Private Equity: Is the Pain Worth the Gain?

Understand the tradeoffs and proceed with caution – these are two key pieces of advice that emerged from a recent webinar on private equity ownership of a CPA firm.

With the news in August that New York-based EisnerAmper (FY21 net revenue of $456 million) had accepted what it called a “significant capital infusion” from TowerBrook Capital Partners – the first such move within accounting in many years – MPs have been grappling with what it all means and whether their firm would benefit if a private equity firm comes calling.

Two consultants, Dom Esposito and Tony Zecca from Esposito CEO2CEO, took on the topic in a Sept. 9 webinar hosted by CPA Trendlines, discussing what due diligence would look like, the pros and cons, how governance would change and whether private equity ownership is an effective way to create wealth.

Zecca said private equity firms are “hovering” over accounting firms because they are attractive investments in many ways: their valuations are low, they avoid heavy debt and clients are predominantly annuity-based, providing a fairly reliable revenue stream year after year. Higher-margin consulting work is particularly appealing.

Upon closer inspection, Zecca pointed out that a private equity firm will look at information systems, cash flow, expenses, liquidity and the cost to deliver services to clients. Therefore, he says, if private equity invests, “They’re going to make sure they’re in control of what we’re doing.” They will scrutinize partner expenses and may cut compensation to boost cash flow. Zecca believes partner camaraderie will take a hit as a result of the increased pressure and heavy oversight of leadership.

Esposito added that private equity firms focus on ROI and short-term gains while CPAs have a long-term mindset and a caring culture. “The senior partners truly see their employees as their most important assets.” Private equity leadership will expect firms to link partner performance to their compensation, but accounting firms “talk about it but don’t do it in a lot of cases.” Partners will most likely be kept on initially to ensure clients are serviced properly, he said, “but some of the same partners might be pushed out of the firm.”

Esposito added that the profession has seen some private equity-accounting firm partnerships that have worked well – notably the public, Cleveland-based CBIZ (FY19 net revenue of $811 million) and the private, Farmington Hills, Mich.-based UHY (FY19 net revenue of $168.7 million). However, the profession has also seen its share of failed private equity transactions over the years – Goldstein Golub and Kessler, SMART Associates and McGladrey among them.

Another consideration is the dramatic change to governance. In the case of EisnerAmper, which is ranked No. 18 on the IPA 100 list this year, the accounting firm will provide attest services while the newly formed Eisner Advisory Group will conduct business advisory and non-attest services. That means oversight by two different boards of directors ­– one for the non-attest side and the other for the attest CPA firm. Both will have to be managed independently.

But with even with the potential downsides, some mid-sized firm leaders may view the infusion of capital as a way to compete and create wealth. A firm struggling to grow and attract talented professionals may find private equity the way to go. “It could be a home run,” Esposito says, “but the question lingers, ‘Is the gain worth the pain? ’ ” Private equity’s No. 1 objective, he notes, is profit and growth before exiting.

Zecca suggested a few ways firms without private equity can compete with their counterparts that do accept private equity ownership. First, find a way to recruit and keep talented professions ­– a huge challenge throughout the profession and the No. 1 pain point. Private equity ownership means staff can take advantage of stock options, which puts typical accounting firms at a disadvantage, but those firms can offer “phantom stock” to allow professionals to carve out an ownership percentage.

Additionally, firms simply must take a long, hard look at making their services more valuable to clients and improving how those services are delivered. “Make sure clients stick to you like glue” Zecca said. “You’re not going to be able to depend just on compliance and make that your future strategy.”