The Potential Problems of PE-Backed Public Accounting
Cherry Bekaert, Citrin Cooperman, EisnerAmper, and now Grant Thornton have accepted investments from private equity firms and the professional world is on the edge of its seat wondering how this will change everything. While no one can predict the future, many public accountants are seeing the growing investment and acquisition activity in recent years in a negative light. Like anything we discuss here, the true answer will involve the words “it depends” and “context matters.” Since these investments are relatively new, we can only speculate as to what impacts these investments will have on the public account profession as a whole, and that’s exactly what we are doing today! Let’s jump into the potential problems that can arise from the new trend of PE firms making investments in public accounting firms!
Why Are These Investments Happening?
Money. Like most things related to private equity, the answer is money. PE firms exist to make investments and obtain a return on that investment in some way. While this has always been the case with PE firms, only recently has public accounting become an especially interesting target for capital investments. Over the last decade, the public accounting model has seen multiple shake-ups in the form of automation, offshoring, and rapid acquisitions. These challenges are best explored and challenged with the support of capital. In a traditional accounting firm, this capital would come from the partners who would forgo some of their own distributions in order to support the continued growth of the firm. But it’s likely that these partners don’t have enough willpower or capital (or both) to meet these challenges on their own, so the PE firms are able to come in and save the day with tons and tons of money. It’s a win-win for the partners and the PE firms: the partners get a payday for some or all of their partnership interest, and the PE firms buy their way into a promising new market. There’s certainly a lot more nuance to these issues and how they weigh into every PE investment, but this should provide a background as to why all of this is happening now.
What Could Possibly Go Wrong?
Private equity investors love to discuss the potential for growth in the markets they are investing in, and there is plenty of potential for the profession with the newest advances in technology. However, the intersection of PE and PA does present some interesting issues that are unique compared to other markets.
Career Progression & the Public Accounting Model - Although becoming a partner is not for everyone, the partnership model of public accounting firms has been the backbone of the industry for as long as I can remember. The idea of working so much unpaid overtime in your earlier years so that you may become the top dog making the big bucks has been the driver of how firms operate for many years. The “carrot” of becoming a partner is what keeps some of the brightest professionals in public accounting firms. But those professionals will soon leave for another firm if they realize that there is no future for them at their current firm. How will private equity play a role in this model? Many are speculating that with the introduction of PE funds into the firms, the possibility of making partner and the partner compensation amounts will decrease in order for the PE firm to get the return on their investment. If the new PE structures don’t properly incentivize younger professionals, there won’t be enough reason for them to stay and keep the leveraged model working as originally intended. The silver lining here is that maybe the PE funds will kick off some long overdue changes to the public accounting business model. We can only hope that they result in an overall positive change for the working professionals that are the lifeblood of these firms.
Independence & Access to Information - The concept of auditor independence is core to the profession of accounting as a whole. Although it may not feel like it at times, accountants are the capital market gatekeepers according to the AICPA, serving as a trusted expert that conducts audits and other assurance engagements while reporting on financial and nonfinancial information of both public and private companies. When PE backing is introduced into the mix, independence becomes a lot more complicated. Large firms have systems in place to monitor every employee and partners investment portfolios to prevent insider trading, but how will those systems change when a huge investment firm that potentially has decision making power at the public accounting firm and/or another portfolio company is involved? Speaking of access to insider information, what’s going to happen when the private equity firm starts looking through the workpapers of its public accounting firm that happens to audit a key player in a new industry the PE firm is interested in investing in? These are questions that we will undoubtedly encounter over the coming years and right now it feels like the firms may outpace the regulators with this new practice structure.
Costs & Quality - Private equity firms are famous for cutting costs to make organizations “lean” in an effort to boost the return on investment. The public accounting industry is in a weird spot right now where the firms need money to invest in new technologies, retain relevant talent, and ensure partner pensions are funded all at the same time. These competing needs have forced firms to be creative with their budgets to balance all the objectives. Two of the biggest ways that firms are trying to save money are automation (artificial intelligence) and outsourcing work to countries that can perform certain tasks for a fraction of the cost. While these money saving strategies have been working in recent years, they come at the cost of quality of the work product. When that work product is a financial statement audit that should be completed in the interest of the investing public, there becomes a clear conflict of interest between firm cost and audit quality. While this has always been the case, I suspect it will become a bigger issue when PE firms start cost-cutting measures more aggressively.
Where Do We Go From Here?
As a financial professional, it’s in your interest to understand how these business models work so you can make informed decisions about where to take your career next. A shift of work culture of firms that have been funded by mergers, acquisitions, and private equity deals has already started, and I don’t see it slowing down anytime soon. That means that you need to watch out for these dynamics in the industry and make your next career move with these shifts in mind. You may be in a position to capitalize on these changes, or you may need to rethink your future at your firm. We can only hope that these changes will benefit the working professionals as much as it does the partners and the private equity firms, but only time will tell!