Dotting the I's

Join this expert panel where legal advisors and deal-builders will discuss the potential challenges and common pitfalls that accounting firms may encounter during private equity transactions. Panelists will share their experiences and insights on navigating complex legal frameworks, avoiding common mistakes, and ensuring that all critical details are addressed in the deal-making process. This session is designed to equip attendees with practical advice on how to protect their interests and secure a successful partnership. Don't miss this opportunity to learn from the pros and gain a deeper understanding of the legal intricacies involved in PE deals.

Transcription:

Daniel Hood (00:10):

Is this going out? There we go. Some of the things that firms should be thinking about as they approach literally writing out a deal, letters of intent, that kind of stuff. So I want to introduce our panel and actually have them sort introduce themselves. I'm going to start with Rick David, the Managing Principal of DANLEX Solutions. Tell us a little bit about yourself and your organization.

Rick David (00:30):

Thanks, Dan. I'm Rick David, I'm the Managing Principal of DANLEX Solutions. It's a boutique firm of one professional. I am not an attorney, so lemme get that out on the table right now.

(00:43):

What I do do is specialize at this point in helping firms adopt, implement, plan, the alternative practice structure. There's only one certainty in any PE deal rather than life and death and taxes in a PE deal. Only certainty is an APS. Everything else can be negotiated and planned and other very creative things, but you must have an APS. By way of background, I spent 10 years as a COO at UHY, which is one of the oldest APS firms in the business these days. In fact, as was alluded to yesterday, UHY was created in the year 2000 to go public. So even going public as an accounting firm is not a new idea. It was tried 25 years ago. I come to there with 30 years of background. Prior to that at KPMG, I also served on the Professional Ethics Committee of the ICPA, which is now looking at independence rules with APS. I also chaired the global board of the UHY International and I also was a state board regulator, so I've dealt with this issue from all different angles during my career.

Daniel Hood (01:49):

Excellent. Alright, next up. Peter Fontaine, partner at NewGate Law. Thank

R. Peter Fontaine (01:52):

You Dan. My name's Peter Fontaine. I am the managing partner of NewGate Law. Our firm only works with accounting firms exclusively Before forming NewGate, a few years ago I was general counsel of RSM alternative practice structure. Before that I was general counsel of American Express Tax and Business Services, another APS organization. And before that I was with that s scarless accounting firm, Arthur Anderson, where I guess I'm still a partner because we own a piece of real estate out in St. Charles, Illinois. So all told I've been working with in the accounting industry almost 30 years and probably almost that entire time with alternative practice structures as Arthur Anderson and Anderson consultants worked in this orbit around each other in a quasi alternative practice structure.

Daniel Hood (02:37):

Alright, excellent. And rounding us out is Ben Schaye, he's a Partner at Simpson Thacher & Bartlett.

Ben Schaye (02:42):

Yes, I'm the newbie on the panel. So my background is in private equity. I've been involved in a number of these accounting deals on behalf of private equity sponsors. Our firms represented the buyers in the Grant Thornton transaction, baker Tilly, Citrin Cooperman, Carr Riggs and Ario. So have the perspective of structuring these deals on behalf of the sponsors.

Daniel Hood (03:14):

Awesome. We've heard APSA couple of times, even just in the first minute of the thing we've been talking about, alternative practice structures have been mentioned in a bunch of other sessions. I want to talk a little bit more deeply about it. Peter, I want to start with you on this one. Just talk about what's an APS all about and what does it mean for the firm?

R. Peter Fontaine (03:31):

Sure. So one of the fundamental rules of the accounting practice industry is that CPA firms have to be owned, at least in most jurisdictions, 50% by licensed public accountants. The other 49% can be owned by individuals that are actively participate in the operation of the business. Well obviously PE firms are not, they're passive investors, they're not consultants, they're not tax attorneys, they're not people who actually are involved in the actual day-to-day operations. So as a result, the only really way that you can do these transactions with PE firms, as Rick said, you have to split the firms into the test practice and you the, there's a non attest practice and the PE firm acquires the non attest practice or a portion of the non attest practice. Some of it remains obviously with the sellers and the role of equity. And between those two entities, there's an agreement where non attest entity provides personnel infrastructure sorts of sort of administrative services to the at test firm in which they get a service fee of some amount to be negotiated.

Daniel Hood (04:40):

Excellent. Alright, Ben, did you want to weigh in on the APS, what it means for firms, how it impacts the deal?

Ben Schaye (04:49):

Yeah, I guess what I would add to that is given that's the baseline, and as David noted the constant throughout all of these, we start with that as the premise and one of the first things that we look to figure out is exactly how do we operationalize that in a certain sense, these deals are both an M&A transaction as well as a carve out transaction and working through the details of the carve out and designing that in a way that's going to be least disruptive to the firm require the fewest number of third party consents and otherwise not trigger adverse tax consequences is one of the first fundamental steps that we'll need to work through in these transactions.

