The Accounting Podcast

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Blake Oliver: [00:00:09] Hello everyone, and welcome back to the show. I'm Blake Oliver.

David Leary: [00:00:13] And I'm David Leary.

Blake Oliver: [00:00:14] And we are joined today by Charles Bedard. He is a M&A corporate development advisor. And we're going to talk about firm valuations, specifically the difference between subscription firms and traditional firms. And this is something I am very eager to discuss, because I have always heard that subscription firms get much higher multiples when they sell, but I've never really quantified it. We've never really discussed exactly what that means. So let's talk about it.

David Leary: [00:00:45] And I've heard it's not just firms. I mean, this is why companies like Intuit, I remember when they're making that transition from the old desktop days to cloud. One of the arguments is the valuations of SaaS subscriptions and having subscription based businesses. You're on Wall Street, right? Oh, actual valuation is worth more. So yeah, just firms.

Blake Oliver: [00:01:04] With software as a service businesses. It's all about that recurring revenue. And that's why you get ten x 20 x your recurring revenue or more even, uh, and I believe the same thing can happen with accounting firms. So let's talk with Charles. Charles, welcome to the show. Thanks for having me. So, uh, before we talk about these valuations, you know, give us a little bit of background. Why are you the guy to talk to about this today?

Charles Bedard: [00:01:27] Absolutely. So I'm an M&A corporate development advisor. I work exclusively with Work tech and B2B tech enabled services across the country. Been doing that for the last 20 years. I've worked at all stages, from startups and small businesses to venture backed, private equity backed family office, and sold some companies to some public companies last year. I've worked at all classes, and I've interviewed a couple hundred people that run practices or professional service firms every year for the past decade, and provide a number of corporate development strategies for firms like this.

Blake Oliver: [00:02:04] So let's get to it. Let's let's just talk the numbers right. What what is the difference between a firm that has embraced subscription pricing and billing versus one that is on a traditional after the fact hourly billing model? Can we quantify the difference in the valuation when a firm goes to sell?

Charles Bedard: [00:02:24] Yeah, absolutely. The short answer is for subscription firms. And the good news is there's a lot more buyers. So there's a lot more options for subscription firms. It's not just limited to other CPA firm mergers or other CPA firms. Industry consolidation. You've got professional service firms. You've now got these private equity backed firms, you've got other bpos. You've got other solution providers that are doing outsourced cloud accounting or even outsourced tax services that are not traditional CPA firms. So you've got a lot more options if you're a subscription, because, as you all alluded to. It's easier for the non CPA firms to value subscription recurring revenues because that's what their models are set up to do. So you got a lot more options. So you know for CPA firms today the good news is if you have if you have a subscription model, you got a lot of different types of buyers and more options.

Blake Oliver: [00:03:20] So when you say a lot more buyers. What's the difference? We're talking about CPA firms.

Charles Bedard: [00:03:26] If you look right at the top 400 firms, everybody below that is below 10 million in revenue. So below that top 400, you're looking at largely being limited to SBA lending or management buyouts or employee esops those kind of options. So you're limiting your total valuation, which I'm sure we'll get into in a second, and you're limiting your options. Of those CPA firms, only about the top 100 have proactive, full time corporate development people that are out there looking. So you might do those next 300, might do 1 or 2 deals every 5 or 10 years as part of their natural progression. But it's a limited space within the CPA world, so it's probably a hundred serial repeat buyers that are traditional CPA firms versus. A couple hundred additional non CPA buyers. Plus you've now got the 65 private equity backed investors that are in the space, another two dozen alternative investors that are looking to make investments, as well as Global's and other people in the space as well.

David Leary: [00:04:32] Got it. If I'm hearing you correctly, traditional accounting firm buyers are kind of okay with possibly buying a firm that's not subscriptions based, but externally, the bigger market of buyers in general doesn't want to touch a non accounting firm or an accounting firm that's not subscription based.

