How Private Equity Is Affecting The Accounting World

Private equity investment in accounting firms has accelerated in recent years, prompting important questions about ownership, growth, culture, and the long-term direction of the profession. To better understand what's driving this trend and what it could mean for firms, partners, and clients, Bruce Benator, Assurance Partner, answers a few questions about why private equity is investing so heavily in accounting and how firms are continuing to being impacted.

Why Is Private Equity Investing So Heavily in Accounting Firms Now?

Private equity firms currently have a lot of cash available to invest often referred to as "dry powder." As they look for places to deploy that capital, they tend to focus on businesses with recurring revenues that are fairly fragmented and where there is an opportunity for revenue growth; Accounting firms check all those boxes. The industry has predictable, recurring revenues with opportunities to expand services and is still made up of a large number of independent firms. From a private equity perspective, that combination represents opportunity.

What Has Changed in the Accounting Industry to Make It Attractive to PE?

Several things have shifted within the profession over the past several years. First, many firms are more open to selling than they were in the past. A significant number of partners/owners are approaching retirement and don't have a strong succession plan in place. In many cases, there are not enough partners ready, or financially able, to fund a traditional buyout of retiring partners. At the same time, firms need more capital than they used to. There is an increasing need to invest in technology, and many firms are acquisition oriented and looking to grow through acquisition. Historically, acquisitions could often be paid out over time, but that has changed. Now, more sellers are demanding a significant amount of cash up front.

Is Private Equity a Temporary Capital Wave or a Permanent Shift?

The jury is still out. Private equity could be here to stay, but there's also a possibility that it doesn't work out the way investors hope. If returns don't meet expectations, we could see less private equity investment in accounting firms in the future. At this point, it's simply too early to know for sure.

How Much Control Do PE Investors Have Over Firm Operations?

In most cases, private equity investors have majority control and can ultimately call the shots on management. If current leadership is not performing up to expectations, private equity firms can look to make changes. On the other hand, if the firm is performing well, there is typically less need for direct involvement. Their focus is usually on improving revenues and earnings over a three to five year period so they can have an exit event. That objective tends to drive many of their decisions.

How Does PE Ownership Change a Firm's Growth Strategy?

Growth expectations generally increase significantly under private equity ownership. Typically, private equity firms are looking for annual revenue growth of 20% or more. That growth is expected to come from a combination of organic growth and acquisitions, with acquisitions often playing a major role.

Are PE Backed Firms Growing Organically or Primarily Through Acquisitions?

While organic growth is still important, private equity-backed firms tend to be more focused on acquisitions. That said, they are still going to look for organic growth as well. The overall strategy is usually a blend, but acquisitions are often the primary driver of rapid expansion.

How Does Private Equity Ownership Affect Firm Culture?

Private equity ownership will typically impact firm culture over time. There is usually more focus on earnings, efficiency, and growth than in a traditional firm structure. Based on discussions with people at firms that are now private equity owned, there tends to be a stronger emphasis on performance and profitability. Compensation structures often change as well. Bonuses are frequently tied directly to individual and firm financial performance. Additionally, as firms grow through acquisitions, multiple cultures are being blended together. Over time, the culture of the acquired firm will change. Depending on the previous situation, that can be a positive or a negative thing.

Has PE Ownership Changed Service Quality, Responsiveness, or Independence?

The jury is still out on this as well. Most firms are creating alternative structures for their attest practices, since those practices typically must be owned by CPAs. While these structures are designed to comply with professional standards, the cash flow ultimately goes to the private equity owned entity. The SEC and AICPA have raised concerns and are actively looking into independence considerations. Various task forces are reviewing these issues, and some guidance has already been issued.

As for service quality and responsiveness, it really depends on the firm and the situation. When long term partners leave, there is always some transition risk. In addition, as larger firms move upmarket, smaller clients may no longer be a good fit for the firm and may not get the attention they received in the past.

Which Aspects of PE Involvement Are Most Misunderstood?

Private equity is often viewed as either the ultimate solution or a terrible outcome, and neither extreme is entirely accurate. The reality is probably somewhere in between and depends heavily on the firms involved. For some firms, private equity may be the right solution to address succession, growth, and capital needs. For others, it may not be the best outcome for the remaining partners and staff and could have a negative impact on the firm culture and client service, especially for a high performing firm.

We will learn more over time. Everyone has an opinion on how this will ultimately play out, but only time will tell which perspectives prove to be right. And in many cases, both are correct, but it depends on the needs and goals of the respective firms.