From time to time we hear news in the profession about private equity transactions occurring within the ranks of midsized to larger CPA firms. Just recently, EisnerAmper did such a transaction with TowerBrook Capital Partners.
While at first glance, a private equity infusion could appear to be an effective growth and wealth creation vehicle for CPA firms; there are elements of structure, due diligence, and corporate governance to be considered.
recently hosted a well-attended 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. Since there was good interest in this topic we thought we should share it through our newsletter. In this Perspective, “Private Equity and You” (Part One — Eyes Wide Open) of a two-part series, we offer an introduction to private equity opportunities, and discuss:
A background on private equity transactions.
Why would you consider a private equity arrangement?
What are the trade-offs?
Case histories of private equity investments in CPA firms.
What History Has Shown
Historically, private equity firms have found midsized to larger CPA firms somewhat attractive investments because they are predominantly annuity-based. CPA firms within the $30M-$40M revenue range seem to be the most appealing although there have been smaller transactions as well as larger ones. Private equity firms are attracted to these CPA firms because:
- They generally have valuations that are low.
- They usually have strong cash flow.
As CPA firms slowly transition from a traditional accounting firm compliance model to a higher margin, more progressive professional services model with a focus on providing advisory and consulting services, private equity firms are eager to invest in them and are out “droning” for opportunities. CPA firms not offering advisory and consulting services are not likely candidates for investment. Private equity firms are looking for the combination of both tax compliance and consulting, and see more value in the consultancy business. For private equity firms, the CPA firm’s client portfolio could provide them access to new clients that they may never have had entrée to previously.
In Our Opinion
, private equity might hit singles and doubles from an investment in a midmarket CPA firm, but generally not a home run which is what private equity is very attracted to. Private equity firms and lenders consider acquiring midsized to larger CPA firms the trailing edge of their investment strategy as CPA firms are not hugely scalable and therefore not in their sweet spot.
So why would you consider a private equity infusion? Aligning with a private equity firm can certainly be attractive to many CPA firms. One of the primary reasons is that it can be a vehicle to accelerate growth and bring an infusion of cash. Such funds can then be used to invest in people and technology, further propelling growth. It could also be seen as a strategy with an end goal of taking the advisory business public. A private equity transaction can attract employees by providing enhanced compensation packages, which may include stock options, It may also be an intermediary tactic to gather wealth as part of partners’ longer-term exit strategy.
Generally, we see that the valuation of these transactions as plus or minus 3X annual partner distributions or about one-time collected revenues.
What Are the Trade-Offs?
First, keep in mind that engaging with a private equity firm may cause a major shift in the way a CPA firm is managed.
There are several possible compromises and reasons why private equity firms and midsized and larger CPA firms have not traditionally mixed well, including:
- Typical of any acquisition transaction, there could initially be a tug-of-war over who is in charge of daily operations and overview strategies.
- Partners could feel a loss of independence if the private equity firm is “in charge,” as we have found that many CPA firms are tightly managed by partners, many who may have been founders.
- To create immediate cash flow for the private equity firms, there could be an initial haircut in partner compensation. Earn-out periods may need to be achieved. Partner perks and discretionary expenses could be brought down to minimum amounts as well.
- There may be a change in corporate culture, as private equity are often less collegiality and have a diminished sense of partnership comradery as they are focused on performance goals. There could be greater pressure and oversight of firm leadership to achieve the financial and performance goals firm wide.
- Inherent in the type of models each pursues, there could be 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 ROI.
- Personnel issues often emerge, as CPA firms tend to cultivate a caring environment and the senior partners truly see their employees as their most important assets. This conflict and the fact that employees may be displaced in a transition is often not palatable to many firms.
- Additionally senior partners, who would be viewed as key players initially to ensure that clients are properly serviced and transitioned, may find their roles diminished or receded over time.
- Private equity firms may load up on debt that could amount to at least three-to-four times EBITDA.
- Cash management of receivables and payables will be run very tightly.
Case Histories: For Good and Bad
Given the confidentiality of agreements, there is little known about the structures of the deals, goals or projections of the entities at the onset of their agreements, but CBIZ and UHY are examples of successful private equity transactions.
- 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 throughout the U.S., CBIZ delivers full-service accounting and business consulting, financial and benefits, and insurance services to organizations of all sizes, as well as individual clients.
- UHY US, initially a roll-up, remains private as a mid-market firm and is growing nicely. It is part of a cohesive international network of independent member firms providing audit, accounting, tax, and business advisory services across the globe.
- In 2007, private equity purchased about 80% of Philadelphia-based accounting firm, SMART and Associates, for $60M by refinancing $60M of debt and liabilities. Smart was combined into publicly traded consulting firm LECG and went out of business in 2011.
- Goldstein, Golub & Kessler was acquired by American Express and was subsequently spun out.
- McGladrey was acquired by H&R Block and was subsequently spun out.