Daniel Hood (05:34):

Gotcha. Rick, you want to weigh in?

Rick David (05:35):

Yeah, that's where too often the APS is the last minute thing they think about after they've gone through the process of interviewing prospective investors and things. And in reality it takes time to put these together appropriately. You can be very creative and you can also do it if you do it right in planet, so the clients won't matter anything, anything. And then when you ultimately do a PE deal, if you already have your APS in place for a time period prior to that, when you go to the market on a PE situation, you'll get a higher value because the investor no longer has an implementation risk of the APS. It's been done, it's already in place. The culture has already adopted that in its work, so you're much better in a better position, but it also doesn't need to be done for any APS or PE situation.

(06:24):

You can do it in advance just for corporate governance. The ability to remove a non attest business from the regulatory oversight is very beneficial. The ability to comply with state regulations regarding non CPA ownership of your test practice, you can address that directly by doing an APS. So it is a way to structure, you'll be creative, I love bringing in the tax partners, give me your two best, most creative tax partners in your firm and let's plan the split and what do you want to create for your new entity? Let's talk about how to make it tax effective, but also put in the proper governance that you want to do going forward. And once you have your APS, as you bring in other entities that may be not directly related to what you're doing in advisory, you can also create unique equity ownership structures underneath the APS banner and the non attest side for these new entities as you grow your business and the non attest area.

Daniel Hood (07:19):

We've heard of a couple of firms that have taken on an APS structure and we were like, oh, you're taking on pe? And they're like, no, no, no, we just things they wanted to be able to offer ownership rights to non CPAs, right? They had professionals who weren't CPAs in different expertise in different areas and they wanted to be able to make them owners and they're like, this is the way to do it. So people are getting creative on that kind of compensation or that kind of benefits a lot these days. I want to also, another word we've been talking a lot about, and Rick, I'm going to throw this one at you first, is the scrape. We've been mentioning that a lot and we've talked a lot about the way compensation will be structured, how it's going to change from the old models, what it's going to look like in the new. Maybe we can start by talking about what the scrape is and how people figure out that kind of value.

Rick David (08:03):

Alright, well, I can't call it ICM because we already told it's been copyrighted as a term of art, but basically we all know in an accounting firm situation, there's a compensation pool. There's only so much compensation that's there. I remember going to the bank my first time to the bank to do a bank loan and they go, what's your EBITDA? I go, it's zero. And he fell off his chair and I said, all the money gets paid out to my partners every year basically. So your EBITDA, you create it and the firm will determine how much EBITDA they'll create by reducing how much they want to reduce the partner compensation pool and scrape a portion of that to fund EBITDA, which in turn drives value. People say, what's the value? Well, everyone talks about multiple, but nobody talks about how much they're going to give up on the reduction of their compensation pool to create the EBITDA, which then gets multiplied.

Daniel Hood (08:58):

Peter, you want to weigh in on the scrape and the,

R. Peter Fontaine (09:01):

Yeah, sure. I mean, I think there's really no formula for the scrape. It's really sort of, as Rick alluded to sort of turning the dials, I mean how much of the compensation someone might lose actually goes into what's paid at closing in sort of a promissory note, some earnouts, some growth incentives, et cetera. So it's really a package. I think one of the things too, and again, we've seen them where there's been no scrape, but there's not a lot paid or less paid I should say. And then we see one of the lots of scrape, but there's more paid. So there's really no formula there. I think one of the things that you also have to sort of balance it against too is that how much of, I would call them perks for lack of a better expression, someone is giving up when they actually go to a PE firm, and obviously some firms, they run expenses through the p and l, which technically probably could be considered to be compensation. So you have to look at the whole package and how much was I really making realistically with everything that I was getting in terms of compensation versus what I'm getting afterwards, both in real comp that I get a K1or W2 on, and then how much am I getting down in payments down the road?

Rick David (10:11):

Let me jump in on that. You mentioned an issue, an interesting concept that comes up too. If you're going from a partnership structure to a corporate, not a test firm, your compensation goes from a K1 or W2, and you can actually pay your owners less compensation on a W2 and have more take home K and taking them. The non-tax guys don't understand that at times. You got to explain to 'em why that's going to be because the self-employment taxes last, your 401k match has changed. Your medical insurance premiums are paid by the company, not by you personally. So you have to explain that to your partners too when you talk about the whole compensation package.

R. Peter Fontaine (10:50):

Exactly. It's a package, right? Exactly. There's no formula.

Daniel Hood (10:54):

Ben, you want to weigh in.

