7 Questions to Ask Before Buying a New Advisory Firm
Before acquiring an advisory firm, ask these 7 critical questions about taxes, liabilities, and finances to avoid costly surprises.
Buying an existing advisory firm can accelerate your growth, but it also comes with hidden tax and financial risks. Asking the right questions before closing can save you from inheriting costly liabilities. Here are seven essential questions to ask, with practical steps you can take this week.
1. What Is the Firm’s Tax History and Are There Any Outstanding Liabilities?
You need to know if the firm has unpaid taxes, penalties, or ongoing disputes with the IRS or state authorities. Request the last three years of tax returns, including federal and state filings, and check for any notices of deficiency or liens. Also ask about sales tax obligations if the firm sells products or services.
Practical step: Hire a CPA with M&A experience to review the tax records. This week, request a copy of the firm’s tax transcripts from the IRS using Form 4506-T to verify what the seller reports.
2. What Is the Tax Basis of the Firm’s Assets and How Will the Deal Be Structured?
Asset purchases and stock purchases have very different tax consequences. In an asset deal, you can step up the basis of tangible and intangible assets, which can reduce future taxable income through depreciation and amortization. In a stock deal, you inherit the firm’s existing tax basis, which may be lower.
Practical step: Discuss with your tax advisor which structure is more favorable. Ask the seller for a detailed asset schedule showing the current book and tax basis of equipment, furniture, and client lists.
3. Are There Any Unpaid Payroll Taxes or Employee-Related Liabilities?
Payroll taxes are a common hidden liability. If the firm has not remitted payroll taxes, the IRS can hold you personally liable as a responsible person. Ask for payroll tax records for the last three years, including Form 941 filings and proof of payment.
Practical step: Verify with the IRS that all payroll tax deposits are current. Also ask for a list of all employees and their compensation to ensure proper classification (W-2 vs. 1099).
4. What Is the Firm’s Client Retention Rate and How Will That Affect Your Taxable Income?
Client retention directly impacts your future revenue and tax liability. If clients leave after the acquisition, your income drops, but your fixed costs may remain. Ask for client retention data over the past three years, and consider how the sale will affect client relationships.
Practical step: Request a client list with revenue history. This week, draft a communication plan to introduce yourself to key clients within the first 30 days to build trust and reduce attrition.
5. Are There Any Pending or Potential Lawsuits That Could Create Tax-Deductible Losses or Liabilities?
Lawsuits can create unexpected expenses and affect your tax situation. Ask about any pending litigation, claims, or regulatory investigations. Also ask about the firm’s professional liability insurance coverage and whether it will continue after the sale.
Practical step: Have your attorney review the firm’s litigation history and insurance policies. Ask the seller to provide a written representation that there are no undisclosed claims.
6. What Is the Firm’s Current Revenue Mix and How Will That Impact Your Tax Planning?
Advisory firms earn revenue from fees, commissions, or a mix. The revenue mix affects your tax planning, especially if you are buying a firm with recurring revenue versus one-time commissions. Ask for a breakdown of revenue by source and client type.
Practical step: Use this data to project your future taxable income. This week, create a simple spreadsheet that estimates your revenue and expenses for the next 12 months, including the acquisition costs.
7. What Is the Seller’s Role After the Sale and How Will That Affect Your Tax Obligations?
If the seller stays on as a consultant or employee, their compensation is a deductible business expense. But if the seller is paid through a non-compete agreement, that payment may need to be amortized over the term. Ask about the seller’s post-sale involvement and the tax treatment of any payments.
Practical step: Work with your tax advisor to structure the seller’s compensation in the most tax-efficient way. This week, draft a transition agreement that clearly defines the seller’s role, duration, and payment terms.
FAQ
Can I deduct the cost of buying an advisory firm?
Yes, but not all at once. In an asset purchase, you can depreciate tangible assets and amortize intangible assets like client lists over 15 years. In a stock purchase, you generally cannot deduct the purchase price until you sell the stock. Consult your tax advisor for specifics.
What happens if the seller has unpaid taxes?
In an asset purchase, you typically do not inherit the seller’s tax liabilities. In a stock purchase, you may. Always verify with the IRS and request a tax clearance certificate from the state.
How long should I keep the seller’s tax records?
Keep all tax records and financial statements for at least seven years after the acquisition. This protects you in case of an audit or dispute.
Should I use an escrow account for tax liabilities?
Yes, consider setting aside a portion of the purchase price in escrow to cover any unexpected tax liabilities that arise after the sale. This is a common practice in M&A deals.
The Bottom Line
Buying an advisory firm is a major financial decision with significant tax implications. By asking these seven questions, you can identify potential risks and structure the deal to your advantage. Work with a qualified tax advisor and attorney throughout the process, and take the practical steps outlined here to protect your investment. With careful due diligence, you can acquire a firm that strengthens your practice and your bottom line.