For many years, merger and acquisition (M&A) activity in the public accounting industry was primarily driven by succession planning issues. While succession challenges still play a role in a firm’s decision to sell or merge, there are many other factors that are driving the elevated levels of M&A transactions throughout the country, such as:
- Difficulty in attracting and retaining professionals to provide quality services to clients
- Private equity making significant investments in CPA firms, providing more opportunities and options in the M&A marketplace, including for smaller firms known as “tuck-ins”
- Lack of sufficient revenue growth due to the labor shortage
- Generalist firms with the absence of high-demand niches, specialty services and formal integrated advisory services, leading to a loss of competitive edge in their local marketplace to larger firms with more resources
- Inability for the partners to agree on a strategic plan together with the necessary investments in resources to remain independent
- Minimal partner accountability for performance and profitability
In this dynamic marketplace, the leaders of today’s accounting firms have several strategic options to consider for their firms’ future.
Private Equity Investments
Private equity (PE) is making an impressive impact in the public accounting industry. Investments have been made into firms such as Citrin Cooperman, EisnerAmper and Cherry Bekaert. The goal of PE is to generate investment returns through capital appreciation via revenue growth, improved margins and increased valuation multiples typically associated with higher levels of earnings. The capital infusion supports the firms’ long-term growth initiatives, which include accelerating advisory and new and innovative services, investing in talent and technology, and expanding through organic growth and targeted mergers and acquisitions.
Once a “platform” firm is secured by PE, they are charged with acquiring tuck-in firms, which benefit by receiving multiples based upon their earnings before interest, taxes, depreciation and amortization (EBITDA) that may provide higher valuations than traditional M&A deals. This is also known as a “buy and build strategy” for the fund to sell to a larger PE fund within three to five years.
An example of a tuck-in transaction structure is as follows:
|Cash at Closing
|Rollover Equity/Incentive Units
- Rollover equity can be available to current equity partners and incentive units available to mutually agreed upon partners, directors and managers.
- The guaranteed payout is paid at the earliest five years from the effective date or sooner if the PE investor exits as part of a change-of-control event.
- The contingent payout is based upon collectable billings to clients during the three calendar years following the effective date and may be paid at the earlier of the third anniversary of the effective date or sooner if the PE investor exits as part of a change-of-control event.
Traditional Mergers and Hybrid Structures
We are seeing a trend with traditional merger transactions where sellers are not seeking involvement with PE but wish to incorporate components of a PE deal into the transaction. The most common hybrid component is an upfront payment to partners. These hybrid deals will continue to evolve and become more widespread in the marketplace.
There are many CPA firms throughout the U.S. that wish to remain independent, but few firms have implemented formal plans to ensure their legacy. Succession planning is not a program that should take place a few years before client service partners and/or leaders are about to retire. Succession planning should be an ongoing, daily occurrence that considers partner governance and compensation, growth through M&A, marketing, recruiting at all levels and human resource management. Succession planning needs to start at the top with a true sense of urgency.
CPA firm owners should maintain a realistic perspective about the changing marketplace.They need to understand the powerful impact that private equity has now and will have in the future, and continuously evaluate the market and assess viable options for their future.