If not exactly at a crossroads, accounting firms today find themselves approaching an inflexion point as they contemplate the future. Will their sustainability derive from M&A activity? Is private equity a likely influence? Or will some tenacious mid-market firms continue to evolve organically to retain their independence?
As advisors, not soothsayers, our ability to predict is limited. But our capacity to analyze current circumstances, fact patterns and market conditions lets us offer a confident forecast as to the future direction of firms, and of public accounting overall.
I recently sat down with award-winning consultant Allan Koltin for a wide-ranging conversation about his vision of the future. As mid-market firm leaders analyze their status and potential, Allan sees three possible scenarios for strategic growth.
Headwinds prevail
Flux is everywhere in our profession. Firms are buffeted by the headwinds of talent, technology, and transformation. No one of these is more responsible for the upheaval than any other, and all contribute to a significant turning point in the profession.
What does this new normal look like? The push to find and retain top team members is fierce across the U.S., as firms strive to meet employee expectations and demands. As a result, in some offices the only people in the building are a couple of interns and the cleaning crew. Other firms are pivoting from compliance to specialization, consulting, and advisory services. Still others are struggling with the absence of a deep reservoir of necessary investment capital as they contemplate future growth.
Which of the three doors that Allan envisions will be right for your firm? You may not yet know, and that’s OK. What matters is to build awareness and encourage discussion as you determine the strategic future of your firm.
Door No. 1: Steady as she goes
You may never have sung a sea shanty, but if you’ve been in public accounting for any time at all you recognize the value of “Steady as she goes.” Firms that enter Door No. 1 are betting on a slow boil. They see more value in continuing to deliver quality work to loyal clients than in M&A, private equity, or other external pathways.
According to Allan, these firms embrace predictability, and they like it that way. Often led by founding partners, they don’t typically make large investments in diversity, technology, training and specialization, and they seldom hire consultants like us! They realize this may not be a long-term strategy, but if the lights go out in future years, that’s an acceptable outcome.
Door No. 2: Bring it on
Firms that seek what lies behind this door are fiercely independent, even as they acknowledge the need to transform. They are prepared to address essential priorities like the war on talent, the cost of technology and the investment in innovation with a blend of organic growth and strategic M&A.
They recognize the need to prune their client list, ridding themselves of unappreciative, low-margin accounts. They also witness firm consolidation in their locale and acknowledge that the “last firm standing” will have a market hole they can fill.
Door No. 3: PE for the win
While firms drawn to Door No. 3 aggressively seek growth, Allan explains, their partners may be unwilling to put their own assets at risk. They believe bigger is better and are less concerned with fierce independence. Their future lies in moving up-market, which often leads to private equity. It can also be a matter of removing the “unfunded chain letter” of partner retirement commitments from the table and monetizing their practice with a shorter, tax-advantaged payout.
Allan notes that in a distinct departure from the past, it’s the younger members of the firm who are unwilling to wait decades for their payout and are supporting the move to private equity.
The appeal of PE
Private equity has become a more viable option than ever before, as firms consider the short- and long-term implications of independent growth. The appeal is strong. Not long ago, the traditional CPA firm offer involved calculating a partner’s retirement benefit by doubling their current earnings and paying out that sum annually over 10 years as ordinary income.
Today, private equity investors are unlocking firm and shareholder value by offering a “foundation firm” a multiple of 10 or more times earnings while “tuck-in” firms generally receive six to eight times earnings. Provided that established performance metrics are met, payout takes place within just a few years, as the potential value of equity shares increases and becomes more attractive to other buyers.
With an increase in valuation and quicker payout come tradeoffs, of course. It’s not only the issue of independence, but a whole new organizational structure as well. The partner governance model so typical in our profession does not lend itself to quick decision-making, maximized accountability and optimal growth and profits.
In the corporate world, where PE typically operates, everyone has a boss, organizational charts are clear, and roles and responsibilities are plainly spelled out. Evaluations tied to compensation are the standard. This type of rigor is not the norm in our firms.
However, Allan points out, the door to direct PE investment may remain closed to most firms, as 80% are either too small or don’t meet the profitability threshold to qualify. But “anchor firms” funded by PE firms will come calling, with an interest in acquiring other practices, which will find themselves in a PE-driven culture.
Are you comfortable?
Ultimately, the future direction for mid-market accounting firms comes down to culture. Allan urges firms to ask questions. Is your leadership generally cautious about the future, or comfortable becoming early adopters in a fast-changing market? Are firm leaders risk-driven, or risk-averse? The higher the appetite for risk associated with continuous evolution, the greater a firm’s openness to explore, invest and innovate.
Ultimately, as Allan Koltin likes to say, change happens in CPA firms only when it is deemed a better choice than the status quo. Are you comfortable with the status quo? Or is it time for a new direction?