Charles Bedard: [00:04:49] They'll definitely look at it. But you're not going to get as a premium valuation if they can't translate it to their subscription. So if you can do the Recasted financials to make it easy for them to look at the business based on the number of tax returns or the number of professional employees, if you can recast, recast that and correlate that to how they're looking at subscription, then yeah, there's a number of people that are actively looking at those firms because they think they can buy them at a discount because they haven't gone through the work to do the translation to looking like a subscription or a recurring business, even though the business, even though those revenues may actually look recurring. On average, they typically going to get a little bit of a discount compared to somebody that's done the work to tell the tell the recurring subscription story.

Blake Oliver: [00:05:36] So let's talk about that valuation then. What is the difference?

Charles Bedard: [00:05:41] Well, the good news is, you know, for two parts. The good news is the accounting firms have a wide range of value. And. I believe that. The modern digital CPA firms are undervalued. They're undervalued historically compared to other functional professional services firms. And I believe for your modern digital firms, that's actually going to change this decade. We started seeing it change over the last few years, and I think we'll continue to see that. So for the modern digital firms, I think you'll see them being worth more than your traditional B2B service firms. But historically, if you look at it, the average CPA firm, small business, private, pre institutional was worth less than a marketing agency, it was worth less than a payroll firm. So it was worth less than the sum of its parts. Because these CPA firms were focused on building their practices, not focused on creating exit value or building businesses. So I believe this dynamic will change over the next few years, where modern firms will be, you know, valued more than your outsourcing, your, your payroll firms. So the range of value depends on the buyer, right? Each buyer has a different set of metrics that they look at. But the valuation ranges, you know, depend on are you perceived as a traditional services model or are you perceived as a modern digital model.

Charles Bedard: [00:07:02] And so that valuation range, you know, from revenue multiples can be the difference between being worth 0.3, 0.4 revenue multiple to the historical average of 0.8 to 1.5 to more. And on the EBITDA or adjusted earnings side, can be anywhere from three times up to 8 or 10 times or higher. You know, and there's deals that transact for higher than that if they're market leader, category leader, niche leader, geography leader. So there's a wide range of value. And that's not the case and won't be likely be the case long term. If you look at other comparable industries, they do not have the same range of value qualities. It's not the case in HR. It's not the case in legal. It's not the case in in other other functions. So there's this window, let's call it 2021 to 2029 where CPA firms can kind of make the the determination. Do they want to go through the effort to be considered a modern firm. Then they're going to be worth one and a half to 2 or 3 times more revenue in seven, eight, nine, ten times EBITDA. If they don't, then their valuations probably are going to decline. All other things being equal for the next few years.

Blake Oliver: [00:08:16] That is quite a spread. So if I heard you correctly, on the low end, a traditional firm might only get 30 or 40%. Of their annual revenue when they sell on the higher end, a subscription Ferm could get. 150%, 200% or more.

Charles Bedard: [00:08:40] Yep, I've done deal in the last two years at both those I took. I took the same company to market last year. Let's call it a 9 million. Let's call it a $10 million ferm. To make the math simple from a traditional CPA firm, we got one offer at three times earnings. We got an offer for three times earning plus a really attractive earn out incentive stock. We got an offer for 1.5 times from an outsourced non CPA qbo provider. We got offer for a 1.8 from an offshore BPO, same firm, same financial profile, same history, four very distinct offers financially and term's wise as well. So it's not just about the valuation but yes.

Blake Oliver: [00:09:28] How long are you going to have to stick around, how quickly you're going to get paid out? Are there clawbacks all that is really important because that can add to or detract from that big number that you're seeing.

Charles Bedard: [00:09:41] Yeah, I think you saw like, you know, the traditional four year buyout from CPA firms for those that were worthy of being the, you know, being private equity bought out that went to 2 or 1 or nothing, you know, between 2020 and today. Right. So you still have your CPA firms that some of them are now offering two year earnouts a lot of them are still offering the four year or the partner track like has historically been the model. But majority of these private equity backed ones, they're. There. They'll apply some stock and some roll forward. So I don't want to say it's a one year or less. But um, certainly from a percentage basis is is a different looks very differently to the take home pay for the partners.

