M&A Due Diligence

Source: The CPA Journal

For accounting practices, due diligence should be performed by both parties.

First, there should be a confidentiality agreement forbidding each firm from contacting the clients of the other, with penalties for violation.

Buyer’s Due Diligence

The intensity of the due diligence by the buyer will increase with the amount of cash up front and vary inversely with the amount of client hold-back. 

Analysis of billings and collections will determine whether cash flow from the acquired company can fund the purchase. The payment schedule should be consistent with the seasonality of the practice. If the seller collects the receivables, the buyer will have to fund the payments until new billings start coming in.  If receivables turn over slowly, the buyer may require the seller to share some of the collections for a time. Alternatively, up-front cash can be decreased or early payments reduced.  Suppose a client is late in paying current receivables while it still is indebted to the seller for older receivables. The parties may agree to split the collections from the old receivables.

If the seller has been losing clients or if there is a question about client loyalty (e.g., new clients may be less loyal than long standing clients), the hold-back period should be increased.

Billing rates should be analyzed in relation to the degree of computerization. If computers increase efficiency, billing rates can be correspondingly increased.

Review the work papers to determine:

·    The likelihood of adding services

·    The amount of time to finish the jobs

·    Malpractice exposure

·    Audit, accounting, and tax risk

What will the profitability be after the acquisition?

What is the condition of hardware and software being acquired?  Are there liens on any of them?

Does staff have noncompete agreements? How much contact do they have with clients? How do their compensation and capabilities compare with that of the buyer’s staff?

Does the buyer have the resources to service the seller’s clients? Are there services the buyer can add?

If the seller’s lease is not assigned, does the buyer have proper space for staff and equipment? If the lease is assigned, it must be reviewed.

What is the financial condition of the seller’s clients? Are they candidates for sale or merger because of their age?

How much field work is done? What are the billing policies with regard to traveling to and from client locations? Office location varies in importance inversely with the amount of field work.

Seller’s Due Diligence

Does the buyer have the resources to service the seller’s clients, including those in niche specialties?

Will the buyer increase billing rates or fees, and what impact will that have on the clients?

Will relocation affect client retention?

Does the buyer have the financial strength to assure success of the combined companies?

How stable is the acquiring firm, i.e. have the partners been together long enough to assure the continuation of the firm?

If clients have chosen the firm because of ethnic, language, cultural, or style reasons, the seller must determine whether the new firm will maintain the same persona.

What is the client turnover in the acquiring firm?  If it is high, it is probable that it will be high in the new firm.

What are the buyer’s goals and how will they affect the seller’s client base?

Noncompete agreements or other contractual arrangements should be in place to protect the seller from client loss because of departing partners or staff.

For the complete article, see CPA Journal, February 2005 or go to

http://www.nysscpa.org/cpajournal/2005/205/essentials/p62.htm