My Personal Take on Private Equity in Public Accounting

Hello, and welcome to the Big 4 Transparency podcast. This is going to be another solo episode. I have been quite sick all week, tis the season for that. And so I didn't get a guest lined up, but I also had some thoughts that I wanted to share. And with a lot of the recent interviews I did, I've really kind of formed my opinion around private equity in public accounting. And so I thought we could talk about that. Before we get into this episode, though, I do have an ask for you. I actually have two asks, and these are going to help me keep the podcast going in 2025. First of all, if you've enjoyed this content, I'd ask you to please give it a rating on whatever streaming platform you're using. The podcast has several thousand downloads and less than 20 ratings across all platforms. I've heard it can really help algorithmically and help new people discover the podcast. So if you're enjoying this, I would ask that you please kind of give it a rating. 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And it might be a little bit different than some of the other opinions and the kind of generic opinion of the media about this. So yeah, I wanted to talk about it, why we're seeing so much activity from private equity and how it can both be a positive and a negative depending on the situation. So first of all, you know, the 10,000 foot view is I think that having non-accountants benefiting from the growth in enterprise value in the accounting space is less than ideal. It's just simply less benefit going to CPAs and EAs as well. There's stats shared on the accounting podcast about this, but on average, income partners were earning somewhere in the mid 300,000 in the US, whereas equity partners are somewhere in the 800,000. So that Delta $500,000 is the opportunity that is going to the equity owners, which historically has been accounting professionals. And in this case is now going to be outsiders who have invested capital into the industry. So that's not the ideal scenario. However, the reality of what's going on in the accounting industry is not that all of the capital that's being collected is being reinvested. So ultimately, PE is coming in to kind of bridge a gap between competing priorities of partners at different stages in their career and in their thinking about the industry. So a prime candidate firm for a private equity deal is where there are multiple partners, some or a majority wanting to prioritize partner distributions by limiting reinvestment in the firm and paying out that capital to partners. There's often a tension in the firm that gets introduced by the younger, more growth minded partners who want to invest in people, technology and growth, but they might be outvoted by partners who do not wish to make the investments and instead want to prioritize cash flows going to themselves and the rest of the partner group. And so this is a little bit of an issue that a lot of firms are facing. And in a lot of cases, PE is coming in to those firms so that people can essentially have their cake and eat it too. So partners wanting to optimize on distributions for the retirements can just get bought out by the private equity firm coming in, whereas the more growth minded existing partners can often invest, let's say maybe half of their buyout value back into the private equity portfolio, which includes their old firms as well as possibly a grouping of a number of other firms. So these growth minded leaders can then continue running their firms with more investment, although with PE being involved now. But yeah, they can invest the capital needed to bring in the right talent, make investments in modernizing their firms to improve operations and operate properly in a way that can keep them competitive and more streamlined in today's markets. And ultimately, I think more investment going into accounting talent, more investment going into running firms properly, having the tech stack that you need for this to be a business that makes sense is a good thing. So with private equities goal of growth and improvement to the bottom line, the younger, more growth minded partners who have decided, let's say, to reinvest into the private equity portfolio can also have what they want in this situation. And they often actually see a greater return on the reinvested amounts if the firm is then resold as part of a larger package five to seven years later. So this increase in value that these kind of growth minded, growth minded partners who stayed on are seeing some of it's coming from, you know, cleaning up operations. So having a better gross margin, some of it would be coming from investing in growth, doing more business development activities, maybe more advertising, things like that. In the case of a lot of smaller firms, this can also be a factor of EBITDA multiple arbitrage. So in a lot of kind of private equity roll ups in Canada specifically, there's been quite a few actually, but there's a very well known one in the dental space. And part of what they were after with that can actually be boiled down to an increase in the multiple you get on EBITDA upon kind of selling or just doing a valuation of that group of companies. So if a smaller firm might be sold for, let's say, six to eight times EBITDA, a larger grouping of firms just on account of it being larger, assumed to be more steady, more interesting to kind of larger acquirers at that point, might end up selling for more like an eight to 12x multiple on EBITDA. And so that kind of helps create some value for the people who have an equity stake in this private equity play. And that can very much be the case, particularly for smaller firms being rolled up by private equity. So in itself, while I believe the ideal scenario would be having firms who are wholly owned by partners, and these partners are reinvesting in growth and technology to improve operations, that's just not really the reality that we're in, in a lot of cases. So having private equity come in and be involved is, I think, better than a world where firms continue to optimize for short-term partner distributions and let the quality of their operations continue to decline because that's not what they're prioritizing reinvesting into. So now if we flip over to the employee perspective, not all private equity firm deals are created equally, of course. In some cases, it can look a lot like a lot of people who are on the partner path having the rug pulled from under them, and they kind of feel like they got screwed in this whole thing. And that is a