Is Private Equity a Viable Strategy for Your Firm?
Understanding the Landscape and Assessing Your Options
Accounting Landscape Overview
For many years, merger and acquisition (M&A) activity in the public accounting industry was primarily driven by succession planning issues. Surely, succession challenges still play a role in a firm’s decision to sell or merge; however, there are many other factors that are driving the elevated levels of M&A transactions throughout the country, such as:
Difficulty in attracting and retaining professionals to provide quality services to clients.
Private equity making significant investments in CPA firms providing more opportunities and options in the M&A marketplace.
Lack of sufficient revenue growth due to the labor shortage.
Generalist firms with the absence of high-demand niches, specialty services, and formal integrated advisory services will lose their competitive edge in their local marketplace to larger firms with more resources.
Inability for the partners to agree on a strategic plan together with the necessary investments in resources to remain independent.
Minimal partner accountability for performance and profitability.
In this dynamic marketplace, the leaders of today’s accounting firms have several strategic options to consider for their firms’ future.
Private Equity Investments
Private equity is making an impressive return to the public accounting industry. Investments continue into firms such as Citrin Cooperman, EisnerAmper, and Cherry Bekaert. The goal of private equity is to generate investment returns through capital appreciation via revenue growth, improved margins, and increased valuation multiples typically associated with higher levels of earnings. The capital infusion supports the firms’ long-term growth initiatives, which include accelerating advisory and new and innovative services, investing in talent and technology, and expanding through organic growth and targeted mergers and acquisitions.
Once a “platform” firm is secured by private equity, they are charged with acquiring smaller firms known as “tuck-ins.” The tuck-in firms benefit by receiving multiples based upon their EBITDA that provide higher valuations than traditional M&A offerings of around one-time revenue. This is also known as a ‘buy and build strategy’ for the fund to sell to a larger private equity fund within three to five years.
Traditional Mergers and Hybrid Structures
We are seeing a trend with traditional merger transactions where sellers are not seeking involvement with private equity but wish to incorporate components of a private equity deal into the transaction. The most common hybrid components are a considerable upfront payment to partners, and multiples based on EBITDA that translate into multiples on revenue of approximately 1.25 and greater. These hybrid deals will continue to evolve and become more widespread in the marketplace.
Internal Succession
There are many CPA firms throughout the U.S. who wish to remain independent, but few firms have implemented formal plans to ensure their legacy. Succession planning is not a program that should take place a few years before client service partners and/or leaders are about to retire. Succession planning should be an on-going daily occurrence that considers partner governance and compensation, growth through M&A, marketing, recruiting at all levels, and human resource management. Succession planning needs to start at the top with a true sense of urgency.
Conclusion
CPA firm owners should maintain a realistic perspective about the changing marketplace. Accounting firm leaders need to understand the changing landscape and the powerful impact that private equity will have now and in the future. CPA firm partners need to continuously evaluate the market and assess viable options for their future.
Joe Tarasco, CEO and Senior Consultant, Accountants Advisory Group, LLC, assists the leaders of public accounting firms by consulting in all areas of firm practice management, including succession and strategic planning, firm governance, mergers and acquisitions, private equity advisory, partner compensation structure, practice development, facilitating partner retreats, and leadership consulting. Click to request a consultation or call (845) 265-9046.