Allinial Global's Mark Koziel looks at the pros and cons of engaging with private equity firms, what firms can expect if they do — and how they can stand independent, if they want to.
Transcription:
Dan Hood (
Welcome to On the Air with Accounting. Today I'm editor-in-chief Dan Hood. Private equity is on everyone's minds these days, as PE firms make deals with high-profile firms. But the details of going the PE route as well as the pros and the cons are often a little fuzzy for those who aren't directly involved in the details of these deals. Here to bring some of those details into focus is Mark Koziel, the president and CEO of Allinial Global, a worldwide association of accounting firms with over 250 members, including some that have taken on PE investment. Mark, thanks for joining us.
Mark Koziel (
Thanks for having me, Dan.
Dan Hood (
Well, let's dive right into what do these kinds of deals usually look like in terms of structure? If I'm approached by a PE firm, what's the deal gonna look like?
Mark Koziel (
It's interesting because I think everyone wants to naturally assume that we're back into the early 2000s and this is looking like the public company deals that happened or that did some massive takeover of a particular firm. And neither one is really the case. This is a very different situation, I think, and it's been really 15 years into making. And if you think about the evolution of where firms have been, we'll kind of talk about that a little later when we talk about business model. But overall, the structure, basically the PE firm comes in and says, okay, we want to buy an interest in your firm. It's not a hundred percent, it is some variation thereof. And there have been a variety of different deals to say, majority ownership, minority ownership, but a big stake minority, whatever it may be. There is cash to the table from the private equity firm to the accounting firm.
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And so then they structure a board setting where there are board representatives from the firm that are sitting on this entity that the PE firm has created. And so at that point though, we still have to be owned by CPAs and CPA audit firms. So where there is commonality is this alternative practice structure that happened in the public space is happening here now, but it's also happening kind of elsewhere too, which we could talk about. But ultimately, you're looking at the, the CPA firm, the LL P remains intact and is owned a hundred percent by the CPAs, and then they create this llc, which is owned by the PE firm. And then shares of stock are then distributed to the owners, the CPAs or the accounting owners, if you will, of the firm that are in there. And so the theory is that those share prices will rise over time and that every five years, in theory, five to seven years as the fund turns over, which is what private equity does, there will be this new cash out, if you will, to the partners.
(
So your first transfer partners, they got the buyout. Now usually the deferred comp, if there was any, it's paid off. And the partners then have been paid some semblance of value of the firm versus their salary, which was paying them some semblance of value to the firm each and every year. So typically there's some adjustment to compensation to now be compensated for doing what the business does, but then holding these shares of stock, if you think about in the firm model and how we got here, a lot of it is, and if people think that they're overpaying for these firms, they're, they're just releasing the value and then they're reducing the overall comp structure in the firm to make it more profitable. And what other business, what CPA goes out to their client and says, I think it's a really good idea that you strip 100% of your profits out of your business each and every year.
Dan Hood (
<laugh>, right?
Mark Koziel (
Nobody does. Yet in our profession, that's how we've grown up. That's what people naturally assume. I need immediate gratification for what I do today. I don't know if I'm gonna be here tomorrow. So in a lot of instances from a business case, it makes a lot of sense. Not gonna be right for everybody, but that's a lot of how we got to where we're
Dan Hood (
At. I listening to describe that structure, I have one question about it that I sort of hadn't really ever thought about, which is, as you say, the current partners get that payout brought forward to say that's one of the reasons why these numbers seem big is because you're pulling forward all that value you're pulling it forward to today to when we sign the deal. What does it look like for people who become partners after that? Or how do you become a partner in just the audit firm, the CPA firm, half things, or you become a partner in the other half? How does that work? Or do you have a sense of how that
Mark Koziel (
Works? It it's still both. And I think it's up to each and every deal's gonna be different and I think it's gonna be a matter of how people decide to structure it. So yeah, the employees, basically the employees of the CPA firm, the LL P, are leased from the llc, right? And so there's a management fee structure that happens between the LL P and the llc. And so that's how a lot of that kind of pay structure happens. But as new partners come in, they're also given some level of stock. And if you think about it now that it's a stock deal, there's no reason why anybody in the firm couldn't get stock.
