Should Your CPA Firm Consider Private Equity? The Pros, Cons, and Key Questions to Ask

Private equity (PE) is moving into the accounting industry, elevating pressure on firms large and small to consider their next move. While direct investments in larger firms began several years ago, PE is now active and likely to keep expanding with targets in the mid-sized firms and even smaller ones (under $30M).

To determine whether your firm wants or needs to consider becoming a part of a PE model, it’s important to consider the pros and cons of being PE-backed.

Pros of Private Equity for CPA Firms

(1) Access to Capital

Private equity, in simple terms, invests money in a company with the goal of improving its value and selling the investment for a return.

CPA firm partners often have been inclined to pay out a large portion or all of their earned income each year and have been relatively debt averse. This leaves firms little capital for large future investments.

Part of the promise of PE is injecting large amounts of capital that can be deployed on things like new technology, infrastructure modernization, and acquiring other firms to accelerate growth.

(2) Higher Potential Financial Rewards

The private equity model is to buy low and sell high to generate a high rate of return for their investors. This involves generating financial gains in any number of ways, including increasing revenue through acquisitions and cross selling, cutting out unneeded costs through offshoring and technology efficiencies, and leveraging up firms with debt to lower the cost of capital and boost the investor’s return on equity.
A pro of the PE model is that your PE partner will be very focused on generating the highest financial return possible. For that reason, PE deals typically give owners and key leaders a generous financial incentive to focus on creating high rates of return.
That can look like partners being able to participate in liquidity events roughly every five years. Partners don’t have to wait until retirement age for a payout. Managers may also get similar incentives that align their compensation with firm performance and liquidity event upside.

(3) A Corporate Governance Model

While some CPA firms already operate under a more “corporate” model of governance, where an empowered board, executive committee or managing partner is leading the firm and can make significant changes that advance the firm, many firms fall prey to a more “partnership” style, where leaders are not empowered and decisions on necessary changes may linger for years. In today’s fast-changing environment, management by committee can be a competitive disadvantage.

PE firms as majority owners (and potentially minority owners as well) can help by legally and philosophically shifting a firm into a more corporate style of operations. If positive business decisions such as technology modernization, moving into advisory, and culling low-end clients are able to be made expediently, firms can become more competitive.

Our PE consulting services are tailored to CPA firms seeking to explore PE opportunities, whether it’s for growth capital, succession planning, or strategic expansion. We can help you with: Initial assessment and strategic alignment • Preparation and position • Partner selection and deal structuring • Closing and post-deal integration • And more

Let’s talk! Contact us to schedule a call.

Cons of Private Equity for CPA Firms

(1) Loss of Control and Independence

While PE may take a majority or minority equity interest in a firm, a key consideration in any deal is who is in control. Many CPA firms would prefer to remain independent if possible. A PE investment inherently requires alignment to certain financial targets and management to support those goals. Clients, staff and even partners may be removed from the firm if they become obstacles to reaching those goals. Decisions must always make sense through a financial lens, which may be contrary to how partners are used to making decisions. Even so, not all PE deals will reach their targeted goals, adding risk to the potential financial payouts that senior leaders will be hoping for.

(2) Pressure for Short-Term Gains

Private equity makes money by improving a firm financially, then exiting for a return on their investment. Typically, there is a three-to-seven-year horizon for this investment-to-exit cycle. The time value of money states that a dollar today is worth more than a dollar tomorrow, so getting out as fast as possible for as much as possible is the game. This can put pressure on to achieve short-term financial results, so CPA firm owners will want to be sure they are not creating negative long-term consequences for the firm, its clients or staff to reach those goals. Not all PE firms are alike. While some may be committed to long-term stability, you’ll want to choose your PE partner carefully.

While PE is perhaps still in the honeymoon phase with accounting firms, in past decades private equity hasn’t always enjoyed the best reputation when it came to looking out for people, firm culture or communities. Negative consequences are certainly not guaranteed; it’s just prudent to be honest about the incentives in a partnership with PE and potential points of tension.

(3) Cultural Challenges

When I facilitate strategic planning, I ask what people value most and what they hope for their accounting firm. Statements like, “We really care about our people,” “We have great clients,” and “We want to preserve our culture even as we grow” are common.

While PE may support your firm’s culture, it also may not. The extra time and prioritization that it takes to really show you care for your team and clients may not be in line with the rapid financial growth and transformation of the firm. Even in the best case, owners may become distracted by managing and scaling their organization. In the worst case, the financial incentives are in conflict with important parts of your culture or firm values. Even if you do thoughtful due diligence on your PE firm and find a great fit, when they exit the firm, partners may have little or no significant input on who the next owners will be.

Key Questions to Ask

• How fast does your firm want or need to grow?
• How much do your partners (including retirement-minded partners) and managers value near-term financial payout versus long-term benefits and intangibles like culture and independence?
• How much capital does your firm need—and for what uses?
• How successful is your leadership team at acting in a timely way to make needed changes to the firm?

Private equity is not going anywhere, and the impact of PE investments will likely intensify in the coming years. Carefully considering the pros and cons of PE can help you ensure your firm’s path is aligned with the future you most want to create.