The Siren Song of Private Equity Acquisitions
The wave of mergers and acquisitions in the accounting industry over the past five years or so shows no sign of abating as small and mid-size public accounting firms seek to gain the size that lets them invest in new technology and recruitment, and gain other advantages of economies of scale.
While there are lots of arguments to be made in favor of joining forces with other CPA firms, it’s still a fraught process with many potential hurdles.
And it’s not just other public accounting firms doing the merging and acquiring. The private equity firms that have been rolling up small and mid-size CPA firms into larger ones come with plenty of benefits, notably the ability to make the investments needed to compete at a time when automation and artificial intelligence (AI) are bringing a sea change into the accounting business, and competitors are getting bigger.
But they also come with their own baggage, such as questions of conflicts of interest and compliance with the auditor independence rules, as well as a focus on the more profitable tax and advisory service side of the firms.
The money from an acquisition can be enticing, but it’s important to go into it knowing that there’s a price to be paid for it, and what that price is. And how to go about paying it if you do decide to join forces with a private equity firm.
Private equity pros
Private equity firms have been competing to invest in large public accounting firms, but also to buy out and roll up small and mid-size firms for two core reasons. One is a steady and predictable revenue stream, particularly on the audit side, which is very enticing to them. The other is the revenue potential of expanding the more lucrative tax and consulting side of the business.
But they also see the opportunity to grow the CPA firms and make them more profitable by investing in things like staff training, recruitment and cutting edge technology like AI that can transform the accuracy and efficiency of audit processes. And, of course, strategic acquisitions that can further strengthen the business.
Another thing they can do is centralize certain auditing tasks like data processing or routine testing, even moving it offshore for cost efficiency. This can give the core auditing team more time for the deep dive and the ability to focus on more value-added services.
Private equity cons
On the con side, the focus on consulting can lead to the auditing quality side being given less priority for investment and growth. With a focus on short-term profit, private equity funding can come with pressure to focus attention on the higher margin consulting side of the business.
Private equity firms are often eager to scale up the tax and consulting sides of the business, to the point of sometimes creating an alternative practice structure (APS) by investing in or acquiring just those parts of a firm and leaving the audit side, with its need for independence and smaller margins, alone. Which calls into question the benefits of a private equity investment, at least on the auditing side of the business.
Then there’s the threat to auditor independence of having an owner or partner with a large portfolio of companies like tech firms that can provide other services to audit clients. And even when there is no actual threat, these perceived conflicts of interest can be a red flag to audit regulators and standard-setters.
Private equity questions
When you’re looking at an investment or acquisition by private equity there are questions to be asked that aren’t always obvious, or at least that don’t have simple answers.
It’s easy enough to start a conversation about auditor independence and the appearance of impairment or conflicts of interest with the auditing side of the business, but it’s also easy enough to promise that these issues won’t be a problem.
You have to be aware of the other types of services that they're planning to provide to that same client, because that could have an impact on whether or not you can perform the audit or the review work that you’re doing without violating the AICPA’s Code of Professional Conduct.
That’s particularly true with small CPA firms focused on the auditing side of the business instead of consulting, which will suddenly find themselves paired with a large and aggressive tax and consulting business.
But whatever size your practice is, you’ll have to update policies and procedures and be cognizant of the need to create an infrastructure that acknowledges the potential conflicts that come with a private equity firm’s offer.
Collemi Consulting leverages nearly three decades of experience to provide trusted technical accounting and auditing expertise when you need it the most. We regularly work with CPA firm leadership to help them reduce risk and maximize efficiencies.
