according to lewis, every buyer has a different need, but the ideal fit is a “well-leveraged firm” – one that has lower (or no) billable hours at the leadership level. it’s a firm whose partners and senior management consistently bring in high-value, desirable clients, and then push the work down to staff to deliver. “those same leaders are spending the rest of their time training, maintaining relationships, and creating new referral partner connections,” noted lewis.
on randy crabtree’s podcast, koltin said that accounting firms with high partner pay tend to be more scalable because they “usually have higher-paying clients and have more assets in play to increase additional services.” one thing’s for sure, added koltin: “when pe comes in, partner comp will go down, because the partners already received a portion of their buyout.”
according to lewis, the ideal firm is value billing, cross-selling other services, offshoring and leveraging a deep advisory services group. “one opportunity that accounting firms often miss is providing other services to their clients,” he noted. “their heavy focus on compliance, which is a repetitive and regulatory-driven need, forces firms to spend a majority of their resources on tax, accounting and financial reporting. their hiring, training, processes and even their software are designed to fulfill those compliance demands. that makes sense because 85 percent of most accounting firms’ business is repeat compliance work.” but according to lewis, the ideal firm, by contrast, “has made investments in dedicated advisory professionals who can focus on cross-selling and delivering consulting.”
he also said ideal firms have a leadership team of varying ages. “they’ve identified a succession team, are actively training that team for the next step and have made them fully aware of the financial buy-in and income potential of becoming a firm owner,” added lewis.
several members of the expert panel believe the catalyst forcing so much merger and acquisition activity in the accounting profession is the lack of qualified or interested succession teams. the staffing shortages in the accounting world have created a talent void. that void, combined with a changing desire to own, is impacting the profession. the ideal firm, they told me, has a detailed succession plan in place that has been thoroughly tested, or the firm is 100 percent aware that it will not be able to conduct an internal succession – and understands it will need to merge or sell on a timeline it has put in place.
what makes accounting firms so attractive to rias?
according to lewis, accounting firms and rias can be a “perfect marriage” when aligned properly. “an ria that’s able to offer integrated investment and tax advice to its clientele has an easier path to helping clients make optimal financial decisions,” asserted lewis. “one of the disconnects in investing and tax strategy occurs when the investment professional and the tax accountant are not in the same room,” he said. “how is a client expected to confer with their tax accountant about investment decisions?”
paikert agreed. “rias are seeing an opportunity to add clients and assets in an aligned market that has proven it generates revenue from people who are willing to pay for advice,” he said.
another advantage for rias, said lewis, is having future asset management revenue. “think about the potential inside an accounting firm,” he said. “accounting firms have large numbers of clients who can be converted to the ria’s services. that represents a material growth path for both the ria and for the accounting firm. now think beyond the surface opportunities. consider how many accounting firm clients who are business owners plan to exit their businesses. when those companies are sold, it creates a large liquidity event,” added lewis. “those newly created funds can be invested in the ria and materially increase the firm’s income.”
as a result, said lewis, the accounting firm is also a “major winner in this situation.” it gains access to the ria’s large installed customer base of mid- to extremely wealthy individuals, families, business owners and executives who have many needs beyond taxes. “the clients of the ria can materially elevate the income stream of the accounting firm – not just with the other services they need for themselves, but for everyone in their circle of influence such as peers, business partners and other family members,” related lewis. “the clients of both the ria and the accounting firm benefit by having a single provider that can manage their diverse and complex needs.”
like lewis, whitman believes accounting firms also present significant cross-selling opportunities for rias, with a range of services from tax and audit to advisory and consulting. “think about the cpa firm as a hub-and-spoke model with the cpa at the center,” said whitman. “the cross-selling potential not only increases revenue but enhances client engagement and client stickiness. additionally, the accounting sector is ripe for scalability, especially with the increasing adoption of digital tools that streamline processes and improve efficiency.”
paikert told me he recently had drinks with an ria owner/cpa who wanted to buy an accounting firm. “the (owner) acknowledged that accounting was a tough business because the rules keep changing, the hours are long, the work can be complex, and clients don’t particularly like you,” related paikert. “he didn’t even think an accounting firm would add to his firm’s profitability. but he wanted to buy one anyway because he was convinced that the accounting firm would help him retain clients; give advisors a complete picture of a client’s finances and word-of-mouth referrals from accounting clients would bring in new ria clients.”
