Accounting firms all across the country are adopting alternative practice structures as private equity investment sweeps across the profession -- but who knows what an APS really looks like? William Kelly, chief counsel at PE-backed accounting firm platform Ascend dives into the details.
Transcription:
Dan Hood (
Welcome to On the Air With Accounting Today I'm editor-in-chief Dan Hood. In every news article about private equity firms coming into the accounting profession — and there are a lot of those articles — at some point the phrase "alternative practice structure" arises, so we thought it might make sense to dive into what exactly an APS is, since it's a phrase that people are hearing a lot and a lot of firms are taking on this structure, which seems new to many people, but it actually has been around for a little bit here. To help us with all that, it's Bill Kelly. He's the chief counsel of private equity-backed accounting firm platform Ascend. Bill, thanks for joining us.
William Kelly (
Oh, it's my pleasure, Dan.
Dan Hood (
So like I said, this is there. We were talking a little before. This is an area I hear this phrase, hear alternative practice structure all the time and know the 1% tip of the iceberg about it, but there's so much more to it because it's a fairly interesting setup. So I want to start, maybe we start with the basics of what legally speaking is an alternative practice structure.
William Kelly (
Well, one of the things you mentioned in your introduction is it's getting a lot of press right now, but it actually has been around for decades and the first major entity that went into it was CBIZ back in the 1990s. And basically what it does and what any alternative practice structure does is it separates into at least two firms. One that does a test work and one that does everything else and that everything else could be non attest, tax work, consulting, whatever's appropriate for that firm to begin with. And it could also include a staffing entity that helps supply people, administrative staff, professional staff, depending on how that particular alternative practice structure is set up. But the alternative to is the traditional partnership model that's been around for 150 years.
Dan Hood (
Got you. How do you implement one? What do you have to do? Do you just say, I'm an alternative practice structure? Now what goes into setting those? Well, those two at least up.
William Kelly (
Well, there's a legal component and there's a substantive component. The first thing you have to do if you're interested in pursuing the alternative practice structure is get firm ownership, get firm management together and say, what do you want to be as a firm? Where do you want go? You've put your lots together, you've put your careers together, where do you want go from there? And then you have to have a conversation with your stakeholders early. Those are your partners. Sometimes your retired partners, if there's a significant retirement payments that are being made, and it should be probably your up and coming partners, you're talking about their future as well. It's also going to have bankers and insurers involved, but you have to have conversations that get their input as well. That's the substantive side. Then there's the legal side. You do need at least two separate legal organizations.
(
That's the traditional test firm, which can be a limited liability partnership, a professional corporation, whatever your state allows, and another entity. And you have to have distinct legal organizations. That's separate TIN numbers, separate e-filing, IRS numbers. If you're going to go that route with tax filing, separate firm management, separate accounts, bank accounts, separate public facing communications. So it may mean two separate websites or it may mean one website with a disclaimer. Most firms go with a disclaimer after you set that up. When you start operating, you'll need to notify clients, make sure files are with the appropriate legal entity because they are two separate legal entities. You got to worry about transmitting information to an entity that's not entitled to it. So there's a lot of other legal things you've got to do at that, but think of it as two separate businesses. What do you need to do to maintain those as separate entities?
Dan Hood (
Gotcha. I think for a lot of people they sort of wonder why, what's the point of this? It is, as we mentioned, it's associated these days with private equity investments. But as you mentioned with CBIZ and with UHY and one of the few different firms that implemented them a long, long time ago, what's the purpose? Why are firms adopting them or why would a firm adopt them?
William Kelly (
The main reason it was adopted way back when was to allow for non-CPA ownership. Traditionally only CPAs were allowed to own accounting firms. And then over the decades, state boards of accountancy relaxed that rule to have some of 'em, as long as the majority is CPA owners New York technically still has a hundred percent ownership rule, but there's political mechanisms in place that's probably going to change this year. But what it does is it allows the sources of capital and equity to come in from outside the CPA partners. And that's a game changer for many firms.
Dan Hood (
And it's that ownership function, right? I mean, in theory, if you were in a state, as you said, New York is a little behind the times, but a lot of states allow that 49% ownership. If you had somebody wanted to come in and own less than 49%, would you need to adopt an alternative practice structure or would you be okay continuing to operate in a state that allowed up to 49% to non-CPA ownership?
William Kelly (
It would likely need to really look at the state ownership. But there are situations in which a PE firm has taken a less than 49% or less than 25% is one situation I'm aware of. But it's really not just there to allow PE to come in and to allow outside funding to come in and also serves other functions.