David Leary: [00:10:23] So you've used this term modern firm a couple of times during the interview here. So are the valuations truly just because they have a subscription model or is it because that's a leading indicator? Okay. If they have a subscription model, they probably also have really good processes. And the the owner is not in the business he's been running. He or she has been running the business. Like is that is that is that really the bigger indication or how do you even maybe the better question is how do you define a modern firm.

Blake Oliver: [00:10:49] Or digital firm. Was the term also used right.

Charles Bedard: [00:10:53] Yeah. So I think we've you know, he you know, I've been talking to CPAs for a long time. My dad's a CPA. And, you know, I heard all last decade and during the aughts that firms weren't going to standardize. Everybody's going to have a different GL process. And, you know, fast forward and with Sage Intacct and NetSuite and Qbo and these other standardized digital solutions, I think we are seeing standardization. And now we're seeing, you know, tech enablement at different levels. But it's clearly out there. Even very small firms are tech enabled or can be. And so I think I would define it as you have your traditional hourly billing services based firm. You've got your tech enabled firms that are more profitable, digital, standardized, probably specialized in some practice areas and niche. And then I think you've even got, you know, the the leaders, which I would call 3.0 firms which have their own proprietary technology in addition to being tech enabled. So I think there's a wide spectrum of firms. There's probably 40,000 CPA firms on the 1.0 level, a few thousand at the 2.0 level, and maybe 100 or to 200 at on their on their way to being a 3.0 model.

Blake Oliver: [00:12:11] All listeners of the accounting podcast, of course. Absolutely. Uh, I want to get back to the valuations because you mentioned two different ways of valuing firms. We've got a multiple of top line revenue or recurring revenue, and that's where we got that 0.3, 0.4 all the way up to 1.52 x or more. You take the annual revenue of the firm and you just multiply it by that. We call it a multiple, or at least that's what I've heard it described as. Then you also have another multiple which is larger, which is based on EBITDA or earnings. Who is more likely to use that? Is that the private equity folks that like to use EBITDA.

Charles Bedard: [00:12:52] Yeah. Historically, your financial buyers, your investor buyers, their models are largely driven by EBITDA. They will take into consideration other factors if the company's outperforming on a number of tax returns per partner or revenue per professional, they'll take those into account and they'll push that from being an average EBITDA multiple up to a premium. So they'll take those other metrics and factors into consideration. But the EBITDA is going to give them a range of which they can afford through the transaction. And then all that other stuff, which is equally important, if not more important than the EBITDA is going to go into, where do they fall on that EBITDA range so that EBITDA is going to give them the range or as the investment bankers would call it, the football field were allowed to play in. And then, uh, all that other all that other culture, the team, the quality of the contracts, the quality of the, the customer base, the amount invested into the IP, all those other assets are going to influence where they fall in that range.

Blake Oliver: [00:13:56] And for a modern or digital firm, what is the range of EBITDA multiples you're seeing?

Charles Bedard: [00:14:04] We saw an all time high in 21. A little bit more structure to get to that valuation in 22. A little bit even more structure in 23 than to get to 2224. It's looking bullish but in early indicators are for if they're private. Pre-funding you're looking at. 4 to 6 on the low end up to 6 to 8. And if you're true market leader category leader. 8 to 10 could be even ten plus structure look like more than that at the end. So that range I would say is kind of you know, it's not just the subscription model. It's also. From the from the buyer's perspective, are you, you know, premium top 1 or 2 in your category or niche or geography, you know, and what other options there are. So that kind of plays into it. But yeah, once you know Florida 4 to 8 is is the ballpark. And then and then we're debating. How much is up front versus structure.

Blake Oliver: [00:15:09] Okay. So this this makes sense because I'm thinking I'm trying to compare this top line revenue multiple versus earnings multiple. And it really seems to come out kind of the same in the end. Right. Because if a typical CPA firm is what. They can be 20% profit, right? Drive 20% profits or 1,020%. Then if you are doing an EBITDA multiple of let's say. 5 to 10 times. Uh, that gets you to that one and a half to two x on the revenue. Am I saying it right? Like it? It's different ways of thinking about it, I guess. Flip side of the coin there is.