Dan Hood (
Yeah, yeah.
Mark Koziel (
They're not limited to say now you must be a partner in order to have some level of ownership in the firm. I've said for years, I always thought an ESOP was a good idea for a firm to say to someone, young professional coming in, you are gonna be an immediate owner of this firm. And I think that with the stock opportunity it, it's going to continue. And so the stock has to continue to rise for all of them to get that. The difference is I think in the young professional, that newly minted partner, rather than coming in and saying to that new partner, congratulations, we wanna make you a partner, you have to pay us $300,000 up front for the promise to get that back in a little bit more When you retire, is it a poor value proposition to the young professional versus now saying, okay, you're going to get X percent of stock, those stock percentages are going to increase over time.
(
And by the way, every five to seven years, there's probably some level of payout from that and then we reset and we do it again as we do it. So the ability to retain into that partner level and the attraction at the partner level is very possible. And all of this is I'm giving you the pluses that they see on that side. Not everyone says, well, we gotta wait for the first flip to see if that really happens. But it is encouraging I think hopefully, especially if we have to attract more out of the traditional CPA path because firms are going out and they are trying to buy, tech companies are trying to buy HR companies, advisory companies. And it became a challenge to do that under the CPA structure the way that we had it. But tech companies totally understand how PE firms work and venture capitalists and all that. And so it brings the CPA world, I think closer to where all of the advisory has gone, not where it's going, it's already here and it makes it a little more competitive I think, for the firms.
Dan Hood (
Sure, sure. And even just on the employee level, as you say, the ESOP structure was always, there are a couple of firms, literally a couple of firms I think that have that and it's a great benefit for staff at all levels, not even just partner potentials. And as the profession, as you say, has to look beyond hiring accountant types cuz there aren't enough of them as they look to hire more engineers and more HR experts on an individual level as opposed to acquisition, the option of being able to say, Hey, you can have some stock too, has gotta be hugely a quiver in their error in their quiver if you wanna put it that way. For sure. We're gonna dive more deeply into the pros and cons. Obviously you've mentioned a couple of pros, we're gonna mention some of the cons as well. But I also wanted to talk about just quickly, and again I know as you said, all these deals are different and all your mileage may vary, everything will look different depending on the size of your firm and the interest of the PE firm and all that sort of stuff.
(
But is there a specific type or size of firm the private equity is looking for or vice versa that should be looking to consider PE as a potential partner? I bring you so mainly because I saw an announcement from a relatively small firm, still top 300 probably, but not a top 100 firm that had sort of proactively switched its structure to one that would work for a PE deal, but they don't have a PE deal or they haven't dated an announcement, they just announced that they had split the firm into those sort of the lllp and the LLC sort of model. And they were not of a size firm that I would've thought would be looking for PE cuz most of the ones we've heard of have been top 100 terms. So is there a specific type or size firm that's attractive to PE or that should be looking to partner with them?
Mark Koziel (
So I think the initial deals are going to be in the top 50, top 25 for sure. I mean I think there has to be some level of a baseline for the PE firm to be interested. The other option would be do they find 10 million firms that they can all roll up together? Those things become incredibly complicated and probably far more unlikely. But once the PE firm has kind of selected that anchor firm, then that anchor firm now is going out and they're doing the acquisition to the rest of the marketplace. And I'd say any size is available depending on at end of the day there still needs to be a culture fit, there still needs to be the reasons why, whether it's geography, specialty, whatever else that I think that the PE backed CPA firm will still be looking for. It has to be strategic but it could be any shape or size. And we're seeing that already with the few firms that are out there. I also believe that some day you are going to see a more internationalized firm that there's going to be multiple geographic markets to that as
Dan Hood (
Well. Oh that'll be interesting. That'll be a development to pay attention to. It sounds like. Makes sense that we, because we have seen some of those firms that have gotten the investment have gone on, I don't wanna call it an m and a tear, but it really an m and a tear. So it makes sense that, so the initial deals will most likely be with larger firms, but then smaller firms may get in by being merged into a firm that's already partnered, a larger firm that's partnered with a PE
Mark Koziel (
Firm.
