Quick answer: In accounting firm due diligence, a buyer tests whether client fees will stay and what the practice earns after market pay for the partners. It rebuilds the roster from the billing system, ties fees to the ledger and bank deposits, measures retention by client, reviews work in process and realization, normalizes partner compensation, and reads quality-control, claims and staff records. Fees at risk lower the retention baseline, and corrected costs lower adjusted EBITDA.
Key points
- Buyers rebuild the fee roster from the billing system and tie it to the ledger and to bank deposits before they trust any retention or margin figure.
- Retention is measured from the clients on the roster at the start of each year, so clients that left stay in the result and the survivors do not flatter it.
- Partner draws are replaced with market pay for the roles the partners fill, usually the largest single change to an accounting firm’s earnings.
- Obligations to retired partners are debt-like, while fees from clients who have given notice lower the run-rate, so the two findings reach price by different routes.
What a buyer of an accounting firm must prove
A buyer of an accounting firm proves two things, in order. The first is that the fees on the roster will keep arriving when the selling partners step back. The second is that the firm earns a profit after paying market rates for the partner-level work. The first sets the baseline for any payment tied to retained fees, and the second sets adjusted EBITDA, which the multiple then scales.
The workstreams run in a set order because each depends on the one before. The roster is rebuilt first, retention is measured on it, work in process and realization follow, partner pay is normalized, and quality-control, staff and technology records are read last. The valuation page for accounting and tax firms covers multiples and value drivers, and the directory of diligence by industry compares other businesses.
Rebuilding the client roster from the billing system
The buyer’s accountants export fees by client and service line from the billing system and tie the total to revenue in the general ledger, to the tax return and to bank deposits, as proof of cash describes. Fees that do not tie are listed one by one. Gaps often come from billing outside the system, such as fees paid personally to a partner or work billed through another entity.
Four tests then follow. Engagement letters for the largest clients are sampled for scope, fee basis, renewal, termination and assignment terms. Fees are cut by client size to show concentration. Recurring work such as returns, bookkeeping, payroll and continuing advisory is separated from one-time projects. Clients tied to the partners, such as relatives and partner-owned businesses, are flagged, because discounted or unbilled work for them may not repeat at arm’s length. If the firm keeps cash-basis books, revenue is converted as cash-to-accrual conversion explains, since fees collected in January for December work fall in different years under the two methods.
Retention history and the clients behind it
Retention is measured from the clients on the roster at the start of each year: how much of that fee base remains a year later, by client, service line and relationship owner. Starting from the beginning-of-year roster keeps lost clients in the result, whereas an average over the survivors flatters it. The buyer asks why each large client left, whether it closed, sold, objected to price or service, or followed a departing staff member or partner. Past transitions are the best evidence of the next one, so the buyer also asks whether the firm’s last partner retirement or key departure took clients with it.
Price increases get the same treatment. The buyer wants to know which clients accepted an increase, which pushed back and whether any left afterward, because a buyer that plans to raise fees will not be credited for an increase the history does not support. After the letter of intent, buyers often ask to speak with the largest clients, with the seller’s consent, and the seller sets the timing so that no client hears about the sale as a rumor. The customer diligence guide covers the technique.
Work in process, realization and filing-season working capital
Unbilled time and fixed-fee work in progress are reviewed at standard rates and at what the firm actually bills, and the gap is realization. Write-offs that recur are an operating cost, not a one-time event, and unbilled time that has survived several billing cycles is reserved. The buyer also compares billing practice with delivery. A firm that bills fixed fees in advance carries deferred revenue, and one that bills after delivery carries work in process.
The balance sheet swings with the filing calendar. Receivables and work in process peak after the main deadlines and advance billings peak before them, so one month-end balance misstates the normal level. Buyers often set the working capital target from an average across the year, which is why the closing date matters, as the working capital peg guide explains.
Partner pay and the adjustments to accounting-firm earnings
Partners are usually paid through draws and profit shares, so reported profit is stated before the cost of their labor. The buyer deducts the market cost of each partner-level role, whoever fills it after closing, and adds back only pay that exceeds that level. The method is in normalizing owner compensation, and these adjustments most often move an accounting firm’s earnings.
| Adjustment | Why buyers question it | Support they expect |
|---|---|---|
| Partner pay restated to market for the roles performed | Draws and profit shares are not pay for specific work | Role descriptions, hours, market pay data, partnership agreement |
| Payments to retired partners | A continuing cost or a debt-like obligation, depending on terms | Retirement agreement and payment schedule |
| Fees from clients who gave notice or whose work ended | They will not repeat | Notice letters, billing history |
| One-time project fees | Not valued like recurring fees | Engagement letters, history of similar projects |
| Pricing catch-up not yet billed | Increases count only after clients accept them | Rate card and acceptance history |
| Staff pay below market or unaccrued busy-season overtime | Underpaid staff leave, and unaccrued costs recur | Payroll registers, market data, turnover history |
| Rent paid to a partner-owned building | The rent may differ from market | Lease, comparable rents, as in related-party rent adjustments |
Illustrative example: How partner pay changes the earnings a multiple scales
A firm reports revenue of $9,000,000 and costs other than partner pay of $6,600,000. Three partners share the profit. Two work full time on client service and review, and one works about half time.
| Line | Amount |
|---|---|
| Profit before partner pay | $2,400,000 |
| Market pay for the two full-time roles, $400,000 each | $800,000 |
| Market pay for the half-time role | $150,000 |
| Adjusted EBITDA | $1,450,000 |
At a placeholder multiple of 5.0x, adjusted EBITDA of $1,450,000 supports a price of $7,250,000. The same multiple applied to profit before partner pay would imply $12,000,000, and the $4,750,000 difference is the value of the partners’ own labor, which the buyer must replace. The pay levels and the multiple are placeholders and the numbers are invented to show the mechanics and are not benchmarks.