Charles Bedard: [00:15:53] And that's why, you know, to give listeners something actionable, I think the most common metric that really didn't exist before 2020, but I believe the most common metric used in the investment banking and investor world today is what I call our value. But it came to be known as rule of 40, which is this this simple formula. But it's year over year revenue growth typically looked at over a 2 or 3 year period as an average. The R value typically looked at over a 2 or 3 year average period, not just a single point in time, but it's the metric is year over year revenue growth plus your EBITDA percentage together those to be a premium. When it was created, this rule of 40 was you need to be over 40 for those two together. What that does with that metric does is it takes away, are you running the business for revenue and selling it to somebody who's going to buy on revenue, or are you running it based on EBITDA and selling it to EBITDA? It normalizes all the different types of buyers. So if I was a CPA partner or owner. And I wanted to have one metric to think about to. If I'm creating value, I look at our value because that's going to normalize that. And then you can always recast the financials or make the case that your revenue or your EBITDA is higher or lower.

Blake Oliver: [00:17:07] And how do I calculate the R value. You said that's my growth rate.

Charles Bedard: [00:17:11] Year over year growth rate plus your EBITDA percentage. So if you're growing at 10% year over year and you've got a 20% EBITDA, you're at 30. So you're a little bit below 40. Got it. You're growing at 50 like a lot of these high flying SaaS companies. But you've got negative earnings. Then let's say it's a -10% earnings. Then you're at you're back at 40. If you're growing at 50 with -10% earnings. So it adjusts. It takes into account where the company is at and its maturity and its life cycle, and normalize it across buyer types.

Blake Oliver: [00:17:44] And 40 is the target.

Charles Bedard: [00:17:47] 40 was the target if you just Google it when it was first published and used by VC firms today, if you're a software firm, you really need to be 70, 80, 90, your early stage. Um, if I think for any accounting firm listener, you know, 40 as a great goal, you know, start with 30, build from there, get to 40. 30 is good. 40 is getting you to where you want to be. And driving starting to get in the range of driving a premium.

Blake Oliver: [00:18:16] So let's say I've got a decent AR value. My growth is good. My earnings are good. I imagine there's a minimum size I've got to be in order to be in the, in the game to, to get interest from buyers. What what should I be targeting for minimum revenue headcount however else buyers look at firms.

Charles Bedard: [00:18:44] Yeah. If you look at I'll give it to you three ways. If you look at Inc 5000 top performers for the last ten years within service companies, those the average has gone from 171,000 revenue per full time employee to greater than 250,000 revenue per full time employee. So if you're not keeping up with that, you're falling behind. So that means yes, you need to offshore more or use contractors or use tech enablement or bots. So I think that revenue per FTE is just a good overall. You know, metric in terms of size. If you look at the average investment by sbic or by private equity, it's gone. It's increased over the years. When I was doing this a decade ago, they would look at stuff below 2 million in EBITDA. Today, it's very difficult for them to look at anything below 2 or 3 million in EBITDA. So that's kind of your size metric. You know, there's there's some other types of buyers that are not private equity but that general.

Blake Oliver: [00:19:50] So to get private equity interest, sounds like I need to be doing about 10 million or more in revenue for most firms. Would you agree?

Charles Bedard: [00:20:00] As a platform? You know, they can look at a smaller deal if it if you're the niche leader, you know, if you're an add on or a tuck in and they've already invested in and they are or they already have a platform and you're going to add an intact practice or you're going to add San Diego, which was a deal that was announced this week, or you're going to, you know, add cash, practice or some specialty. Then they can look at doing some smaller deals. But yeah, for the but for the majority, for the majority of the deals that they've done, they're looking at 2 or 3. And in fact, you know, you go to the private equity conferences. They want to look they want to talk to people that have 4 or 5, 8 million in EBITDA.

David Leary: [00:20:38] So yeah. So I have a firm I use an analogy of house, I'm ready to sell my house. And there's a list of things I should do to increase the value of my house. And I get an ROI on that. And there's things I'm not. Can you give a list for accounting firm owners, what they should be doing in their firm, and what should they not spend time doing in their firm to maximize their exit? Potentially.