lewis observed that many in the accounting industry worry about how assurance clients will be handled when an accounting firm and ria merge. “there is an independence concern, but that can be managed by creating an alternative practice structure or by making the financial decision to focus on the wealth management opportunity of that assurance client,” he said. “not all assurance clients will want to use the ria’s services anyway, so the run-off of audit-related revenue may not be a major factor.”
what makes rias attractive targets for accounting firms?
accounting firms have been investing in, and trying to build rias, since the 1990s. at first it was selling life insurance, said koltin, “which felt sleazy to many cpas,” but it has grown from there. the russ alan prince surveys say 90 percent of clients who have used an accounting firm for wealth management have had a great experience and 88 percent of them have referred others.
“it stood the test of time,” noted koltin. “but to be wildly successful, you either have to invest a lot of years and a lot of money, or you have to go and acquire it and that costs a lot of money,” he said. “so, accountants being notoriously cheap, try to do it themselves. they tell themselves: ‘let’s go take joe or mary out of the tax department. they think they might want to try this. we’re going to have them hold on to their book of business but at night and on weekends, they’re going to build a wealth management business,’” lamented koltin. “how are you going to do that when your competition is going seven days a week?” he added. “you can’t make it happen. so, maybe one in 10 accounting firms have been able to establish an ria successfully.”
according to whitman, bdo sold its wealth management business to choreo, “indicating instances in which accounting firms have developed rias that are later acquired by larger entities. we saw similar growth, and then ultimate sales, by many cpa firms including giants like cherry bekaert and wipfli,” he noted, as well as a 100 percent acquisition of bergankdv by creative planning.
while acquiring an ria is possible for accounting firms, it’s not something most can easily afford, observed lewis. “the prices for rias are typically higher than for comparably sized accounting firms, which can create a material barrier to entry for an accounting firm interested in offering wealth advisory services,” he noted. “the more common path is for the accounting firm to partner with an ria and to take a smaller percentage of the investment income, or the accounting firm can try to build their own ria,” explained lewis. “partnering might be the smarter way for accounting firms to develop an investment practice. bringing in a vetted professional group and receiving a share of the investment income enables the accounting professionals to stay focused on what they do best – tax and accounting – while easing into the investment profession.”
how are accounting firms partnering successfully with rias?
whitman said he’s seen more and more rias acquiring minority interests in cpa firms. “obviously, there are exceptions, but cpa firms generally fail at building aum organically to the level one would expect based upon the size of their firms. the convergence of tax and wealth management is becoming more widespread,” he said. “the number of rias seeking tax-focused cpa firms has increased exponentially. rather than assign the role and responsibility to an existing cpa partner who gets licensed, there needs to be an affiliation with a wealth management organization to professionalize the family office wealth/financial planning business within a cpa firm. a handful of firms we work with have it right and their aum exceeds several billion dollars,” whitman concluded.
lewis agreed. “building an ria from scratch can be a lengthy and difficult path because it requires the accounting firm to identify and bring into the firm a dedicated investment leader. otherwise, it will require one of the existing accounting firm partners to shed their accounting responsibilities. that transition can be difficult to execute,” he said, adding that converting an in-house leader will likely require the other partners to fund the startup to establish the wealth management arm. “this becomes a more difficult decision when that partner also stops his or her compliance billing. this is a key point. building your own ria will stall if you ask a partner to lead the effort, but at the same time, not shed their billing responsibilities,” noted lewis.
another challenge is overcoming the mental barriers that accounting firms have when it comes to acquiring an ria. “some firms feel strongly that tax and financial reporting should not be done in conjunction with investment management because it is a conflict of interest, or because it’s an independence issue,” explained lewis. “these concerns may be emotionally driven because of relationships that partners may have with other investment groups or because some partners simply don’t feel comfortable making the changes necessary to add wealth management to their firm’s services. we are seeing stronger interest from firms either in starting or restarting a wealth management arm.”