Ben Schaye (10:55):

Yeah, I come at this from a different perspective a little bit. So there's the economic substance of the scrape, and as you've heard, there's 1,001 different ways you can structure it, and then it's a function of how the firm has been run to date and all the dials that you want to tweak as you go. But in addition to that, and this is important, is figuring out a way to actually implement the scrape. And so as you're going through this exercise, obviously you want to make sure you're being fair and thoughtful in how you do it, but you also need to then take a step back and this is a plug for lawyers, right? Involve lawyers and in figuring out, well, how does your partnership agreement work? What flexibility do you have? How do we actually get from what you're currently at to Z where you want to be as a legal matter?

(11:55):

And in some of the prior sessions you heard, well, what happens if somebody doesn't like it? Right? Well, you can't set up a deal where any individual has holdup value. So figuring out a way to implement the scrape as a legal matter in a way that if somebody decides that they're not interested, that's not going to blow up the entire deal, is of critical importance and being thoughtful about that and memorializing that in the legal documents because ultimately you're going to come up with a model and it's going to be a spreadsheet and it's going to be as complicated or uncomplicated as you want it to be, but people don't sign spreadsheets. They sign legal documents. And translating that spreadsheet into a legal document that's enforceable and binding on the signatories is of critical importance to the success of the transaction.

Rick David (12:49):

You heard a lot about talk about culture of the firm when the potential investor comes in and the management of the firm will present to them at some point in the dialogue, your potential scrape allocation that says a lot about the culture of the firm and I investor's going to take close note of what you did, how you approach it, was it across this board? Was it recognizing certain potential growth opportunities for some of your partners that are the key to the future? Was it just paying it to the senior people because they have the most equity in the place? It tells a lot and they'll pay close attention to it. Do you see, are they being fair? Are they looking forward? Are they the type of management team that will drive the culture forward in a positive way that I'm going to invest in?

Daniel Hood (13:34):

Peter you,

R. Peter Fontaine (13:36):

I just want to add one thing. So the administrative services agreement between the test and the non attest practice part of that, as I mentioned before, there's going to be a service fee which is associated with that, which is charged by the test practice to the non-test practice, to the test practice. But a certain portion of the money is going to be left inside of the test practice to cover a test only expenses. And part of it too that there will probably be some left over for partner comp. So again, part of the compensation package is how much it comes out of the test practice, how much of their comp comes out of the non-test practice, right? At the end of the day, it doesn't really matter because the comp is the comp is the comp, but it could just to take example. So $500,000, a hundred thousand could come out of the test practice and 400,000 come out again dials to be turned. Right.

Daniel Hood (14:30):

I think we've talked a little bit about how the old compensation models aren't going to need to change. Maybe we talk about some of the new compensation models and one of the things I particularly want to dive into is rollover equity and what that means and how firms should be thinking about that or different ways they can think about it. Ben, if you want to kick us off with this one, just go back down the line.

Ben Schaye (14:50):

Yeah, sure. So look, obviously it's important, and you've heard in I think probably every single session throughout the conference that keeping skin in the game for the accountants and in particular the younger generation is critical to the success of the firm. And so figuring out the comp scrape model, and people call it a scrape or income contribution, it's really three things. It's how much compensation are you going to be getting as an individual going forward. Maybe that's the same as you got before or maybe it's less and how you decide is up to you. The second piece is how much cash are you going to get at closing for selling the whatever percent of the business that you elect to sell? And then the third piece is obviously how much are you keeping? And for each of those three pieces, deciding how that gets allocated is obviously of critical importance to motivating and incentivizing people to come to work the next day. And depending on how your firm is structured and depending on your philosophy, you don't necessarily need for everything to be the same. So you can perhaps for an older individual, more seasoned to use the phrase that was used previously,

(16:14):

maybe they get slightly more cash, but less equity for a younger generation who's going to stick around for longer. Well, maybe they'll be more weighted towards equity and to keep using the tweaking the dials. It's a mix and match and ultimately it's the firm's responsibility as an initial matter to propose something that they think they can sell to their partners that is fair, equitable and motivating for individuals to continue to work and grow the success of the firm.

Daniel Hood (16:49):

Peter?

R. Peter Fontaine (16:51):

Yeah, I think one of the issues that we struggle with, that we deal with whenever we're counseling sellers is this whole notion of rollover equity. What does it really mean? How do I redeem my role over equity? When can I redeem it? How much is it worth? As Ben suggested, how much do I get versus somebody else? And then some individuals, and Ben can talk more about this more intelligently than I certainly can. There's this other little piece of equity which is called mips, right? And these are sort of units that are given to performers after the deal is closed. So there's all these nuances in how the whole rollover equity is structured and when you can redeem your interests that people need to understand, it's very, very complicated things like I'm not going to explain, Ben is much better explaining than I am, but drag on rights and tag on rights and Pauls and puts and all these other things that again, it makes the deals a lot more complicated than a straight up traditional acquisition of accounting firm.