Dan Hood (
Right. Gotcha.
Mark Koziel (
What's interesting is then you still have, it's funny cuz I've heard some people in the market outside of our firms that I've talked to some other firms that are not part of millennial and they're like so and so firm. Well they're not as active in m and a as they used to be. I said, no, that's not true. They said they're just not winning as much as they used to be <laugh>. And now the market has gotten that much more competitive. I think with this all started too, before even PE came into the market, if a firm came in with cash, they had a competitive advantage over those who were trying to do ownership swaps. And so you're seeing that really play out today.
Dan Hood (
Gotcha. That makes you, as we've always sort seen for firms that are big into acquisition, they go through dips and periods of frenetic activity. And it's worth bearing in mind at all times that not every deal pans out. Not even if you're in the top five of contenders, you don't always make it so excellent. All right. So let's, we have mentioned some of the pros of working with private equity firms. Obviously cash is a big pro. Are there others? And I wanna then dive into the cons. What would you say, have we touched on all the pros? Are there others that people should be thinking about? I mean like I said, the cash is a big one. What else is there?
Mark Koziel (
Sure. I think in summarizing, I think the biggest thing is attraction to the young professional. It is the next iteration of where we've been going to a corporate model anyway. A lot of corporations have gone to PE route two, access to capital is so there is greater investment opportunity in technology. It also brings a sense of outside advisory to the firm, to the board. If you think about it now, and it's funny because in the UK they had talked about as part of their audit reform that they wanted to mandate that you had outside board members sitting on the board of the firm. Okay. And so now in addition to the firm owners who are sitting on the CPAs that are part of the partner group if you will, the traditional, you're also getting this kind of built in advisory group out of the private equity firm that has seen a lot of different things. So I think that that brings even more strategy to the leadership table I think, which is an advantage. And then I think those are the biggest probes for
Dan Hood (
Sure. I mean that's always been one of the things private equity has prided itself on is that we bring senior level business expertise, we make the businesses we buy better. So it'd be interesting to see cuz then they're matching up with accountants who would say the same things about themselves. We make our clients better. I wanna dive, as I said into the cons of this cuz it all sounds very attractive but surely it can't be that great. But we're gonna take a quick break. All right. And we're back with Mark Koal of Lineal Global and we're talking about, I don't wanna call it the PE invasion, but I kind of do wanna call it the PE invasion. Let's go ahead and call it the PE invasion. We've gone through a lot of the pros of it. What are some of things that firms should be thinking about if they're worried about if they go into a deal like
Mark Koziel (
This? I think the first worry for any of the firms is control and how much loss of control. And then on the next PE deal, what does that look like? Who are they matching up with? Is it the right fit? The unknown of what that next turn is gonna be inside of the private equity deal I think is probably one of the greatest risks. There's the independence issue and the regulatory and where regulatory goes. Independence. If there's still an association with having, even though you have an alternative practice structure, it's not like the CPA firm who's connected and invested in the PE firm can audit other funds within that PE firm. And so that is the limitation within there. But you know what? There's plenty of PE firms and plenty <laugh> work that's out there. I don't think that's gonna be the biggest hindrance. But then I do think you have to look and watch what regulatory is doing.
(
The general accountant from U S G A O kind of sent out a letter saying look, there's all this activity that's happening, let's not forget independence and who we are and we need to satisfy that. And so when you pull in the EY deal where they were siphoning off a separating audit from everything else, you know had the deal in the two thousands, independence is still has to be front of mind, front and center inside of who we are. And looking at that. And then if regulatory decides to bear down on something down the road that is out of anyone's control I think is the greatest risk. And then turnover is, I think the messaging inside the firm is communication strong enough to eliminate any outside forces from giving hearsay, if you will, of what's happening from a cultural perspective. And I think that's gonna be the greatest challenge. Challenges to overcommunicate with current team members to make sure that they're on board right?