Quality control, peer review and claims records
A buyer inherits the firm’s reputation along with its files, so it reads the records that show how the work is controlled. If the firm has undergone peer review, the buyer reads the report, any letter of comments and the firm’s response. It also reads quality-control policies, engagement acceptance records, independence confirmations for attest clients, and any notices, penalties or inquiries from tax authorities or licensing boards about the firm or its preparers.
Professional liability policies are commonly claims-made, so the buyer asks for loss runs, notices of circumstances and open claims, and for the tail coverage the seller will buy for work done before closing. A quality problem shows up as a tighter indemnity, a larger escrow or a decision not to take the attest practice, and a pattern of claims lowers confidence in the earnings behind it.
Staff, busy-season capacity and the systems behind the work
The staff roster lists each person’s role, license, tenure, pay and bonus accrual, with turnover by year and by month. Departures that cluster after busy season show a capacity problem the buyer will inherit. Seasonal and part-time staff are checked for classification and overtime treatment, as HR and employment diligence describes. Work that is outsourced or sent offshore is reviewed for who performs it, what client data they hold and whether the contract can be assigned.
Technology comes last. The buyer asks which practice-management, tax and document systems the firm runs, when licenses renew, how client data is protected and whether a security incident has occurred. It also reads the agreements with staff and partners, including non-solicitation terms and who owns a client relationship when a person leaves, since those terms decide whether a departing manager can take clients.
How findings reach price and structure
Each finding takes one of three routes. A run-rate finding, such as partner pay or lost clients, lowers adjusted EBITDA, and the price falls by the multiple. A past obligation, such as payments to retired partners, is deducted as a debt-like item. A retention finding sets the baseline for the payment tied to retained fees. A seller can run these tests first through a sell-side quality of earnings report, and the process that follows is described in how to sell an accounting firm. Buyers use the same list to plan, as buying an accounting practice shows.
Frequently asked questions
What documents does a buyer request first from an accounting firm?
A client list with fees by service line for several years, billing and work-in-process reports, engagement letters for the largest clients, the partnership agreement, partner and staff compensation records, tax returns and financial statements, professional liability policies with claims history, and any peer review or quality-control records. Together they test fee quality, partner pay and risk.
How do buyers measure client retention in an accounting firm?
They list the clients and fees at the start of each year and track how much of that fee base remains a year later, by client, service line and relationship owner. Counting from the start of the year keeps departed clients in the result. Buyers then ask why each large client left and who held the relationship.
How is partner compensation normalized in an accounting firm?
The buyer replaces partner draws and distributions with the market cost of the work each partner does, such as client service, technical review and management, and treats the remainder as profit. Partners who plan to leave are replaced at market pay in the model, so the adjustment follows the roles, not the people who fill them today.
Are payments to retired partners a debt or an expense?
It depends on the agreement. A fixed schedule of payments owed to former partners is often treated as a debt-like item that reduces price. Payments tied to the firm’s current profit may instead be treated as a continuing cost. The buyer reads the retirement provisions of the partnership agreement and asks how the firm’s accountants have recorded the payments.
Preparing a company for sale or a buyer's diligence?
The Impetus Group offers fractional investment banking support, including earnings normalization, financial projections, CIM preparation and help navigating buyer diligence, with an engagement scoped to what the business needs.
Related guides
- Accounting and tax firms: How accounting and tax practices are valued: recurring fees, client retention, service mix, seasonality, staff and succession, ownership rules and deal structure.
- How to Sell an Accounting Firm: Buyers, Client Retention and Transition: How to sell an accounting practice: who buys, how client retention shapes price and terms, what to prepare and how the filing season affects timing.
- Buying an Accounting Practice: Client Transfer, Staff Retention and Valuation Checks: Buying an accounting practice: screen client transfer risk, test fee quality, check independence and ownership, tie price to retained fees, plan integration.
- Supplement Company Due Diligence: Quality Records, Claims and Add-Backs: What buyers test in supplement company due diligence: lot traces, label and ad claims, marketplace payouts, subscription cohorts, refund reserves and add-backs.
- Beauty and Personal Care Brand Due Diligence: Returns, Retailer Terms and Margins: What buyers test in beauty brand due diligence: gross-to-net and returns, retailer terms, inventory reserves, marketing spend, formula files and add-backs.
- Engineering Firm Due Diligence: Utilization, Work in Process and Adjusted EBITDA: Engineering firm due diligence: how buyers test utilization, the multiplier, work in process, fixed-fee margin fade, contracts, insurance and principal pay.
This guide is general education. It is not a valuation opinion, appraisal, investment advice, or legal or tax advice. How these guides are made.