Ben Schaye (17:58):

And it's worth double clicking on that just a little bit because it's really important and I think it's one of the major advantages of entering into this structure. So we talked about how CPA firms generally have to be owned exclusively by CPAs or at least majority. That means there are likely to be individuals in the organization who are critical to the success of the organization, but to date have been ineligible to be owners. So when we say rollover equity, if we're being technical about it, rollover equity means exchanging some of your current equity in the firm for equity in the go forward venture. But there are individuals who don't currently have equity in the firm and this structure enables you to equitize them. And so the MIPS that you heard Peter referenced, the problem is if you don't have anything to exchange for value, and I recognize I'm talking to a room full of accountants and tax professionals, but it's taxable if you get something back in value, having not exchanged something for value so that the management incentive plan, the MIPS is a way to equitize individuals without causing them to incur a tax liability upfront, which is obviously not desirable.

(19:20):

And so that unleashes a lot of opportunity to then provide equity in a tax efficient manner to the next generation or the professionals who are not CPAs but are rainmakers and value drivers of the firm.

R. Peter Fontaine (19:37):

I always learn something whenever Ben speaks.

Rick David (19:41):

You heard earlier today in the last hour or so about a firm that gave 700 members of the firm equity in their management incentive plan. And in reality, it's also something that you got to prepare for as you go and do these calculations. How big of a management incentive pool will you create? The investor will want that. They'll want you to have probably 15% is what I've seen lately of an incentive pool. They want this next generation to be able to have something to work towards and be committed and add the value because if they add value, the investor gets value also. And so it's very important that that's where it really impacts the second and third generations of your firm, your future leaders, by putting that incentive plan in place on day two, not on day one, but on day two, once you do the transaction, you create the alternative structure with the common ownership which gets you into a tax, tax-free hopefully exchange.

R. Peter Fontaine (20:37):

This is really talking about a very important point is I think sometimes sellers think that it's a part of their succession plan, but it's actually the beginning of their succession plan in my view, and it kind of goes to the MIPS issue, is you got to make sure that the sellers have got to make sure that the next generation is in place, right? And that they're going to be successful because the value of their firm and the value of their rollover equity is really going to be contingent upon the performance of the entity. And that's really going to be in the hands oftentimes of the younger generation. So you really have to think about, I'm not, this isn't my succession plan, it's a start of second. Another generation of succession,

Rick David (21:17):

Under the old structures we all came up with that was your succession plans. Make sure the guys coming up behind you are stable enough and workable enough to be around to keep the firm in good hands for the next 10 to 15 years. So I get my retirement pay and a lot of judgments were made on whether this person will keep the firm intact for 15 years to pay me out. And now that's doing your shifting that because you no longer have that overhanging obligation. I mean, I laugh about we're a bunch of audit firms and out of the top 500 firms in the country, only one audit firm ever got audited financial statement audit wise in the last 15, 20 years. Only one.

(22:00):

The other ones would never get an audit opinion because they're all bankrupt with this pension overhang, the unfunded pension obligation. Only one firm was audited and actually it was UHY, they did it for the IPO and they kept it auditing it for 10 to 12, 15 years afterwards. They kept getting audits, but that was always the case of you heard the talk about the new guy's going to pay for the old guy and they don't realize that. And you got to explain to 'em in this new world that the value creation now will be, they'll be able to generate more and get more benefit and not have this 5, 6, 7, 8%, 10% overhang that they didn't know was out there. They don't see the numbers. Well now they're going to be able to see the value creation upfront and benefit from that twice from a value issue and also not from a cashflow aspect.

Daniel Hood (22:45):

Well, I mean it's interesting just because suddenly the partners think, wow, PE firms are going to come and take care of our retirement. They forget that the PE firms are also, they're not buying an opportunity to pay off your retirement. They're buying an opportunity to have a firm that's profitable going forward, which means somebody still has to care about the younger generation and make sure that they stick around. So we've heard a lot of talk about, I've talked to accounting firms, some of the earliest deals talk about how they feel about the governance of their level of control in their deal, and they're very comfortable with it. They're like, we've figured this out. We are comfortable that our voice is heard in a lot of decisions when they look to the first turn. They're very comfortable about the amount of say they'll have and who their PE partner might sell it to.