Dan Hood (
Well, let's dive into those, lay out some of those because I think for most people who like me, have a very surface level understanding of it, that the assumption was that it was all about how much someone could own and that's why PE firms were interested in or why it was a question when PE firms come in. But so what are some of the other functions that it fulfills?
William Kelly (
One of the main functions it fulfills from a legal perspective is it isolates liability and risk into two separate entities. If you do treat them as two separate entities and you avoid any cross-contamination or the legal term piercing the corporate veil between the two entities, then you actually do isolate those entities. And if you're an audit firm in a particularly high risk audit area, foreign investors, SPACs, things like that, you may want to isolate your audit risk into a separate entity than your whole practice. And that goes the same. If you have a tax practice that's a risky tax practice, you might want to isolate that and go with an alternative practice structure. One of the other things that allows, it allows the equity positions to be distributed in a way that attracts younger, more ambitious accountants, those who are maybe not old enough to be the full equity partner that we have. Traditionally in the alternative business structure, alternative practice structure, you can get them equity or ownership interest in a related entity much sooner. It makes the profession more attractive to those ambitious go-getters that we're all looking for the A-players.
Dan Hood (
That's really interesting because we have seen firms that have taken on alternative practice structures, not for the purpose of bringing on large scale external investment for instance, but to allow, these were in New York, so they were giving them the option of making partners out of non CPAs. So they were looking for that opportunity. And it's interesting to hear those other possibilities like for instance, around ring fencing tax or a risky tax practice or I guess in theory you could do it for financial planning practice or anything like that. Do you see a lot of firms adopting them for those reasons or is it mostly for the outside investment?
William Kelly (
Like you said, there were a few firms that did it for their internal reward systems, but even if they did it for that reason, that makes 'em attractive for outside investment. And I can't say they've all eventually looked into outside investment, but judging by the headlines in accounting today, it seems like a lot of 'em did
Dan Hood (
Well, and it certainly, everyone's got to at least be thinking about it. So it's setting them up for that. I'm kind of curious, this is one of those weird things. Are these in any other professions? Is it just accounting or is it other professional services or other sort of firm style partnership organizations? Do they use these?
William Kelly (
Yeah, actually the legal practice has started to begin this process of looking into the alternative practice structure. Right now there's just two states, Arizona and Utah and Washington DC also allows for alternative practice structure. And Arizona, as you've probably seen in accounting today, just gave their first license to a non-law firm to operate a law firm. And that was KPMG,
Dan Hood (
I assume, as you said, Arizona. I'm like, wait a minute. And also Ario as well, I think is looking into, they've done some kind of similar organizational thing in Arizona where they're trying to be a law firm or going to be a law firm, which is fascinating. I didn't know that about that. Alright, well that makes, tying it all together here, filling out the whole range of what's the developments are going on. There was for a long time there had been talk about creating this sort of multidisciplinary practice that would bring different things together. It comes up every 10 to 15 years.
William Kelly (
And what I think people also have to remember is Europe's had this multidisciplinary practice for generations. There are lawyers and accountants in the same firm in Europe, different rules for different countries, but this is not a new concept that we're talking about where a law firm is reaching over an accounting firm is reaching over to different professionals. Now, the US has much more stringent rules about the practice of law. So I don't see that happening anytime in the near future where the US firm will offer both services, but having an ownership structure or a joint venture with a law firm, yeah, that's definitely a possibility in the years to come.
Dan Hood (
It's interesting, they sometimes people will say every once in a while that the big four firms employ more lawyers than some even very large law firms. But as you say, not for the practice of law or very careful being very careful about when they're not practicing law. But it'd be interesting to see if that goes forward. I had not realize that it was so common in Europe, which may or may not make it likely to be more or less likely to be adopted here. I dunno, it's a recommendation for a lot of people that Europeans are doing it, but it certainly, I mean there's a lot of, you can see a lot of potential synergies and a lot of reasons why it might makes sense, particularly if they're allowed to actually practice law. But we're getting a little far afield. This is all good stuff, but a little far afield from the original alternative practice structure question. I have a couple of things I want to follow up on about that, and particularly how it impacts people in the day-to-day, both at the partner level, but also in the corridors of the firm themselves. But first, we're going to take a quick break.
(
Alright, and we're back. We're talking with Bill Kelly of Ascend about the alternative practice structure and what it means when you hear that phrase attached to every single private equity deal and in some cases other deals as well at firms across the accounting profession. You had mentioned some of the very specific detaily type things that you have to do when you're setting up an alternative practice structure to make sure that different client facing communications, different ownership structures, different management, that sort of thing. So I want to dive into some what that looks like on the ground for people in firms, and maybe we start at the partner level. How does that change their stake in the firm? How does it change their relationship to the firm? How does it change their sense of ownership, both practically, literally? How does it change their ownership maybe how does it change their sense of that?
