Private equity and you: keep your eyes open
Accounting Today mourns the loss of our longtime columnist Dom Esposito, former CEO of Grant Thornton, vice president of BDO, national director of practice and growth at CohnReznick, and most recently the head of his firm of board Esposito CEO2CEO, who died Sept. 22 at the age of 74 at his home in Westport, Connecticut. He is survived by his wife Dorothy, his daughter Karen and a granddaughter. You can find more information about his career at CPA trend lines.
From time to time, we hear news in the profession about private equity transactions occurring within the ranks of mid to larger CPA firms. Most recently, EisnerAmper completed such a transaction with TowerBrook Capital Partners.
While at first glance, a private equity injection might appear to be an effective vehicle for growth and wealth creation for CPA firms; there are elements of structure, due diligence and corporate governance to consider.
Esposito CEO2CEO recently hosted a well-attended webinar, “Private Equity and You: Is Private Equity Your Future? In which we discussed the opportunities, challenges, pitfalls and potential outcomes of such a measure. As there was great interest in this topic, we thought we should share it through our newsletter. With this in mind, “Private Equity and You,” part one of a two-part series, we offer an introduction to private equity opportunities and discuss the history of private equity transactions, why you might consider a private equity deal, what the trade offs are, case stories of private equity investments in CPA firms, and what history has shown.
Historically, private equity firms have found mid-sized to larger CPAs to be rather attractive investments, as they are primarily annuity-based. CPA firms with revenues between $ 30 million and $ 40 million appear to be the most attractive, although there have been smaller and larger deals. Private equity firms are attracted to these CPA firms because they typically have low valuations, their balance sheets are free from heavy debt, and their cash flow is generally strong.
As CPA firms slowly shift from a traditional accounting firm compliance model to a higher margin, more progressive professional services model focused on the provision of advisory and advisory services, private equity firms are eager to invest in it and seek opportunities. CPA firms that do not offer advisory and consulting services are unlikely to be investment candidates. Private equity firms seek the combination of tax compliance and advice, and see more value in the advisory business. For private equity firms, the CPA firm’s client portfolio could give them access to new clients that they may never have had access to before.
Private equity can hit the singles and doubles of an investment in a mid-sized CPA business, but usually not a homerun, which attracts private equity. Private equity firms and lenders are considering acquiring mid-to-large CPA firms at the forefront of their investment strategy, as CPA firms are not extremely scalable and therefore not theirs. square.
So why would you consider an injection of private equity? Aligning with a private equity firm can certainly be attractive to many CPA firms. One of the main reasons is that it can be a vehicle for accelerating growth and providing an injection of cash. These funds can then be used to invest in people and technology, thereby stimulating growth. It could also be seen as a strategy with the ultimate goal of publicizing the consulting industry. A private equity transaction can attract employees by offering enhanced compensation packages, which may include stock options. It can also be an intermediary tactic to gather wealth as part of the partners’ longer term exit strategy.
Generally, we find that the valuation of these transactions corresponds to more or less 3 times the annual distributions of the partners or approximately once the revenues are collected.
What are the tradeoffs?
First of all, keep in mind that engaging with a private equity firm can lead to a major change in the way a CPA firm is run. There are several trade-offs and possible reasons why mid-to-large private equity firms and CPA firms have traditionally not mixed well. Typical of any acquisition transaction, there might initially be a standoff over who is in charge of day-to-day operations and big-picture strategies. Partners might feel a loss of independence if the private equity firm is “in charge”, as many CPA firms are tightly managed by partners, many of whom may have been founders.
To create immediate cash flow for private equity firms, there might be an initial reduction in partner compensation. Earn-out periods may be necessary. Partner benefits and discretionary spending could also be reduced to minimum amounts.
There may be a change in corporate culture, as private equity is often less collegial and has a diminished sense of partnership camaraderie as it focuses on performance goals. There could be greater pressure and oversight from company management to meet company-wide financial and performance goals.
Inherent in the type of models each pursues, there could be a conflict between the mindsets of the CPA firm and its private equity investor, as CPA firms tend to manage and think longer term, while private equity firms focus on short-term return on investment.
Staffing issues often arise, as CPA firms tend to cultivate a caring environment and senior partners truly view their employees as their most important assets. This conflict and the fact that employees may be moved during a transition is often not acceptable to many companies.
Additionally, primary partners, who would initially be seen as key players in ensuring clients are properly served and transitioned, may see their roles diminished or receded over time.
Private equity firms can take on debt that can reach at least three to four times EBITDA. The cash management of receivables and debts will be very rigorous.
Case stories, for better or for worse
Given the confidentiality of the deals, little is known about the deal structures, goals or projections of entities at the start of their deals, but CBIZ and UHY are examples of successful private equity deals.
CBIZ is now public and doing well (NYSE: CBZ). With more than 100 offices and 4,800 associates in major metropolitan areas and suburban cities of the United States, CBIZ provides comprehensive accounting and consulting services to businesses, financial services, benefits and insurance to organizations. of all sizes, as well as to individual customers.
UHY US remains private as a medium sized business and is growing well. It is part of a cohesive international network of independent member firms providing auditing, accounting, tax and advisory services to businesses around the world.
In 2007, private equity bought about 80% of the Philadelphia-based accounting firm, Smart and Associates, for $ 60 million while refinancing $ 60 million in debt and liabilities. Smart was merged into the listed consultancy firm LECG and ceased operations in 2011.
Goldstein, Golub & Kessler was acquired by American Express and subsequently split.
McGladrey was acquired by H&R Block and subsequently split.
Depending on the size and mix of service offerings of a CPA firm, it may be a prime candidate for a private equity investment. The timing may be perfect; Private equity firms actively seek out medium to large CPA firms with the goal of expanding their client portfolio. For some CPA firms, private equity investing could be the path to growth and wealth creation for partners. But such arrangements do not come without compromise and compromise. There could be major changes in the culture, goals and structure of the company. With few success stories, we advise partners to consider such arrangements with their eyes wide open.