Dan Hood (
Cause they already, I, they have tremendous options. They can go anywhere they can get. Most people at accounting firms could probably get work at another accounting firm that if they're concerned about isn't entertaining pe. So that's gotta be an issue. And I wanna just briefly just to go back to the, you mentioned control and as a part of that, I imagine there's gotta be some concerns, at least for some firms about accountability. I mean this has been an issue the accounting firm's been talking about for more than a decade. Decades I should say, about how do we make sure everyone's accountable to the firm and to the firm goals and that every partner is doing what we need them to do to build the firm and that sort of stuff. There's gotta be some worries on some partners parts about ooh, this might actually bring real accountability.
Mark Koziel (
And I think early on in the deal too, I think that's something that to always watch out for. I mean you give every partner a big check, are they gonna work as hard as they did the day before <laugh> or are they gonna stay? I mean, you know got that trying to be able to retain even at the partner level that they're able to do it. And I think at every turn that's gonna be a constant reminder of how and what risk is going to be involved in getting people to still be motivated to do it again and to turn it again. I mean we're all working hard and at some point they may seem like the jail sentence is over. So in a lot of firms there's mandatory retirement and a lot of 'em, but they also have kind of minimum stays. So you, you're a partnership jail sentence that you can't leave until X and you're taking that dynamic away a little bit. I think with doing the PE deal and they can basically walk out the door any day they want,
Dan Hood (
Right. Cash in their chips and go Interesting. Yeah mean are a lot of facets to it. It is a very complicated in a way, you mentioned the consolidation consolidators that went around in the late nineties and early two thousands. I mean were certainly complicated in their time. Didn't seem as complicated as these deals. It seems like there's a lot of extra wrinkles to think about. And now I wanna talk about the model itself specifically. You mentioned one detail about the leasing of employees back and forth between the two structures and that was something I think we saw a little bit with. I don't remember thinking about the structure of the RSM and Mala and Poland when they went back and forth about who there was leasing employees back and forth. Similarly, are there other aspects of that model that are different from the sort of standard accounting firm model?
Mark Koziel (
I think well, and what we talk about the standard accounting firm model, I think we have to delineate, I have a lot of conversations with our member firms today that the partnership model is dead. It's not dying, it's dead. And if we think about who we need to be as a profession going forward, we do need to move to a corporate model. I'm not saying that PE is gonna be for everyone and I hope that not everyone says, oh my God, he's saying we must do pe. I don't think it's for everybody, but for those who it's working for great for others who wanna do other things, I think there's opportunities but they gotta get their house in order. And so the two biggest things for me on why for himself is governance and keeping up with technology. And so if we can stay ahead of those two things and the governance model and I'm still seeing this time and again and I look at your accounting today top 100 list and I look at the next 200, the next 300 and I start to make predictions on who's next to merge out doesn't necessarily mean up, but if you're still in that founding firm partnership, it's gonna get really tough to get out if we don't set up a level of success for our future partners.
(
And so this one partner, one vote thing doesn't work. And if you think about even how firms started, I was at one of our firms celebrating their 50th anniversary. And so they're reminiscing about how the firm started and it was the founding partner at his kitchen table and his wife typing the financial statements for the client and taking on any kinda work. And I'm like, I've heard that story well over a thousand times in my career. I worked for two firms that were exactly the same way. But what happens is that that partner, that founder, if you will, finds a friend and the two of them decide to share office space together. And from that they decide to hire employees. And before they knew it, they actually had a firm of multiple people but never change the governance structure from two people sharing an office.