Charles Bedard: [00:20:59] Yeah. It's a great.

Blake Oliver: [00:21:00] And I'm going to add to David what David said. Sorry to interrupt, but I'm going to say like let's assume that this firm is traditional. So they are billing hourly after the fact. They are doing a mix of services. You know, let's say it's tax and accounting and bookkeeping. Maybe they got some audit in there. Right. But it's mainly like traditional. So like yeah where do I, where do I get the quick wins.

Charles Bedard: [00:21:21] Yeah absolutely. So. I like to tell people, if you want to create wealth and value from your. Your practice in corporate development is as important as business development or service quality. Meaning you have to know. And have a plan. For exit and well, we'll work with people and develop two year rolling plans that adjust will give them a few key metrics that they should follow, and we'll have a general idea of we're either going to we're going to steer the business towards this direction. It can change, but we're going to have a plan. So I think that's the most important thing. If you wait till the end, you're not going to capitalize on all the opportunities. And there's so many opportunities out there for traditional CPA firms today, they could divest part of the business. They could do a small acqui hire. They could merge with somebody else. I mean, there's just so many opportunities today for these traditional businesses. I've got a guy down in Texas who's bought and sold five small practices. He buys them up, puts them together, and then divests them. But he's basically taking books and creating these niches and doing it. But there's just so many options for these traditional service firms. So I'd say, you know, number one thing, if you're going to do nothing else is understand where you're steering your exit. Don't wait five years. Don't wait. Don't be an ostrich and put your head in the sand. You know, if you want to buy a beach house down the road, have a plan of how much you need to make to get there.

Charles Bedard: [00:22:50] So I think that's the first thing. And then I'd say. You can rank. If you talk to a bunch of advisors, they're going to give you a different list. I rank all the things you could do into two categories protect the business and protect the minimum valuation or build the valuation. So at a minimum, there's some things you can do to protect the valuation. And there's some things you can do to build the valuation at a minimum. To David's point you know, understand how your financials look to a third party. You know, I've definitely tell people all the time that accountants and shoemaker shoe effect, they haven't had a third party look at their own book. You know, they're managing them for tax or they're managing them when they get to them. So, you know, there's a number of things you can do to protect the valuation and just demonstrate that we're the best version of ourselves as a traditional firm, you know, do some basic benchmarking. I'm happy to provide a free consultation, 30 minute session on benchmarking. Aicpa provides benchmarking. There's a lot of benchmarking groups that are out there. But get a benchmark, understand where you're at, do a few things to protect your IP. Those are just standard things that you can do to, you know, get a traditional valuation. But I think, you know, have a plan.

David Leary: [00:24:00] On the opposite side. Do you see, like people heading down wrong paths? They think that's the path and they start implementing things that are not going to help them get a better valuation, like mistakes, if you want to think of it that way.

Charles Bedard: [00:24:11] Most firms don't exit for a premium because they're not thinking about exiting for a premium. They're just thinking about running their practice. So you know, what are the most common mistakes? I think firms all the time make investments that they heard about at this stage, or they read about on CNBC, like, I'm going to go hire salespeople or I'm going to spend more on training and development to keep my people. I think firms make decisions all the time. And if there are 40 year old owner, maybe that's a good decision. If they're not, if they're 64 and they're going to go add intact because they hear that's the next big thing so that they can land some bigger accounts because they hear that's what CPA firms want. You're 64 and you're retiring in the next year or two. You're probably never going to get the payback on that. Right. So I think you've got to know where your exit is coming and where you're steering the business. So I think a lot of these investments. In both money and time are not tied to actually increasing the value. So yeah, absolutely. I think a lot of the efforts that people take, because they're not tying it back to the game plan, are. Not bad for the employees or the customers, but they're not creating wealth or value for the entity.

Blake Oliver: [00:25:24] I tell people all the time, and I'm curious to hear, Charles, if you think this is a good strategy. I tell people all the time that the simplest thing you can do is to not change anything that you do in terms of the services in your firm. But, you know, let's say you're doing a bunch of tax returns. It is to switch your clients to upfront billing for the returns and get 100% upfront if you can, and put them on a recurring billing structure. You don't have to do anything else. And if you do that, you'll recapture all that working capital that you've essentially loaned out to your clients every tax season.