(23:34):

We've heard PE firms talk a lot about, and this seems to be the case, definitely it's reinforced by what the firms talk about is, Hey, we're not here to run your business. You know how to run an accounting firm. We don't want to tell you how to be accountants, that sort of thing. And I'm curious about for all those sorts of issues, are those things that can be written into the deal? Is that a thing you can actually say, we will have X amount of say in who you sell it to, or we can veto a purchaser or we will only report X number of times a month to you or that kind of thing. Rick, is that the kind of thing that gets written into these deals or is it more of a cultural fits we're all comfortable with? We know what kind of reporting you expect, so we don't need to memorialize it kind of thing?

Ben Schaye (24:17):

Yes, yes. In all seriousness, yes you do. And obviously you could spend the rest of your life trying to envision every possible decision that you might make over the next three to five years and legislating how that particular decision would get made. That's not a productive use of anybody's time. So what you typically see is a relatively discreet list of critical decisions where the parties are deciding upfront, is this a decision that requires a majority or certain of the partner representatives on the board to be in the majority in order to approve? Does this require the sponsor to be in the majority to approve? I think some of the things that are of critical importance, and you've heard this in prior sessions, is private equity firms and you've heard various different flavors, but nearly all of them ultimately have investors to whom they're responsible and have fiduciary duties.

(25:29):

And so the flexibility to be able to exit and determine the timing of that is always going to be of critical importance to the firms and figuring out whether and if there are going to be guardrails on that is a topic that should be discussed upfront and decided ultimately these structures need to have the ability to compel a sale, otherwise there's no opportunity to realize the value. And we talk about, well, there's going to be a turn in three years and another one, three or five years after that. And in order for that to happen, there needs to be a mechanic in order to ensure that whatever the deciding body is and how that decision gets made, once that decision is made, the entirety of the firm can be sold subject to, and this is an important feature of these deals, the accountants, the partners, continuing to have a stake going forward and under the next sponsor ownership.

Daniel Hood (26:42):

Rick, do you want to,

Rick David (26:43):

Yeah, I mean you talk about pe. That's also, it's a broader issue of any outside investor, whether it's a family office, a pension, an insurance company. We might see it down the way. They want to have the flexibility, and as we said earlier, everything's negotiable other than APS and your buyer. As you evaluate your prospective investor, you're going to hear how they feel about these things. They're going to come to you and say, we need these kinds of rights and these abilities. They will, I mean, one of the issues that you talked about, they're going to want to make sure that there's enough partner support of any of these decisions. Also, they don't want to have invested funds and time over the years in an entity, a firm that where the partners themselves don't agree on what's going forward and they want to be able to sell, liquidate their thing.

(27:34):

And at times, who knows what's going to be out there in five years as far as sellers or buyers. But it's the same approach you would take if you were making a major investment. You also want to provide is you, one of the big issues or opportunities they're seeing is they want you to grow. And when you grow and acquire other firms, there are times when you will need to increase, say your board to include leaders from the firms you acquire and you have to have the flexibility to expand that governance structure to accommodate the future. But they want some guide rails. I mean, there's been talk lately about whether it's majority interest or majority interest. If you don't get along with your investor, whether you have majority or minority, it doesn't matter. I will say that a majority, they'll do a little higher valuation if it's majority, but they don't want control.

(28:21):

They're there to buying what you bring to the table. They wouldn't be talking to you unless you were a successful firm and they want you to continue to guide. They don't want to get involved in details, day-to-day details. They want to give you guidance on big strategy issues, big expenditures, big acquisitions. You might do other wins. They want hands off, they want to be kept informed. They don't want to get involved in nitty gritty. And they'll tell you that if you negotiate with them, they'll tell you what their expectations are and you decide as a firm whether it's something you can live with.

Daniel Hood (28:50):

So to follow up on that, Peter, and then I'll give back to you, Rick, will you talk about their expectations in terms of reporting? Have you seen it that, I mean, is there generally a very clear understanding of yes, we expect you to report to us biweekly or monthly or with these things, or is that something that generally gets worked out afterwards? Like a general sense of the level is explained,

Rick David (29:11):

It's worked out afterwards. And part of it is some firms do not have a very robust internal financial reporting system now,

Daniel Hood (29:18):

We heard about that the first session this morning. They kept talking about, we didn't have the numbers.

Rick David (29:21):

They know how profitable their business is. They don't know where the profitable clients are or the profitable departments or offices. They just don't. So to ask them to report on how profitability is, they didn't even know themselves. It's going to be a challenge. So it's really, again, what they're comfortable with doing. And it's a negotiated aspect. I mean, I think over the last three, four years, the PE firms have gotten more educated in the accounting industry. Some of the early deals fell apart when the comment was they started treating it as a PE deal, and this is not a normal PE deal. And they'll tell you that. I mean, you're dealing with people. It's people business. They leave every day, the assets leave the door. You can't go in and do a management change out overnight because you're not happy with management. And they understand that and they understand it more now than they did three or four years ago. And also the firms have a better expectation of what can be demanded of them. So it's evolving. I mean,

Daniel Hood (30:18):

But it's funny sorry about that. I mean, three out of four, at least three out of four people on our first panel this morning said, yeah, we had to get our reporting up to speed. We were not prepared to deliver these kind of numbers. And then they all managed to do it, I think relatively easily, but it was still a thing that they had to take care of after the deal started. Peter, sorry, we skipped it. Let me let Peter weigh in.

