- within Accounting and Audit topic(s)
- in Asia
- in Asia
- in Asia
- in Asia
- with readers working within the Accounting & Consultancy, Banking & Credit and Retail & Leisure industries
- within Accounting and Audit, Media, Telecoms, IT, Entertainment and Technology topic(s)
- with Finance and Tax Executives
SMART SUMMARY
- Investing in accounting firms presents unique regulatory, incentive and structural hurdles, but dealmakers have broken new ground to solve these problems and unlock new opportunities.
Private equity interest in accounting firms has grown significantly in recent years. Rising technology costs, demand for advisory services, and succession challenges have created conditions where outside capital is attractive. We see the market for accounting firms continuing to augment and then mature.
Regulatory and Licensing Restrictions
Most U.S. states require CPA firms that perform audits to be majority-owned by licensed CPAs. This restricts direct private equity ownership. To navigate this, many deals use an “alternative practice structure” (APS). In an APS, the attest firm remains CPA-owned, while a separate management company – owned by the PE fund – provides administrative support and receives fees similar to structures we have seen used for a long time in the corporate practice of medicine and other similarly regulated businesses.
Independence and Conflicts of Interest
Audit independence is a cornerstone of the profession. PE ownership can raise questions if portfolio companies are audit clients. On-going post-Closing conflict checks and service-line separation are essential to avoid regulatory or reputational risk.
Partner Economics and Talent Retention
Traditional CPA firms operate on a partnership model, where profits are distributed annually. PE sponsors, by contrast, seek returns on invested capital. Aligning these models to implement a “scrape” and avoid leakage, requires creative compensation structures.
Retaining partners and key staff is particularly important – if too many partners “cash out” at closing, the firm risks a loss of leadership and client relationships. Rollover equity subject to vesting is commonplace in these transactions and liquidation preferences – even if just at 1.0x – are on the table as the transition to the new model is implemented.
Valuation and Exit Strategy
PE buyers typically value recurring revenue streams such as audit and tax compliance, but may see higher growth potential in advisory and consulting practices. Exit options are somewhat limited: future buyers are often other PE funds or larger CPA firms already operating under APS models. Any future acquirer will need to address many of the same issues highlighted above – so, having robust obligations requiring partners to rollover a substantial portion of their investment even where the exiting sponsor is selling 100% is important.
Conclusion
Investing in accounting firms offers opportunities for growth and diversification, but it also requires navigating a thicket of regulatory rules, cultural norms, and economic considerations. These issues initially proved challenging to overcome but as the market has matured, the volume of transactions has increased. We expect these new-found tools to spread into other professional services businesses that previously were not the subject of a robust M&A or PE market.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