William Kelly (
Well, first, every firm is going to come from their own unique starting point. So we're going to talk in generalities because every firm has a different history, different ownership structure, different management structure. But the first thing that is going to force the firm to undergo is a self-examination of what does their ownership structure look like, and it's going to have to be transparent to all partners about what that is, and that may be a change in culture for how some firms have operated, but that you have to have that transparency in order to take the next step to go to the alternative practice structure where you separate out the ownership structure theoretically day one before the transaction to day one after the transaction. Your equity total should be the same. All you're doing is changing in what entity you're an owner of. Theoretically, audit partners will all become equity owners of the audit entity.
(
Some firms will want all of the partners to be partners in the audit entity, but if you're a tax partner or a consultant partner and you have no expertise or added value to the attest entity, it might not be the right structure for you. So let's assume that all audit partners become owners of the audit entity and then everybody becomes owners of the non-attest entity and you have to now make sure that the ownership amounts equal the pre-transaction amount and then from that point on, they operate a separate businesses. You'll have a contractual agreements between them. Where it really affects the day-to-day of a partner is knowing for what entity you're doing the work for. If you're a tax partner, you're now using new tax firm letterhead with new billing documentation, new accounts. You're getting your pay or your draw or whatever it is from a different entity than it was previously.
(
If you're an audit partner or you're a partner that straddles both, you might be getting 2K ones or a K one and a 10 99 or a K one and a W2 at the end of the year, depending on how you got paid. And depending on how you structure it, you can actually have different growth levels at different amounts. And now if it's a great audit decade and there's a lot of orders that may increase their value more than the tax partners who are just breaking even, that's a potential risk. In any alternative practice structure. You can come up with contractual arrangements that can mitigate that risk, but you have to look at what each firm wants to do.
Dan Hood (
Interesting. So that's at the partner level. What about the employee level? Does it make a difference? I mean, how different do they have to be in different offices? Are they reporting to different people if they're just getting a W2 from somebody else who cares something? Most people don't care where their W2 comes from as long as it shows up.
William Kelly (
Yeah. Well, for the average accountant or professional at these firms, there will be a change in the day to day. They will have to recognize, again, like the partner for which entity are they now doing the work. And there will be many who are doing work for two separate entities on two separate days. Ideally, they'll have separate timekeeping record, so there's records at different firms for the different time they worked separate entities. Ideally, the file and the data management systems will be different. If you have a reason to access data across the firms, great. Then you have access. But if you're only a tax person, you shouldn't have access to audit files, or if you're only an audit file, you shouldn't have access to someone's tax returns. That's just the way it needs to do if you're really going to honor the alternative practice structure. This shouldn't just be on paper. It shouldn't just be a change to your website. It's got to be changing your philosophy and your business approach.
Dan Hood (
Gotcha. Well, it can't be, it's like tax creations can't be just for tax evasion purposes or tax avoidance purposes. They've got to have real substantive business purposes and applications. Is that sort of that a fair assessment?
William Kelly (
Yeah, absolutely. Treating it as a real thing, it is a real thing. That's the only way this will work for any individual firm and the industry as a whole. The industry is going through upheaval right now. The accounting firms are facing challenges they never thought they'd face, and they have opportunities that they'd never thought they'd have. These opportunities, these opportunities are to seek outside investment, but also opportunities to reward those people who are interested in pursuing careers in accounting. Historically, accountants have finished their education, gone to a firm and stayed there their career. That's not really the case anymore. I don't think there's a single person graduating today who's going to be at the same firm they started at. This alternative practice structure gives an option, an opportunity to reward a player sooner, to give a players opportunity to be exposed to a new experience and not feel that they're tied to a firm for the rest of their life.
Dan Hood (
Yeah, no, I mean there are a lot of benefits to it, but it is fascinating to hear the seriousness with which you take it. Because I think for a lot of the message sort of nudge, nudge, wink, wink has been, yeah, it's just a paper transaction doesn't really make any difference. But to hear that some of the precautions in terms of data sharing and stuff like that, I think is something that for a lot of people may be new or news maybe is a different way to put it.