reality for some of these deals, and that's truly unfortunate. In other better deals, a change to the firm structure away from a traditional partnership can actually result in employee stock option plans being created. So I spoke with Tim Petri about the deal that HD Growth Partners made with Ascend and how many employees around the manager level, or even in support roles who were maybe never on a path to get equity, were actually the recipients of very meaningful equity grants in an organization that is now focused entirely on growth over, let's say, a five to seven year timeline, improving their chances of actually cashing out. So private equity firms are also, in my opinion, much more likely to be able to generate the type of deal that would create liquidity for these equity stakes being given to employees. Anecdotally, I'm also just hearing good rumblings online about the equity conversations happening at Aprio. So some of these private equity backed deals might actually be a good thing for a lot of employees. And not everyone's going to make it to partner. Not everyone even wants to be a partner. So having the door be open to equity in a firm where you don't necessarily need to be an equity partner to receive it is very interesting, in my opinion. And I think if I were starting a firm, which could be in the cards one day, I honestly think that's the approach I would take, which is starting to grant equity at the senior or maybe manager level to help staff build up equity in the firm, or give an option to convert cash bonuses into equity, and then internally reinvest that cash flow into firm growth and improvements to operations. And you can kind of create a little bit of a flywheel of a growth firm where the equity is actually a lot more interesting, motivating employees to stay, invest more of their equity, and so on. In the tech industry, for example, a lot of the wealth creation that happened for employees was through equity. And we could be entering a new era where that happens for accountants. And I don't think that's a bad thing. If that happens, I'm all for it. And accounting firms are much less of a boom or bust business than tech companies are. We may never see firms where employees are becoming multi-millionaires at 30, like we see if you were in a tech company and you joined at a Series A valuation and it then made it to IPO. But what we may see is a much higher hit rate of people actually benefiting from the equity that they have in these firms. And a lot of 30-somethings in the accounting industries could see themselves making high five-figure or six-figure outcomes from smaller returns on firms, which I think is also life-changing for a lot of people. So a little bit more on the employee perspective as well. I did a bit of a deep dive into the data in a three-newsletter series recently on the Big Four Transparency newsletter. And the high-level takeaways there are that PE-backed firms had slightly higher year-over-year increases in salary. In a year following a private equity deal, bonuses increased by 16.5% on average, with senior manager bonuses increasing 43% in the year following a deal. Now a lot of people are going to say, yeah, of course they need to reward senior managers because they've now just potentially lost the equity partner route. But again, if they're also receiving a good employee stock option package, that might actually not be entirely a bad thing. PE-backed firms self-reported on Big Four Transparency hours were about one hour per week more than non-PE-backed firms. So not a super meaningful difference. I mean, still higher hours on average, but nothing too, too crazy and nothing that at all compares to the discussions being had online where people are just saying that it's going to become just an absolute hellscape and people are going to be working all kinds of hours. So that one hour increase. And job satisfaction was slightly lower overall at the PE-backed firms, but that was really split with some firms seeing the job satisfaction pre- and post-deal be pretty steady or improve very slightly, while some other firms, I think it was Baker Tilly, for example, had a pretty sizable drop in job satisfaction. All in all, if you're at a firm that does a private equity deal and you do feel a strong decline in working conditions, then yeah, get out of there. But I'm just kind of, my opinion is that maybe you shouldn't hit the panic button as soon as a deal is announced because you might actually be part of a firm that has one of the better deals where things actually kind of work out for staff. So to wrap up my thoughts on all of this, I think some of the media's reaction is maybe a little bit overblown and lacks nuance. So is PE and accounting ideal? I would say no. But is it the end of times? I would venture to say also probably no. And some good can actually come of this in the form of helping firms move past legacy mindsets that may be holding them back. Getting some investment into technology, talent and growth might actually be a good thing for some of these firms, right? And there are some elements through a PE deal that might get pushed onto firms that I think are best practices for firms in general, right? So with the conversation that I had with Michael Hoover from Bennett Thrasher, he talks about a huge, huge strength of Bennett Thrasher being that they have outsiders on the executive team, right? So head of strategy and growth, head of marketing, odds are that the best person for that job maybe isn't the former audit partner who became a partner and then took on some sort of an executive position. It might be the person who actually like specialized in marketing and growth their whole lives and who brings perspective from other industries, best practices and brings in fresh ideas, right? And in a lot of the cases, this is what might be happening with private equity being involved into senior leadership. So yeah, that's kind of my opinion thus far. My opinion obviously continues to evolve as I have more and more conversations with people who are informed, as we see more and more things happen with firms, and of course, as Big Four Transparency database kind of grows and grows, and I can do better and better analysis on what's going on within these kind of private equity firms. But yeah, that's kind of where my thoughts are at right now. I would love to hear your opinion. Don't be shy. Definitely shoot me a message on LinkedIn or, you know, an email with your thoughts and maybe I'll do a follow up and share what kind of people had to say about this. Thank you very much. Bye.