according to koltin, today’s firms are smarter, more receptive to risk and more open to investing in capital. “rather than buy on the cheap, they’re doing it for the long haul. that’s one of the big reasons that private equity came in,” he said. “they saw that accounting firms needed capital to transform their business and they also felt that they could help accountants to make better, tougher decisions.”
what are accounting firms’ biggest concerns about offering wealth management?
according to lewis, the two major hurdles are (a) lack of time and (b) lack of experience. “current partner compensation in the accounting world is high,” said lewis. “it can be challenging to divert energy and time into other types of advisory services that they’re not familiar with. wealth management is an advisory service, but it is not a typical advisory service. it has an attractive annuity feature that other consulting services often lack,” he added. “when it comes to time requirements for wealth management, accounting firm partners are already stretched thin, especially with chronic labor shortages in the accounting field. as allan said, you can just take joe or mary out of the tax department and have them do wealth management at nights and on weekends.”
from where i sit, being an accountant is a complex job that is very rules-driven and requires constant study of changing regulations. even with software that helps accountants make decisions, they still need to review and interpret the outcomes. wealth management should be a simple service to start at any firm, but accountants often lack the time to get their core accounting and tax compliance work done, let alone start something new.
when it comes to wealth management, lewis said another hurdle for accounting firms is getting partners or shareholders to buy into the process. “the buy-in is not a financial commitment; it’s an emotional one. will the other partners be comfortable talking to clients about wealth management? can they be taught to identify the signs of a wealth management opportunity? these questions should be easy to answer, but too often they are not,” he noted. lewis has also found that the majority of an accounting firm’s clients already have someone else helping them with investments. “partners need to be trained properly to ask clients the right questions about their investment advisory needs and to ask for the opportunity to review the client’s current investment strategy. unfortunately, many cpas are not comfortable with (or capable of) upselling services, so a wall comes up,” he noted.
finally, there are legal concerns. “firms can get stymied by requirements over how they word their websites, engagement letters and introductory discussions with potential wealth management clients,” said lewis. “investment services are highly regulated and that can dissuade many accounting firms from offering wealth management to clients – no matter how keenly their clients seek their advice.”
how do you help accounting firms think differently about wm?
for too many years, accounting firms didn’t value their businesses enough, lamented koltin. “when a partner retired, we would sale our shares or units back to the younger group. in exchange for that we would get 2x what we made (i.e., our earnings). if i made $500,000, i’d get $1 million at age 65, which translates into $100,000 a year for 10 years in retirement,” he explained. “the 39-year-olds today think that’s lunch money. ‘you really think i’m going to stick around until age 65 to get that?’ they’ll tell you. now private equity comes into the picture and says: ‘we hear you. we’re going to value your business at 8x to 13x ebitda. even better, we’ll give you half of that at closing as capital gain,’” said koltin. “that’s a huge shock to the system. and the remainder is called ‘rollover equity’ – the ability to grow a business and make it more valuable so you can someday sell your shares. as accountants, we never had value in our business like that,” he said. “we essentially gave it away. all that started to change in 2021 when citrin cooperman sold 60 percent of their business to new mountain capital. their rollover equity has already doubled in value, which is huge, especially for the younger partners.”
but as lewis noted, many cpas worry understandably that they’ll stop getting referrals from wealth managers if they enter the wealth management arena themselves. “on the surface that’s true. but consider the type of work that cpas are typically getting from wealth managers,” he said. “it’s usually low-margin 1040 work that doesn’t add much to the bottom line, and that tends to detract from the accounting firm’s enterprise value.”
lewis said most accounting firm partners don’t like change and adding wealth management is a major change. “however, if partners take the time to do the math, convert the annual wealth management income, and see how it would positively impact the partner or shareholder’s income annually, wealth management is hard to ignore,” he explained.
real world example
lewis shared this example of a three-partner cpa firm. for every $100 million of client assets the firm has under management, it will yield about $800,000 to $1 million in investment income. even if your firm does not have wealth management capabilities in-house, if you partner with an ria in a revenue share agreement, your firm would receive conservatively $150,000 or so in income, i.e., $50,000 more per partner. this would be annually, and those assets under management will continue to grow.
