EY’s attempt to split its audit and consulting business sent shockwaves through the top tier of the accounting profession.
The break-up, eventually abandoned last year after infighting among EY’s top ranks, challenged the prevailing partnership model in which professional services firms are owned and run by their senior practitioners without external investors.
Below the top echelon of global accounting players, business models are already being transformed in a wave of consolidation fuelled by private equity groups.
Buyout investors are betting they can profit by rolling up small partnerships into bigger groups, investing in technology and using their scale to attract bigger clients that have traditionally turned only to the Big Four accounting firms — Deloitte, EY, KPMG and PwC — or the very largest mid-tier players.
Supporters of the wave of private equity interest say it provides capital to smaller firms to fuel growth that would not be possible under the traditional partnership model.
“There comes a point where partners don’t want to take further risk with their own capital,” said Timothy Mahapatra, a former Big Four partner who is now head of deals at Cooper Parry, a UK accounting firm backed by Netherlands-based private equity house Waterland. “In some cases, growth opportunities require capital in excess of what partners themselves can actually fund.”
Private equity involvement in the UK accounting sector is less extensive than is the case in the US, where domestic accounting firms are larger, but interest has been gathering pace. While the Big Four and the largest mid-tier firms such as BDO and Grant Thornton have remained independent, the long tail of smaller tax, accountancy and advisory businesses are being targeted.
Cooper Parry received investment from Waterland in 2022 and used the funds to go on an acquisition spree including the purchase of the 11 London offices of top 20 firm Haines Watts. In July, Waterland also invested in Moore Kingston Smith, another top 20 UK accounting and advisory firm.
Private equity investor Hg has used accounting and advisory group Azets to roll up more than 90 firms in six years, saying it now has annual revenues of “about £700mn”. PAI Partners, another buyout group, bought part of Hg’s stake in July.
Warburg Pincus and Permira own Evelyn Partners, formed by the 2020 merger of wealth manager Tilney and financial and professional services firm Smith & Williamson. It reported revenues of £600mn in its most recent financial year.
Part of investors’ rationale is that by combining forces, the smaller and regional firms that often work for small and medium-sized enterprises can win mandates from bigger clients that were previously out of reach.
“Over the last 10 years, the Big Four, Grant Thornton, BDO and RSM have effectively been growing the size of clients they wish to serve, so deserting the lower mid-market and the mid-market,” said Mahapatra.
Some of the top firms’ smaller audit clients have been “effectively jettisoned”, creating “an opportunity for the next wave of players, who probably prior to this change were highly fragmented small firms in very local areas.”
Winning work from the larger clients requires smaller or regional firms to bulk up and extend their geographic reach.
The change is also being driven partly by accounting firms’ need to invest in technology to make their systems more user-friendly for clients and to make rudimentary tasks more efficient.
Proponents of the partnership model say that the benefits include being able to manage the business for the long term because they are not answerable to external investors or stock market analysts.
But most accounting firms pay out the bulk of their profits to the partners each year, making it hard to get agreement for big technology investments. These reduce partners’ pay in the short term, a particular disincentive for the older among them who will retire before reaping any long-term benefit of the investments.
“Partnerships typically are structured on cash drawings in the moment so they tend to optimise for 12 months — cash conversion and withdrawal — whereas most industries have optimised for enterprise value over the long term,” said Caroline Plumb, chief executive at Gravita, a private equity-backed accounting firm.
As well as improving the service clients receive, better technology could improve efficiency and reduce data security risks, said Plumb, pointing to the fact that many accounting firms have systems containing banking information but much weaker security than banks.
Mike Reynolds at private equity group Tenzing, which has invested in Gravita and its UK peer DJH Mitten Clarke, said the case for backing tax and accounting firms was similar to the rationale for involvement in areas such as payroll and compliance services. These also sold directly to companies’ finance functions, he said, and had “high recurring revenue” because they were “reasonably mission-critical”.
Improving technology could allow firms to win more work, he added.
But expanding rapidly carries risks, particularly in an industry where attracting and retaining good staff and partners is crucial. “Some consolidators have tried to go too big too fast,” said Reynolds.
While he believes there is a strong investment case, Reynolds acknowledged that not every investor will win. “What typically happens is you see that there’s a large number of players . . . and then it narrows down probably, to four to five winners.”
Andrew Jeffs, a partner at Cavendish who advises on UK accounting firm mergers, said the question for investors would be about how they could achieve an exit.
“Trade buyers are few and far between,” he said. “So it looks like investors are banking on another round of consolidation led by bigger funds.”