R. Peter Fontaine (30:38):

Sure. If I can use your expression, double clicking to double click on something that Rick said with respect to taking a minority interest in the firms, what we're seeing in some of our transactions is that the sponsor will take less than 50%, but they'll bring in a co-investor. So between the two investors, it'll be more than 50%. That sort of drives some of the governance issue. So who's on the board? So maybe if you have a seven member four board, you might have three from the sponsor, three from the former owners or now other current owners, and then one from the co-investor. So now have this board consisting of these three basic parties. So what does that mean for governance and has been suggested? Okay, what rights do the sponsors have in order to make the call with respect to selling et cetera and major decisions.

(31:29):

And then an area's near dear to my heart, of course, is the whole auditor independence issue and what does that mean for auditor independence in terms of control, and how does it go over, and I don't want get into it because it's way too complicated for this for days. Yeah. Ben and I have worked on some transactions together. He always calls me, what if can we do this? And I like, I don't know, Ben, let me see. Let me try to figure it out. It's such a complicated, but I just mentioned it because the ownership in the board and how much control that the sponsor can exercise over what goes on is critical to the auditor independence issue.

Ben Schaye (32:05):

Makes sense. Sorry, cut you off. Yeah. What you didn't hear in the earlier sessions is, well, how did you decide what the reporting package was going to be? And the reason you don't, and you can't really negotiate all that upfront or it doesn't make sense to is because, well, it's a function of what you're capable of and what resources do you have, what resources might you need in order to enable the sort of reporting. That's the sort of thing you only get into down the road once you're really under the hood. And once you can figure out what's possible, what's not possible, ultimately data is important and data drives results and figuring out how, if you don't already have the capabilities to generate that data or at least analyze it, how do you get from where you are to where you need to be? That's going to dictate what the reporting looks like and it's a partnership and you've heard this time in and time out throughout the sessions. It is working together to figure out something that makes sense. So that's not the level of detail that you'd expect to get into kind of upfront in the negotiation of the transaction. In the negotiation of the transaction. You're really focused on what are the absolutely critical kind of fundamental decisions that you might find yourself making over the next three to five years, and how are those decisions going to be made.

R. Peter Fontaine (33:38):

Dan, I would be remiss too if I didn't mention that there's two or one depending on how you want to count 'em, fundamental principles of these alternative practice structures. And that is that the attest practice has to stay financially and operationally distinct from the non attest practice, which means that the attest practice is going to have its own individual governance. And so what does that mean? What does the agreement between the partners of the old attest practice, what's their relationship, how are they governed? And then is there any overlap and what kind of overlap is permitted between the attest and the non attest practice with respect to the governance issue? So again, these are the kind of issues that we try to deal with, right, Ben, in the agreements that we draft and making sure that whatever we set up and whatever makes sense also passes the regulatory muster, I would guess would be missing. Saying too is I think the regulators are going to be interested in understanding how this all plays out and are we maintaining that or making sure that that fundamental principles followed the independence of the attest and the non attest practice financially and operationally.

Rick David (34:44):

Might turn to double click.

R. Peter Fontaine (34:45):

Okay,

Rick David (34:46):

You have your separate board for your attest practice. The managing partner of the attest practice cannot be an officer, an official on the non attest side. They can have observer rights on the board and they quite often do, but they don't have any jurisdiction on the non attest side. Additionally, you talk about financial aspects. When you go into your APS, you got to negotiate your bank agreements, renegotiate them with any banks you use. You can't, the non attest practice, which will be billing and doing all the collecting and billing for both sides of the business, you cannot pledge the receivables from your test practice against the non attest debt.

(35:24):

Independence wise. The only issue that comes along in these agreements is that the attest firm has a responsibility to enforce and supervise and oversee independence of all the non attest personnel. Right now, the ethics committee, the peak is looking at defining covered persons for that purpose also, but they're responsible for all non attest employees for independence and investments and things like that for the entire entity, even though they're separate entities. But under the APS structure, they're obligated to comply with independence rules throughout the whole organization, but they are a separate entity. They determine who makes partner, how that decision is made. Not every partner in the attest firm will be an owner, equity owner in the non attest firm. It can happen, so they are run distinctively, but it's ironic that the attest firm will look to the non attest firm for recruiting their professional personnel, leasing those employees over to the attest practice when they do audit work, training, the attest personnel that are really the non attest employees, recruiting, training, scheduling, all that stuff is done by the non attest personnel as a service organization to the attest enterprise. And that's spelled out in the services agreement? Exactly.