“let’s push the envelope a little further on the math,” said lewis. “go back into your client base and just assume 10 percent of your clients become wealth management customers. then calculate the income potential. the numbers should be eye-opening,” he asserted.
what could make pe investments in cpa firms more successful?
as crabtree has long argued, “pe must understand that accounting is a relationship business. slowly but surely, pe folks are realizing that both employees and clients are very, very important to an accounting firm’s future success,” he noted. “if you start doing things that strain those relationships, you’ll ultimately hurt the firm’s bottom line and adversely impact the pe investment. pe folks must ensure that anything they try to do to scale the business won’t hurt the firm’s underlying relationships,” said crabtree. “that’s an area in which smaller firms can compete successfully against private equity because they have more of a human touch with respect to the services they’re providing.”
crabtree observed that pe and public accounting seem to have completely different values and priorities. in general, he said cpa firms are built for the long term. “the focus has always been on building and maintaining client relationships and employee relationships. by contrast, pe is all about generating a short-term bump in the bottom line and then getting out. you can’t build long-term client relationships with that mindset,” he asserted.
“when i see long-established firms getting flipped every four to seven years, i have to wonder what the end game is,” said crabtree. “it’s been said the key assets of a cpa firm ‘walk out the door every night’ and hopefully return the next day. fortunately, there are a few pe firms – and pe firm advisors – that get it,” he noted. “they’re starting to understand that so much of the value and goodwill they’re trying to unlock in a professional service firm comes from its longstanding employee and client relationships. technology and automation are not going to change that,” he concluded.
according to koltin, a high-performing firm must be built for speed. “you must have the ability to make hard and tough decisions. you must also have great leadership that gets everyone aligned with the firm’s goals. you must also be willing to take risks.” he calls it the three c’s: the climbers, the crazies and the content. “you have to have a climber and crazy mentality,” said koltin. “if you just get content, you go into cruise control, and invariably, mediocrity sets in. so, you have to have that culture where you’re continuously climbing the mountain,” he said. “great firms have a lot more failures than successes. lots of arrows in their back, but they know that one success is going to dwarf all the failures that they make along the way.”
with 10,000 boomers retiring daily – one fifth of whom own small businesses – what’s the opportunity for accounting firms to start offering m&a advisory?
with the right relationships in place, whitman said accounting firms can earn significant fees by quarterbacking a client’s transaction, rather than just submitting the tax returns and helping the newly wealthy client with tax mitigation. “naturally there are limitations about accepting fees for attest function clients because of potential impairment of independence,” conceded whitman. “however, there remains a strong opportunity for cpa firms to participate in m&a to a much greater extent than they currently are, particularly in the small and medium-sized enterprise sector. accounting firms are uniquely positioned to lead transactions here, because of their deep financial expertise, especially firms that have business valuation units, which are essential in m&a transactions.”
whitman said that because accounting firms already enjoy a trusted advisor status with many small business owners, advising them on business sales or mergers only seems natural. he said expanding into m&a advisory will allow cpas to offer comprehensive services, including tax planning, due diligence and post-merger support. “this not only diversifies their service portfolio but, as mentioned earlier, opens cross-selling opportunities,” said whitman. “by moving into strategic advisory roles in m&a, accounting firms can differentiate themselves from competitors. they can also leverage m&a capabilities to establish ongoing relationships with newly formed or expanded businesses post-transaction. furthermore, the global nature of m&a offers firms the chance to expand their market reach beyond domestic transactions.”
according to whitman, the tidal wave of retiring boomer business owners is an “opportune moment” for accounting firms to expand into m&a advisory by leveraging their existing relationships, financial acumen “and the growing demand for comprehensive business transition services.”
conclusion
as the landscape changes, accounting professionals can embrace these new developments and view them as opportunities for growth and success. the combined effect of the m&a tsunami, the entry of smart money, new organizational structures and the flywheel expansion of services indicate that we have entered a very prosperous brave new world for the profession. as koltin noted: “it’s no longer enough to be a client’s most trusted advisor. you need to be an impact player – the most valuable advisor.”