William Kelly (
Well, the situation that we're finding at Ascend when we are trying to figure out what's the best practice is, although this has been around for decades, there isn't really a huge body of authoritative guidance on how you set up the day-to-day stuff. Yes. This principles, there's the ICP code talks about how to set up an alternative practice structure, but it doesn't talk about different bank accounts. It doesn't talk about how your webpage should look. That's things that a lot of firms are going to struggle with.
Dan Hood (
Yeah. Well, as you say, I mean there really were, like I said, there were only two basically for a long time, and I don't know that anybody was paying attention to. I mean, it's just sort of the fascinating question. Who's overseeing this? Is there anybody paying attention to saying, ah, ah, your alternative practice structure isn't quite right. You know what I mean? What kind of authorities are there?
William Kelly (
Well, the AICPA ethics committee has put out a document for comment about how the private equity involvement in the alternative practice structure is affecting potential rule changes or rule interpretations of the AICPA code. So it is starting to get looked at, and many state boards of accountancy have issued guidance on that. Now, I happen to be looking at Nebraska of all states. They have a guidance that they issued a year and a half ago. It covers many of this stuff for those Nebraska firms. And I was surprised. I didn't think, no offense to my friends in Nebraska.
Dan Hood (
Sure. But of all the places you wouldn't not expect the deep dive into the consequences of PE investment would go that far in Nebraska. But good for them.
William Kelly (
And what I'm concerned about is that there's going to be a firm who does this and does it wrong, and it's going to blow up that firm and it's going to contaminate the other firms who took advantage of that. So I'm very interested in making sure that the whole industry takes it seriously, make sure that it's done and the rules are followed because it makes the industry stronger to have more options, more opportunities.
Dan Hood (
Yeah, absolutely. And PE is a huge opportunity for so many firms that you do want to make sure that the ground rules of it are the foundations of it are solid. So very important. Very cool. And good for Nebraska. Again, sorry, I'm just going back to Nebraska. What for them, because as just, Hey, when you look around about it, no one is really in charge of this. It's not like the PCAOB is coming in and saying, well, wait a minute. I mean, I suppose at some point they might start including that as part of their inspections, but so far they haven't.
William Kelly (
Right. The FEC has actually raised some issues about this because of the independence concerns where you have private equity coming into the alternative practice structure, even without private equity, to what extent of their separate entities does independence flow from one or address the other firms? So the SEC is concerned that an alternative practice structure that's done improperly could open a test firm, the auditor up to some independence violations that would not otherwise be out there. So there is a concern there. The regulators have it on their radar, but except for some very early messaging that went out years ago, there hasn't really been a heavy regulatory crush against the alternative practice structure.
Dan Hood (
Right. Well, now that they've got dozens and dozens and dozens and dozens, more examples of it live in the field out in the wild as it were, there's lots more chances for them. Well, let's hope there's not more chances for people to get it wrong, but there's lots more examples of it for them to investigate and look at and make sure that everyone's doing it right and to see what all the different variations may be.
William Kelly (
By my last count, there was 20, more than 25 of the top 50 firms have undertaken an alternative practice structure reorganization. And that's a lot.
Dan Hood (
And it's going to get, that number's only going to grow. I mean, we just added one more the other day, and I'm sure we'll add more over the next several weeks and months. It is a trend. People are excited about it and adopting it as particularly as well currently as a role, a way to bring on PE investment. But I wouldn't be surprised if we've seen more and more firms adopting it for some of the other advantages you've been talking about here.
William Kelly (
Yeah, the potential liability isolation for the high risk audits, or maybe even in public practice being its own entity, could be public company audits being their own entity. That could definitely cause a firm who isn't interested in the PE structure at all to explore the alternative practice structure.
Dan Hood (
Yeah. Yeah. Very cool. Alright, bill, any final thoughts as we head off? Anything people should be particularly bearing in mind as they think about or contemplate or start setting up an alternative practice structure?
William Kelly (
Well, the thing I just want to reiterate that is it's available for any accounting firm who has the type of practice they want to do that it's not just a top 20 methodology. Any firm across the country can explore this. It does take some investment and some wanting to take advantage of that structure, but it's available for firms from 2 million to 200 million. It's whatever you want for your firm. It's not just for the big guys anymore.
Dan Hood (
Very cool. Excellent. Alright, well Bill Kelly of Ascend, thank you so much for joining us and for Clueing everybody in, or at least me on the alternative practice structure. Great stuff. Thank you.
William Kelly (
It's been my pleasure.
Dan Hood (
Excellent. And thank you all for listening. This episode of On Air was produced by Accounting Today with audio production by Aon K Radio to review us on your favorite podcast platform and see the rest of our content on accounting today.com. Thanks again to our guest and thank you for listening.