— Ludwig Mies Van Der Rohr
Midsized to large CPA firms may be considering a private equity transaction as a growth and wealth creation vehicle, but there is much to be considered beforehand.ESPOSITO CEO2CEO recently hosted a webinar “Private Equity and You: Is Private Equity Investment in Your Future?” in which we discussed the opportunities, challenges, pitfalls, and potential outcomes of taking such a step. As a follow-up, this three-part series discusses the potential outcomes. In Part Two of this series, we address what CPA partners engaging in a private equity arrangement can expect. Private Equity Due Diligence If you have been through the due diligence process with your bank, just hold on! Going through private equity due diligence, you should be prepared for a very deep dive. With some variety by the size of deal, generally, the process will focus on these areas:
ESPOSITO CEO2CEO considers the ‘structure’ as the ‘plumbing’ of the private equity transaction. Typically the investment creates an Alternative Practice Structure (APS) resulting into two entities: an Attest CPA Firm which is 100% owned by the CPA firm partners and which is the vehicle for the firm to be able to continue to do attest work. The second entity will become a Non-Attest Consulting Company which is jointly owned by the CPA firm partners and private equity investor. The Non-Attest Consulting Company essentially leases employees to the accounting firm to conduct the attest work and perhaps the tax compliance work. It also would not be unusual for there to be affiliates or subsidiaries to the non-attest consulting firm.Since the Attest CPA Firm only retains the audit and tax compliance work, the retirement plan (deferred compensation) that it had in the past may very well be reduced as part of the transaction since the accounting firm is not as valuable as it once was with the consulting revenues. It also would not be uncommon to see a slight reduction in draws and partner compensation. Sometimes in the initial transaction, a portion of the proceeds go directly to the CPA partners in a ‘dividend’ form, and in firms where the partnership agreement and compensation plan require it, the retired partners may also share in that ‘dividend’. The new APS must satisfy AICPA 101-14 requirements and state laws:
The Attest CPA Firm Board is distinct from the Non-Attest Consulting Company Board, so there will be two Boards, and the private equity firm will have no representation on the Attest CPA Firm Board.
So if your partnership can accept the aspects of structure and governance changes, is a private equity infusion an effective vehicle to create partner wealth? We believe so, but with the caveat that if a CPA firm has a strategic plan that it revises to reflect how strategies and tactics will be enhanced as a result of the private equity infusion, and that the APS effectively delivers on that plan, private equity could be beneficial for the partners.But the question remains: is the gain worth the pain? With bank borrowing rates being very inexpensive these days and many firms under capitalization with partner cash capital accounts, these vehicles could also be considered as alternative vehicles for growth as well as a private equity infusion, but without all the bells and whistles that private equity demands. Only time will tell if these transactions gain traction and are more successful than in the past. If you would like to view the full webinar “Private Equity and You: Is Private Equity Investment in Your Future” click here.