Charles Bedard: [00:26:04] You can have them pay up front. You can have them pay on an annual basis and give them discounts if they if they lock in their rate over a 2 or 3 year contract, which is a very common software strategy. You can announce price increases that are increasing in the future for the smaller or less profitable accounts. I think there's so many things you can do to increase the value without having to spend a lot of money. Absolutely.

Blake Oliver: [00:26:30] So the lesson here is don't get distracted by implementing some sort of new technology in your firm before you actually fix the. What would you even call it? It's like the billing structure or just the the way you work with customers, because that's actually fairly easy to to do. You can do that in almost any firm. It's a little painful because you have to have some perhaps awkward conversations. Yeah, but but it's all doable, right.

David Leary: [00:27:00] David? It looks like you say so at the time that that's the that's the forcing function. Fixing the billing and how you charge clients forces you to do all the other stuff in your firm. Right.

Charles Bedard: [00:27:10] Yeah. So I mean, you can have somebody actually size like what the impact of these changes are going to be. Right. Like we can we can size moving to upfront payment or moving to annualized payment or moving to longer term payments. We can size that into impact. And then we can assess that back to what's the profit and then what's the value? I'm working on a project with Right Works. We're launching into April Home Exit Right Works, where we're going to provide different types of valuations and recommendations on how to increase your value. And it's it's these kind of very practical, actionable things that they'll get. And the idea is to democratize the M&A and exit options for accounting and related professional service firms so that you don't have. So if you're half $1 million firm or $1 million tax practice, you can go out there and get real time feedback from buyers, lenders, M&A intermediaries on what's your value and not just what's your value, but tips, resources for benchmarking, for succession planning, for things that you can do in your business. Connect with your peers. Get real time feedback from buyers. Again, don't wait five years or don't wait till it's too late. Every two years, you should probably update your corporate development plan and understand where you're steering the business.

Blake Oliver: [00:28:32] And if you're $1 million firm, this could be $1 million in value. That's the spread we're talking about here. Uh, in terms of whether you get that traditional I'm going to buy your book of business kind of deal or whether you get that modern digital firm. Deal with the higher multiple.

Charles Bedard: [00:28:52] Yeah. And whether you're earning out your payout over four years or you're earning it out over six months, or you're taking off some of the. I've talked to somebody this week who just they're tired of doing the administration, sales and marketing. They just want somebody else to do that. And her to focus on her key, key clients that she loves. You know, she's 62. She's not ready to retire, but she wants to get down that path. And she just wants to hand off all that hassle and that actually thinking about it that way you can get higher. Total consideration than you would if you just exited today, or you just wait till the last minute. So I think having that plan creates optionality, right. And you can increasing the valuation is good. Increasing the overall exit experience is more important. Mm.

Blake Oliver: [00:29:43] Yeah that that's that's interesting because a lot of these firms that are acquiring are short staffed already. So if you're willing to stick around and be a subject matter expert and service clients. Then I guess that is kind of like that's always been the most common sort of situation. When you merge your small firm into a mid-sized firm, you become for a few years a service provider, and you're no longer managing the business, and then eventually you transition out. So knowing if you want to do that is really important.

Charles Bedard: [00:30:20] Yeah, absolutely.

Blake Oliver: [00:30:21] Oh, well. Hey, Charles, thank you so much for your time today. We have been speaking with Charles Bedard, an M&A corporate development advisor for businesses. Uh, Charles, if people want to follow you online, get in touch with you. Maybe they want to ask you for, uh, some of those tips. Uh, maybe a benchmark. Where can they find you?

Charles Bedard: [00:30:44] I'm at LinkedIn. Charles Bedard. I'm at. I'm on Twitter at solving the value. I'd love to connect.

Blake Oliver: [00:30:51] Thanks so much. Hope to talk to you again soon.

Charles Bedard: [00:30:54] Thank you for having me, guys.