(
And so now when you've have six partners or 12 partners, it becomes really hard to unravel cuz each one of 'em think they have a FDO in there that they are, do something along the way and then they're gonna get that immediate gratification that we're gonna pull all the profits out. So when I looked at the ebbs and flows of the profession, even to say the 2008 firms did fine, they didn't growing the way that they did, profitability was down but not losing money. And I think about all those years that were so incredibly successful and yet we didn't learn from the squirts <laugh> what in the winter when times are tough, you gotta have stored your nuts before you got there. And just from a governance perspective, understanding that the firm is our focal point, not the individual partner interests. And the firms that have moved to a corporate structure, they're getting it. And I think that they're making great strides in doing that. But there's still firms kind of stuck in that governance structure that's really going to be, that puts them whether they know it or not today on the market platform because they're not gonna be able to survive like that forever, right?
Dan Hood (
Cause it requires that constant inflow of partner material to keep the, it's a little bit, I don't wanna call it a Ponzi scheme cuz it's not, but it's a little bit like a legal Ponzi scheme. It's like yes you have to have new people coming in all the time for this to work. And as we all know, that's not happening the pyramid,
Mark Koziel (
Right? Yeah. We're gonna hire a lot of people, we're gonna help a couple of them stay and when they do, we'll call 'em manager and we hope a couple of them stay and we'll call 'em director and the ones that left are left over. Finally we're gonna call partner <laugh>, make them the best. Just the ones who outlasted the rest of
Dan Hood (
Em, right? It's just patience <laugh>. So I think my next question was gonna be about how do you stay independent if you're not interested in making the deal with, if the cons seem too much free or the loss of control or the change in the model, obviously one of the things right that's gonna help you stay independent is adopting that corporate structure. Cuz that's just good for running a modern business or particularly a larger one. You need more of that sort of centralized decision making somebody an individual or a small group of people who could pursue a vision and pursue a goal for practice areas and development, all that sort of stuff. Are there other things that firms can do if they don't wanna to go the route of PE or get, even if it's not them making the deal, if they get snapped up by some larger firm that has made the deal, how do you avoid that to
Mark Koziel (
Yeah, I think the biggest thing is just the governance model. And I've said for our member firms, it's the thing that I've said time and again, I said Look, if you wanna be independent, great. If you don't, great. We have several options for you within our structure we help with governance where need be. But you know what, it's gonna be some tough conversations and we're gonna look at that partner agreement and we're gonna make some changes. You have to be up for it. Your partners are gonna have to vote on it cause they stop it that they have to vote on every decision. It is gonna be fit the holiday parties. So stop trying to vote on <laugh>, right? It is. Now let's talk about the things that become important in the firm and let a ceo, I have said this time and again to our firms and I'm trying to get them all to change the dynamic of who they are by saying every firm should have a CEO whose so job it is to worry about the firm when they wake up and when they go to bed.
(
And I said the managing partner title to me, I have yet to find a partner who could be managed. So I don't know how we ever came up with that title. <laugh>, it is, you need to be a ceo, you need to have some semblance of a board so that the decision making can happen faster within the firm. And it's from the firm perspective and what it's human nature. I've seen it with people retiring out that they wanna just hold on to things that they have. And not even just in a partnership model, but in other things too. And that whole succession idea and the fact that you're gonna groom your replacement and you're going to allow for things to happen out of your control and you're gonna let that happen earlier. All of those things. Having a succession plan in place that the partners actually penalized if they don't transition their clients appropriately. And these are all things that become really important to the firm and we gotta get that in place first.
Dan Hood (
And these are things, as you say that we've been talking about for a long time. Firms have needed to do for a long time before PE was really even on the horizon. They've been, these have been good strategic moves for
Mark Koziel (
Firms. And I think for a small firm too, a alliances become important whether you're in an association or network or not. What, and I've said this to our member firms constantly. I said, I don't ever want to hear that you lost a client cuz a client felt that they outgrew you. We have every capability within our house to be able to get it done. In fact, I just gotta, in part of our community system, someone says, help. I need somebody with esg. Well, we have a whole ESG community that we can line them up and they can still take care of the client, still their client, they own the client relationship, but they're getting it done so that the client constantly says, well, you know what, if I need anything, if I need tickets to the ball game, I better call my CPA firm first because they seem to know everybody.