Ben Schaye (36:48):

Real estate, hr, it, finance, accounting. The list goes on,

R. Peter Fontaine (36:55):

Goes on and on. I think it's like 18 items on the list.

Rick David (36:57):

Signage on your signage on your offices need to have both entities listed.

R. Peter Fontaine (37:02):

Websites.

Rick David (37:03):

Websites have to be researched,

R. Peter Fontaine (37:04):

Engagement letters,

Rick David (37:05):

Two engagement letters, two separate bills go out to a full service client. It's a lot of detail. It is, but it's doable. The idea is I propose that you plan for it, and if you have the time to plan and the luxury of planning for it, it can be done very smoothly, very little disruption, and it minimizes any future impact as you go forward. And again, takes a lot of the regulatory oversight because no longer when the PCOB comes in or the peak or the peer review comes in, they look at the attest function only. They don't do anything with the non attest side other than the independence checks.

Daniel Hood (37:38):

Just briefly, we hadn't talked about this earlier, but we've talked about the service agreements between non attest and attest. Are those relatively uniform across the profession? I mean, is that sort of a standard boilerplate or do those get as every PE deal is different for every other, but are those service agreements tend to be standard or is that something where it might get wacky depending on how your firm is structured?

Ben Schaye (38:01):

They are pretty standard. And one of the interesting things about these transactions, and I've done a handful of in the accounting space and many more outside the accounting space, if you think about a deal as being comprised of a zero sum, certain aspects of it are going to be zero sum negotiations. You're going to want to receive more money as the firm consideration, private equity firm is going to want to pay less. That's zero sum. The portion of matters on a particular accounting deal that are not zero sum, where your interests are aligned in many sense, vastly outweigh the zero sum portion. You have a common interest in making sure that the APS is set up properly. You have a common interest in making sure that the attest firm remains independent. It's a bad look for everybody, whether you own the attest firm or not.

(39:03):

You have a common interest in making sure that the actual transfer of assets in order to set up the A alternative is done in a tax efficient and otherwise efficient manner. So really you're collaborating from the very beginning with the private equity sponsor and their advisors to figure out the best way to do this. And then there's obviously also things that are zero negotiations, but many, if you actually think about the amount of time that people spend on these deals, and most of them, it's the aspects that are of critical importance, but there's a total alignment of interest that actually take up the most time to just make sure that they're done right.

Daniel Hood (39:50):

Exactly. I want to pursue that idea a little bit. These are partnerships you are putting together a deal with somebody you expect to work with for a long period of time. I like the notion of thinking, right? There's some stuff that'll be zero sum, but there's some stuff that where you should be mutually collaborating and agreeing. But Rick, maybe you can kick us off with this one. When you go into those negotiations, whichever, wherever they're the zero sum or the ones where you should be collaborating, how does a firm, the accounting firm, and again, PE firms can cover yours for this part, how does the accounting firm make sure they're in the best position for that negotiation? What do they need to do to make sure that when they go in and say, Hey, we want this, they have the weight behind them to achieve what they want. Again, knowing that this is not a hostile negotiation thing, but they will have some interest. How do they defend them or put them in the best position?

Rick David (40:44):

Well, part of it is you got to know your business, know what your strengths are, and have a strategy in place for the future where you want to take it, and what assets and resources will need to get you there. So that helps determine whether the investment amount is suitable to make that happen. You want to go in there with your census of your employees and your partners. How old are they? What their years of experience are. You have to understand your deferred liability, your deferred comp programs, what your obligations may be for that. You want to also show 'em the culture, explain to them how you expect to allocate your scrape, how you expect to reward management below the partner level, what your goals are from a, again, show them that you're a quality organization. We talked earlier, will an outside investor take on and influence the quality and poor quality in the future of your audit work or your tax work? The answer is no. They're coming in to buy a quality organization. You want to show how that's established. You can maintain the quality aspects, the independence, the ethics, the professional being of what you are as a firm. That's very important. You want to be able to share that with a potential intentional investor as you prepare. Go in.

R. Peter Fontaine (42:01):

Peter, how would you, I think I echo that. I mean, I sort of look at, it's important for the selling firms. Do you have their house in order, right? I mean, there's huge demands for information. We talked about this for the availability of information. Are you prepared to give the PE firms what they need? We look at the due diligence list, right, Ben? I mean, they're pages and pages and pages and pages and pages, right? My apologies. Thank you, Ben, because I look at them and it's good for us, but preparedness of being able to really respond to what the PE firms need and really deserve, and then also understanding how complicated these things really are and setting aside the time that you need and order to devote to it. And I'll do deference to my brother at the bar here to say the documents are pretty enormous, right, Ben?

