September 3, 2019

IN OUR OPINION, PERSPECTIVE #91 — SEPTEMBER 3, 2019

(A Continuing Series for Leading CPA Firms)

WE STILL DON’T HAVE A CPA FIRM WITH MARKET DOMINANCE IN THE MID-MARKET. WILL WE EVER? IF YES, WHAT WILL IT TAKE?

“Business is war, I go out there, I want to kill the competitors.

I want to make their lives miserable. I want to steal their market

share. I want them to fear me and I want everyone on my team

         thinking we’re going to win.”                                                                               

                                                              —Kevin O’Leary

It is a widely held view that the Giant Four (Deloitte, PwC, EY and KPMG), with Deloitte being the largest, have “market dominance” when it comes to providing professional services to the Fortune 1000.  They own that space and their positioning will not be challenged in the foreseeable future.  It is also a widely held view that the Next Six (RSM, Grant Thornton, BDO USA, CLA, Crowe and CBIZ + MHM) are designed to be the preferred service providers in the mid-market space.  All of the Next Six firms, RSM being the largest, are very high quality firms with different strengths and weaknesses for sure but, in our view, not one of them has “market dominance” with owners/operators of mid-market companies.  Not one of them is widely accepted as top of mind.  Arguably, not one of them is dominantly aligned with an industry sector.  For the most part, they are about the same size and breadth of skills and credentials.  Arguably, not one of them has demonstrated that they seek “market dominance’ in the mid-market.

In today’s marketplace, when either public capital or outside private capital (principally from private equity groups) is sought by clients, your firm becomes very vulnerable without capital markets skills and credentials and a recognizable brand – – at a minimum nationally and, ideally, globally.  The question that is often asked of mid-market clients by investment banks and private equity groups is “who or what is XYZ & Co., CPAs”?  If you want our capital, you have to retain a Giant Four firm or, perhaps, RSM, Grant Thornton or BDO USA.”  As a result of lacking market permission, your client who is in need of the outside capital, is forced to change CPA firms.  If you’re lucky, out of loyalty, you will retain some tax work and from time to time, get an opportunity to propose on some consulting work.  Very frustrating!

It’s a safe assumption to say that there isn’t a week that goes by when a Top 100 CPA firm doesn’t have to deal with this vulnerability – – – oftentimes with some of its best clients.

After all these years, it is fair to ask why hasn’t one of the Next Six, or some other Top 100 firm, achieved “market dominance” in this space? It might be for a lack of even trying because the size of the commitment is more than anyone firm is willing to take on. Not sure. In Our Opinion, if one of the mid-market CPA firms strengthens its industry specialization skills and credentials, develops a fine tuned global brand, and closely aligns itself with bringing value (initially in a specific industry sector or two but eventually to a much broader swath of corporate America) to capital formation, one of the greatest challenges faced by owners/operators of mid-market companies, that firm will achieve “market dominance” and all the benefits that come with it.

This perspective demonstrates on the size of the opportunity with just a small slice of the capital formation challenge in the mid-market – Russell 3000 public companies (1,235 companies in total) with revenues between $50 million and $1 billion. It also addresses what it will take to build capital markets skills and credentials.

Bottom line is – for a CPA firm to achieve “market dominance”, the firm needs to be (arguably must be) closely aligned with companies (at least in certain industry sectors) that:

1. seek outside private capital (other than from commercial banks, family and friends), and
2. subsequently seek (at least potentially) public capital vis-a-vis an IPO.

Building capital markets skills and credentials is a two pronged initiative:

• Firstly, it is a defensive strategy that enables you to retain your private company clients.
• Secondly, it enables you to attract both existing public companies and IPO candidates. This is your offensive strategy.

Let’s look at the opportunity at the Russell 3000 companies. According to www.info@auditanalytics.com , as of July 2019:

• The Giant Four audit 778 or 63% of these companies with three-fourths of the revenue within this population.
• Four of the Next Six (Grant Thornton, BDO USA, Crowe and RSM) audit 281 or 23% of these companies.
• Six of the Top 100 firms (BKD, Moss Adams, Dixon Hughes Goodman, Baker Tilly Virchowe Krause, Marcum and Plante Moran) audit 86 or 7% of these companies.
• CLA and CBIZ+ MHM and many smaller firms audit one or two of these mid-market companies each. In the aggregate, this group audits 90 or 7% of these companies.

This is a perfect example of where the Giant Four, not the Next Six, have “market dominance” with the mid-market Russell 300 – just a small slice of mid-market America. Why is that? Why don’t the Next Six own the space with both public and private mid-market companies? For sure, the Next Six and some other Top 100 firms (most notably Marcum) all have public company practices, but they currently evolve around micro-cap companies with higher levels of risk, lesser market capitalization and lesser market credibility.  If one of these firms wants to gain “market dominance” in the mid-market, it will have to step-up its games and start adding capital formation skills that add value and public companies with greater capitalization and greater market credibility.

So how do you get traction with this initiative?

Here are some of the keys:

• Firm leadership needs to talk about the importance of this initiative in their communications to partners/staff. This needs to be one of the handful of important strategies for your firm.
• Marketing dollars need greater focus on your ability to help companies who seek private/public capital and those who will eventually do so.
• Your quality control effort has to have a mindset that appropriately balances risk and entrepreneurship.
• M&A and IPO readiness skills are a required compliment to this practice.
• One of your partners needs to become the firm’s “market face” with investment bankers, attorneys, regulators and other centers of influence (such as the U.S. Chamber of Commerce).

IN CONCLUSION

For years now, the accounting profession has been concerned about the commoditization and shrinking margins of audit services and we all understand why that concern exists. Yet, capital formation (both private and public) will never go away as it is the cornerstone of entrepreneurship. Therefore, helping companies identify sources of capital and auditing companies that raise capital are valuable services that, if effectively presented to the marketplace, will continue to demand healthy margins. There is a huge opportunity for one of the Next Six or one of the other Top 100 firms to “disrupt” the marketplace by capturing significant public company market share and ultimately becoming the mid-market “category killer”.  Will one of them seize the opportunity?  We think so.  Stay tuned!

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Dom Esposito, CPA, is the CEO of ESPOSITO CEO2CEO, LLC — a boutique advisory firm consulting to leading CPA and other professional services firms on strategy, succession planning and mergers, acquisitions and integration. Dom, voted as one of the most influential people in the profession for two consecutive years by Accounting Today, authored a book, published by www.CPATrendlines.com., entitled “8 Steps to Great” which is a primer for CEOs, managing partners and other senior partners. In Our Opinion, is a continuing series of perspectives for leading CPA firms where Dom shares insights, experiences and wisdom with firm leaders who want to “run with the big dogs” and develop their firms into sustainable brands. Dom welcomes questions and can be contacted at either desposito@espositoceo2ceo.com or 203.292.3277.