Dan Hood (
Right?
Mark Koziel (
And that's the relationship.
Dan Hood (
Well that's a great point because I mean, as we were talking, right, nothing beats cash. So when people are going out and saying, well we need expertise in an area, a firm that's got, that's backed by PE can say, well, I'm just gonna acquire it and I have the cash to acquire it and just say technology firms. And a lot of consulting firms aren't based on, aren't familiar with the accounting CPA firm model more, way more in tune with the PE model. So they want the cash. But if you can find that expertise without having to acquire or build it, if you can find it in a network or an alliance, that's a great way to maintain, help maintain that independence, to give you that. Absolutely to give you
Mark Koziel (
That extra. There's plenty of firms that'd be more than happy to help out in that realm. We see this time, and again, we see it where some of our firms, and this happened in the SOC world when SOC first became big and there were firms who said, I don't wanna do it, so I'm just gonna refer it and I'm gonna use somebody that I know or I better learn it because a lot of my clients are asking me for it. So they bring that other firm in and five to 10 engagements, they go through it and they go through the training, they get stock, get someone sock certified, and then they're in the business. All of those different ways or options, but you cannot ignore the client need. Ultimately knowing what the client needs wants and then being able to line it up with having the connections around the market, whether it's in your geography or not. There are plenty of firms out there that can help with that, I think in a regular way.
Dan Hood (
Excellent. All right. I think we had obviously talked about this for a lot. There's a lot going on here and a lot it leads to a lot of other issues that are going on in the accounting profession. But I do want to, but I wanna just try one question, and this is wildly unfair cause I'm asking you to make predictions about way in the future, but do you have any, I mean, as you said, there's that sort of standard 4, 5, 6 year window for PE where they tend to turn over their funds. And I'm curious because when you think about it, in five years, they own that stock. They can pretty much, unless their deal restricts them, pretty much sell it to whoever they want, does mean do we envision a appointment five years or four to five years where suddenly accounting firms find themselves owned by CalPERS or a pension fund or somebody who's looking, or an Annu annuity creator that's looking for a steady cash flow business that does well in good times and bad. Is that a future? Is that in the future? Or do you imagine that being in the
Mark Koziel (
Future? No, it's in the past. That started in the two thousands when they went public. Right, good point. Good point. Funds on 'em and yeah, I mean I think the financial services business and, yeah, I'm trying to think of a gentleman's name now. Cbis, another Buffalo guy. I got to meet him along the way that he's the overarching, and then they have their cbis for the accounting firm leaders, but the overall leader for Cbis has talked about just how strong the financial services market is and you tie up all the insurances and everything else. So yeah, it's been around for a long time. Will it be greater with the pe? Quite possibly, but it is, that theory's not new. It's been around, so it's a matter of whether or not, I think part of your question too is will there be buyers of the firm in the five to seven years? And I do think is there's a lot of interest from private equity currently inside the space. It's stable and it's attractive to private equity firms. So I do think you'll see that and that turn will be, it'll be telling when that happens. And I do think you'll find even more firms kind of going into it. Not everybody, it won't be for everybody, but I do think you're gonna see a lot of that.
Dan Hood (
Excellent. All right. Well, we'll be paying attention. We'll have you back on a regular basis to keep track of that and to talk about it much for other things. There's a lot going on, as we say in the profession. So Mark cozy of millennial Global. Thank you so much for joining
Mark Koziel (
Us. Thanks Dan.
Dan Hood (
And thank you all for listening. This episode On the Air was produced by Accounting Today with audio production by Kevin Perise. Rate us or review us on your favorite podcast platform and see the rest of our content on accountingtoday.com. Thanks again to our guest and thank you for listening.