Private equity firms have been doing more investment deals in the accounting profession lately, causing some firms to restructure their practices, and they've needed advice from law firms on how to set up their attest practices in a way that doesn't run afoul of regulators.
Hunton Andrews Kurth, a global law firm, has been assisting in several deals, including an investment from
"We're really seeing interest across the board," said Hunton Andrews Kurth partner Matthew P. Bosher. "We've seen private equity interest in very large firms and in firms outside the Accounting Today Top 100. You've got big private equity firms involved and middle-market private equity firms involved. So far we've seen interest in very large firms, smaller firms and firms in between."
"There is this high level of interest by private equity to think about these professional services businesses and get their foot in the door," said Hunton Andrews Kurth partner Kevin Georgerian, who also leads the accounting firm M&A team. "Some of the interest is probably arising from the fact that it's relatively new, so there's an opportunity to get in here early. There's a view that there's probably going to be consolidation in the industry, and if you invest in and then you grow a platform, there's a real tail to the investment."
Private equity investors view CPA firms as a good bet. "They're trustworthy partners and generate steady returns," said Bosher. "There's not a lot of debt generally and real opportunity for growth, particularly in non-attest advisory services. You combine a history of steady returns with an opportunity for growth and scalability through technology, and it becomes a good bet."
In some cases, PE firms have been cold calling accounting firms, and CPA managing partners also have been talking with each other about the interest they're seeing.
"The list of PE firms that are interested in accounting firms — and that's a very long list, by the way — is generally known to accounting firms," said Bosher. "I think the list of accounting firms that are potentially interested in a partner is generally known as well. There are also investment bankers who specialize in this area, and we've seen in some instances large accounting firms start by teaming with an investment banker that will be bringing potential investors to the table."
In some cases, CPA firms have needed to separate their audit and attest practices before other parts of the firm could accept the investment, particularly on the consulting side, as occurred last year when
"Where there's attest work, whether it's audit or SOC work, that attest business has to be owned by a licensed CPA firm," said Georgerian. "In New York, a licensed CPA firm has to be 100% owned by individual licensees. In every other state, a licensed CPA firm has to be at least majority owned by individual licensees. So that really precludes private equity investment, or really any outside investment, in a CPA firm that does attest work. So in every one of these deals where there is attest work, it remains in the licensed CPA firm. The non-attest work is contributed to a new entity, and it's that new entity where the outside investment — whether it's private equity or another outside investor — has its ownership."
Some accounting firms have been hesitant about accepting PE funding because of perceptions about giving up control or being subject to intense cost cutting.
"I think culture matters, and the culture at some accounting firms is not going to fit well with the culture at some PE firms," said Bosher. "There's no doubt about that. We have seen accounting firms think very hard about whether the culture and the business model of the PE firms that might be interested in them are a good fit, but it's probably wrong to think of private equity in a monolithic way."
Convincing all of the partners to go along with the deal can also be a challenge.
"Obviously an accounting firm is a human capital intensive business, and it has a lot of owners, so those owners do have a lot of leverage," said Georgerian. "Oftentimes they have the ability, with some potential constraints, to 'walk' if they don't like the transaction, so the buyer wants to make sure that they're not going to walk prior to closing. The partners do have power in these transactions. All of our experience with the management teams of accounting firms is that they want very much to make the transaction happen in a smooth and logical way where there's an appropriate rollout of information to the partnership, where the partners have the opportunity to ask the questions that are on their mind and really understand what the transaction is going to do for them from a day-to-day ownership perspective. There is a lot of emphasis on not just negotiating the deal documents, but then on explaining the deal to the broader partnership."
The roles of the managing partner and CEO may shift if the firm splits up the audit and advisory sides during the transaction, and the board will probably be restructured as well.
"Initially, post-closing, the roles are relatively the same in the sense that they are now the CEO of advisory, but advisory is essentially running the business other than the pure audit practice, which is retained by the accountants at the audit firm," said Georgerian. "The bulk of the business is in advisory, so the CEO role is fairly similar, and that goes down the chain to the other leadership of the accounting firm. What is obviously different and is clearly a key part of the negotiations on these transactions is that you have a board or some other governing body that is now broader than just accountants and includes private equity representatives, so there is a new governance committee that involves outside investment."
The overall structure of the firm will change after the transaction. "The attest business and the new non-attest company are separately governed and have separate leadership and separate boards," said Bosher. "The difference from the old model is those business lines don't all report up to one firm managing partner or one board because the attest business is truly separately governed from the non-attest business. But otherwise, the roles are similar. The other thing is certain senior service providers who aren't CPAs who would not be technically speaking owners of the CPA firm, when the new non-attest business is created, those individuals can be partners in the new non-attest entity because the new non-attest entity is not a CPA firm and is not regulated in the same way. So you will have some senior service providers who today at a CPA firm are not partners but will become partners or members or owners of the new non-attest entity, which is not a CPA firm. So, there are some differences in titles and ownership. And then the key is the attest business is separately owned and governed from the new non-attest business."
With any such PE investment deal, some adjustments will need to be made for the members of the firm.
"Generally when you're taking a CPA firm and splitting it into two where the attest business remains in one entity, and the non-attest business and all of the employees go into a new company, you can imagine there are some operational challenges in the short term," said Bosher. "We think those challenges are very much surmountable, and we've seen some of the challenges. But in any enterprise, when you're splitting it in two and all of the employees are moving to a new separately owned and governed entity, there are certainly going to be operational challenges in the short term."
Firms also have to be cognizant of the SEC audit independence rules when accepting PE investment, and those will often dictate the split between the audit and consulting sides. SEC acting chief accountant Paul Munter weighed in with
"The SEC independence rules do not currently contemplate this structure, so for a long time parties were left to form judgments about how to apply the SEC independence rules in a structure of this nature," said Bosher. "The SEC published high-level guidance, but guidance nonetheless, as to how the Office of Chief Accountant views the application of the SEC independence rules in this context. That's new and is a helpful roadmap in some ways for parties considering setting up an alternative practice structure where there is an SEC audit practice. Obviously that guidance is relevant only where there is an SEC audit practice and the SEC independence rules apply, but it is a helpful roadmap that did not exist previously."
The SEC guidance may help more accounting firms get clarity on how the SEC views such deals, although some may see it as a warning.
"I do not view it as a deterrent because what you had before was uncertainty and ambiguity," said Bosher. "That guidance eliminates a lot of the uncertainty, which I think creates a roadmap for parties to follow in applying the SEC independence rules in this structure. I view it as an aid. It's certainly an admonition to parties to make sure they're paying attention to the rules. But what you had before was uncertainty, and I think elimination of a lot of that uncertainty will ultimately help parties close deals rather than deter them from doing so."
Some firms have also received funding from investment firms outside the PE world, as
"You don't need an alternative practice structure to sell your wealth management business," said Bosher. "The attest business is not impacted by that generally."
His law firm hasn't been handing those types of deals. "The regulatory issues there are not the same as the regulatory issues and the alternative practice structure transactions we're working on," said Bosher.
As for PE firms buying into the accounting profession, the trend doesn't seem to be slowing down anytime soon.
