Retention - What You Need To Know

Published August 2023.

Retention is a key part of any practice sale or purchase. Whether you are a seller or a buyer, being aware of all the key elements of retention will set you up for a successful sale outcome. 

1. What is retention?

Retention is the amount of the purchase price held back by the purchaser for a given period, to be paid to the Vendor based on the performance of the practice that has been acquired over the retention period.

2. What is its purpose?
The purpose of the retention is to mitigate potential risks, uncertainties, or contingencies associated with the performance of an accounting practice following its change of ownership.

3.  How does retention work?

Using a simple example, if a practice with $1 million in fees was sold at 100 cents in the dollar with a 20% retention for 12 months, then the Vendor would receive $800,000 (80%) at Settlement, with $200,000 (20%) held back for 12 months.

• If the fees from the acquired practice were $1million or more in the first 12 months, the Vendor would receive the full $200,000 held in retention.
• If the fees from the acquired practice were less than $1million in the first 12 months, the amount the Vendor receives would be reduced by the shortfall at the same multiple of 100 cents for every $1 of revenue less than the $1 million.
• Where the shortfall is greater than 20% of the Purchase Price, then the loss will be borne by the Purchaser and no further amount of the purchase price is paid to the Vendor

3.  How is the percentage determined?

This is a great question and will depend on who you speak to! In DMY's view it should be based on the specific risk profile of the fees being acquired, and the transition role of the Vendor in supporting client retention. This is logical and fact-based. Many buyers agree with this approach which leads to a sensible conversation around the retention terms and a positive outcome for both parties. Where some buyers come unstuck however, is when they insist on onerous retention terms that bear no relation to the risk profile of the fees being acquired.

5. How long is the retention period?

From DMY's experience, the vast majority (>90%) of retention periods are for 12 months. Occasionally we do see two years but there needs to be a specific risk identified - either with the client base or the Vendor's role post sale -  to warrant this.

6. What is included in the retention revenue?

Obviously, any fees generated from existing practices of the acquired practice get included. The nuance here though is that if there are material fees generated from additional services provided by the Purchaser then there may need to be a specific conversation around how these are handled.

As with any practice, clients do come and go over the course of the year and some clients will choose to leave following a sale.  DMY's position is that any revenue of the practice acquired from new client referrals by either existing clients or by the Vendor during the period of retention should be used to offset any shortfall arising as a result of departing clients.

Finally, all recoverable Work in Progress (WIP) as at the anniversary of the Settlement Date should be included in the calculation of the retention period revenue to capture any material work that has been performed but not yet invoiced.

7. How can Vendors help secure their full retention payout?

Choosing a buyer who is a strong cultural fit with the clients, the team and the Vendor themself is the most important way to secure your retention. If the cultural fit isn't there,  the entire sale is at risk of failure. Beyond that, having the Vendor actively involved over those crucial first 12 months is another key success factor.

We also recommend to clients that they seek agreement from the Purchaser that:

• They will provide the Vendor with a monthly report showing billings in that month and year to date (by client) to enable the Vendor to track progress against the Target Amount. This should generally be provided within seven days of each month end.
• They will not make any material changes to the existing services offered to the clients of the Business or the current pricing of the services offered (either up or down) within the first twelve months from Settlement.

8. What retentions are we seeing in the market?

Based on our latest Market Data (April 2023) DMY are seeing an average of 17% held in retention, with 15% the most common amount.  However within this data set, there is a broad spread ranging from 10% through to 30%. This reinforces the need for both sellers and buyers to focus on the specific risk profile of the fees being acquired, and the transition role of the Vendor in supporting client retention. 

Pragmatic sellers with higher risk client portfolios are recognising they need to be flexible on retention while sellers with less risky books, or mitigating factors, are holding their ground to agree lower retentions. Conversely, smart buyers, once they can see a strong cultural fit with the seller, use retention as an effective negotiating tool to differentiate from the competition. Buyers who insist on a high, multi-year retention without specific logic continue to miss out.

The supporting data is provided below: 

Note: Sales Listings are ranked in ascending order in each graph ie Listing #1 above is not necessarily the same as Listing #1 in other depictions.
Only 19 listings are featured as one was subject to an alternative structure.

The Wrap

Retention is a key part of any practice sale or purchase. Understanding its purpose, how it is calculated and where the market is at, will help both sellers and buyers have logical, fact-based conversations, agree sensible outcomes and ensure both parties are motivated to work together to achieve a successful outcome. 

To discuss these findings in more detail and what they mean specifically for your situation, contact DMY’s Directors below. 

Mark Emney

Mobile: 0434 079 530
Email: mark@dmyassoc.com.au

Daniel Jones

Mobile: 0401 493 773
Email: daniel@dmyassoc.com.au  

Disclaimer: The above material is general in nature and not intended to be specific to the reader’s circumstances. You should not act solely on the basis of the information contained above and should always seek expert advice specific to your own situation.