(42:53):

And they're complicated, and someone's got to read through them and understand them, and they got to be able to devote the time to it and not say, geez, we're going to close this transaction in two months. And oh, by the way, I'm going to be in Cancun this week and I'm going to be there next week, et cetera. And we went into it, right? It's just trying to get that, and I think also mentally being prepared for change because there's going to be a change. It's not going to be business as usual, whatever that means afterwards, whether your billing's going to change, you're not going to be able to let your AR and your whip Legg. There's going to be whatever you need to do, there's going to be a change. And I think you have to prepare yourself and understand that whatever it is, I've got to be prepared for it. I've got to embrace it. That's the way it's going to be, and I know I can negotiate some things, but at the end of the day, these PE firms on a spectrum of strategic buyers and financial buyers, they're probably a little bit farther to the end of the financial buyer. And you got to be prepared for the change.

Ben Schaye (43:53):

I would add, do homework, right? There's going to be a lot of aspects of this transaction where there isn't a negotiation at all. Everybody wants to buy out the deferred comp and the pension. How do you do that? Do you have a unilateral right to pay people out? Do you have to make an offer that they have to accept? In which case, how do you price that offer? It's those sorts of details where you know how your pension plan works or your deferred comp plan works. You know how your partnership agreement works is what you're proposing possible. If it's not, how else can we get to the right outcome given the constraints of whatever currently exists, recognizing that what currently exists may have existed for 80 years or well longer than anybody who's actually reading the documents has been at the firm, but you're pitching a transaction to sponsors who are coming at this cold.

(44:56):

Yes, many of them are very familiar with the space at this point, having looked at multiple firms and been interested for a little while, but nobody's going to know you better than you. And if you can come to the table with, here's our proposal and here's actually how we affect our proposal, you're going to find a much more successful transaction and you can do it faster. It's not going to probably be two weeks, but it'll be faster than it would be if you have to then go back to the drawing board and figure it out when a whole nother team of lawyers start looking at it with fresh eyes saying, I actually don't think it says what you think. It says,

Rick David (45:37):

Dan, if I can add, when you go through these deals, it's so exciting to see when the firms that are being talked to are firms that have done many of their own acquisitions.

R. Peter Fontaine (45:48):

They've

Rick David (45:48):

Gone out, they bought a lot of accounting firms in the past, but watching how they would approach buying something versus how the outside investors approaching buying them two different worlds. And it is fascinating to watch 'em scream and squirm and oh my God, they're not used to that. They assume it's this way. You do audits. Do you have any problem? Okay, I'll pay you. Pay you in 10 years when you retire. Where as someone said earlier, the spreadsheet jockeys come involved, and it's a whole different way of looking at your firm, and it's very enlightening for your business, by the way, in many cases. But it's a whole different way to approach an acquisition they're not used to because they've done 'em, but not in that scope.

Daniel Hood (46:28):

We have just a couple minutes left, so I talked, do your homework. I think it's great advice for firms going in. Any last minute, other advice? Peter, maybe you can go in first here. Any just quick piece of advice for firms as they look at a potential PE deal?

R. Peter Fontaine (46:42):

Yeah, I guess think whatever I already said is do your homework. Make sure that you understand what you're getting into and make sure that it's a good fit with the PE firm and that you understand what their approach is and how their governance is going to work. And I think to some extent, what's their long-term plan? And try to, at the extent you can understand that, I think in a much better position to make the right decision about potentially multiple offers.

Daniel Hood (47:07):

Awesome. Rick, final advice any?

Rick David (47:10):

Go in with your eyes open. Don't lead with what's my multiple going to be, but that's the one thing everyone wants to talk about, and it'll help you learn a lot more about your own firm when you go through the process.

Daniel Hood (47:21):

Excellent.

Ben Schaye (47:23):

I would say give some thought to what your interests actually are, right? I see A lot of times private equity sponsors come to this with the perspective of we want to set up a structure that is very protective of the firm, of the enterprise and not necessarily and candidly sometimes at the expense of individual partners. And is your objective different than that? If you take a moment to think about it, maybe it's not. And maybe what we really should be talking about is what's the best way to protect the enterprise going forward for the benefit of all the stakeholders into the future, because that's going to be how you maximize value.

Daniel Hood (48:10):

Awesome. This is perfect. We are literally right at the end of time, gentlemen. Great stuff. Thank you so much. Thanks for having us, Ben, Peter and Rick. Gentlemen, great stuff. Thank you.