Thought Leadership

The impact of private equity

The following is the all-star lineup driving this change. The main catalyst was the introduction of private equity right around 2021. The initial investment was in a few large, established firms. Then, new large firms emerged led by private equity groups who did not exist before 2021 who acquired a series of small to mid-size firms. At the same time, additional established large firms started accepting outside capital. This move balanced the difference in how a larger firm could compete against the newly formed private equity groups.

In a short five years, the Top 30 firms in the United States, removing the Big 4 left twenty-six firms. Eighteen of them, 75%, have taken alternative funding. Fifteen accepted outside investment, selling a majority stake in their firms. One has been public for years, another recently became publicly traded, and one adopted ESOP ownership.

During this journey, those newly formed private equity groups that were not firms four to five years ago grew to one hundred million to a billion dollars. Not all transactions are announced so the exact number of firms owned by outside investment is not completely understood. Country by country the level of investment in accounting firms varies based on regulations, interest in this form of ownership, and interest by investors.

Several forces accelerated the profession’s shift.

Baby Boomers continued aging, while labor shortages changed how firms operated. Rather than learning to sell and build networks, many younger professionals focused on production because firms already had too much work. At the same time, a broader cultural shift was already underway which intensified during Covid. Remote work became mainstream, and much of the workforce embraced the lifestyle it created.

A diminished succession pool contributed to heavy private equity investment as there were not enough potential future partners with an interest in pursuing an ownership role. This combined with the labor shortage, investment in artificial intelligence, business development challenges, and the liability of paying the unfunded deferred compensation or retirements became daunting. The final piece which has been the most difficult to overcome is the difference in the purchase price of a firm by a private equity group or a capital-backed firm compared to a lower price in an internal succession. The gap is quite wide.

In our session we covered other issues which we do not have time to go into in this article: the K-Economy, the boomerang, critical key metrics, our accounting firm valuation model, deal points and terms, layoffs occurring at places like KPMG, Intuit and others, and addressing any change with less emotion and more data. Emotion should be part of the process, but it should not be the core decision factor.

Questions and significant misinformation exist in the market due to rapid changes and challenges in the profession. Often advisors who have not been involved in these transactions have opinions on prices, multiples, and terms, but this information is not public, and any advisor involved in a transaction would never talk about specific deal terms. We conduct about twenty accounting firm transactions annually, see the LOIs, and work in the deals, but most people do not know the details.

How we would like to end this article is by focusing on how to remain independent and the endgame of private equity. Remaining independent is possible but it takes significant effort. Business as usual will be hard to maintain when the competitor down the street becomes part of a $250M or $500M plus firm and has deeper financial resources, more people, and the ability to bring more services and skillsets to support the firm.

Independent firms must take four mission-critical steps.

• First, align partners and establish accountability. These are separate actions but must be one integrated process. Without this independence will gradually slip away.

• Second, develop an independence plan that defines how to compete proactively against larger competitors.

• Third, reassess the client base. Clients shape every aspect of the firm, including processes, pricing, value, and communication. Firms must continually upscale clients, reprice, and add more than compliance.

• Finally, focus on what moves the needle. A $20 million firm will not achieve 10% organic growth by pursuing $5,000 tax returns. It should pursue engagements of $100,000 or more by presenting itself as a high-value provider, attending the right networking events, speaking regularly, and continually innovating.

These actions build internal capital and provide the investment resources needed to compete with larger firms.

The endgame

In our view, the endgame is straightforward, but this is our speculation because the maturity of private equity in accounting is still new.

Firms are strong at compliance, which remains their core focus. Others successfully expanded into advisory and wealth management, while many have limited capacity to do so.

Consider the thousands of clients at firms with more than $100 million in revenue who also need human resources, technology services, investment banking to grow or sell their businesses, wealth management, family office services, and more.

The ultimate opportunity is to serve clients through the sale of their business and continue advising them and their family for generations on wealth, estate, and tax strategy.

About the author

Bob is President of The Visionary Group and one of Accounting Today’s Top 100 Most Influential People. He has relationships with key leaders in accounting firms nationwide and is a frequent speaker on M&A, private equity, and organic growth. Bob helps firms assess their ability to remain independent, build enterprise value, and creates and facilitates dozens of accounting firm transactions annually.

The Visionary Group has thirty-five years of exclusively helping accounting firms with growth and transitions. They provide private equity and M&A expertise through sourcing and conducting approximately twenty transactions annually and helping firms seeking to remain independent develop an independence plan to achieve that goal.

Their core focus is to provide objective advice and actionable plans to help accounting firm leaders make rational, informed decisions.