Article - November 1, 2022
Accounting Services: The growing investment opportunity
The accounting services sector is going through a significant evolution that began with the passing of the Sarbanes-Oxley Act (SOX) in 2002 and continues today. While private equity interest in the sector is established, recent trends bode well for even greater investor involvement.
The Harris Williams Business Services Group closely watches the latest accounting and audit trends that are providing new ways for investors to create value. Senior bankers Derek Lewis and Bryce Walker see three macro themes in the accounting and audit space that are generating new opportunities for investors. Here we highlight those themes and what investors should consider as they evaluate the space.
Non-audit finance and accounting growth
SOX strengthened audit independence and created more executive accountability for financial reporting. “SOX requires auditors to be independent and prevents audit firms from providing other accounting, tax, technology, and consulting services to their audit clients,” says Lewis. “This led to the rise of non-audit accounting and finance firms that could serve these client needs, often with client referrals coming from the audit firms. There are many of these firms in the sector now that are ripe for PE investment.”
For their part, private equity investors are attracted to the accounting sector because it is a stable, profitable industry that is generally resistant to market volatility. It’s also an industry that, relative to other service industries, has been slow to adopt technology and innovative business practices.
Walker notes that proactive acquisition strategies, along with needed investments in technology and talent, are creating great demand for capital among non-audit accounting firms and opening the door for more private equity growth in the sector. “Where PE is fully involved in these firms, there’s a clear path to growth,” he says. “Many PE-backed companies are on their second or third sponsor, each pursuing loftier value creation goals.
For example, CFGI was founded in 2000 in anticipation of helping public companies brace for SOX when it was enacted. It is a highly specialized financial consulting firm, staffed by former Big Four (EY, PwC, Deloitte, and KPMG) accounting professionals, that offers accounting, interim management, restructuring, financial planning and analysis, valuation services, and more. In 2014, Flexpoint Ford invested in CFGI. Since then, the Carlyle Group and CVC Capital Partners have made additional investments.
WilliamsMarston is a national leader in complex accounting, tax, and valuation services, and has completed five acquisitions since its founding in 2014. It pairs Big Four experience and strong technical expertise to help companies navigate challenging situations. Since Align Capital Partners’ initial investment in WilliamsMarston in 2020, the firm has achieved transformational growth. Align Capital Partners sold its interest in WilliamsMarston to Kelso & Company in August 2022.
New structures opening the door for investors
The audit segment is characterized by sticky customer relationships, since once an auditor is in place, clients have little incentive to switch. While good for incumbents, this customer stickiness can challenge growth for firms pursuing a largely fixed universe of customers. This is particularly true for firms targeting the largest corporations, which are limited in number relative to the size of the middle market.
“In many firms, the audit practice is the slow-growth cash cow that funds growth in other practices of the firm,” says Walker. “Partners working within non-audit services see their service lines driving the growth of the business, while all partners are looking for attractive liquidity options. All of these dynamics contribute to a rise in creative structures happening across the industry.”
In these structures, the legal entity that does the audit work remains owned by the partners. For all other work, a new legal entity is created, structured as a corporation with officers and employees. This approach satisfies independence requirements and, importantly, offers significant private equity investment opportunity.
EisnerAmper is a recent hallmark example of this type of structure. In 2021 the firm received a significant investment from TowerBrook Capital Partners and restructured into Eisner Advisory Group, which offers business advisory and non-attest services, and EisnerAmper, which offers audit and attest services. This investment has helped EisnerAmper accelerate the evolution of its service offerings, invest in talent and technology, and expand through both organic and non-organic growth.
In October 2021 Citrin Cooperman took a similar path. New Mountain made a significant investment in the firm, which split off its non-attest side to create Citrin Cooperman Advisors LLC while the attest side became Citrin Cooperman & Co. LLP. Since receiving New Mountain’s investment, Citrin Cooperman has acquired multiple firms, including two consultancies specialized in the music and entertainment industries. As new firms are acquired, such as its July 2022 acquisition of Shepard Schwartz & Harris, they are split, with the attest portion of the acquired firm aligning to the Citrin Cooperman attest business and all other services aligning to the non-attest side.
Similar to the above examples, Big Four accounting firms have also begun to move toward separating their audit and non-audit practices, motivated by the need to ensure audit independence while not constraining the growth of non-audit services. Given the breadth and scale of these firms, such moves will certainly disrupt the industry.
Ernst & Young is leading the pack in its intention to separate its audit and consulting businesses by as early as 2023*. Lewis sees both opportunity and challenge in this separation. The transaction will free the newly formed consulting business to pursue clients previously off-limits due to independence issues. In addition, service lines with already-strong growth can accelerate that growth even further.
However, the newly created business will require significant rebranding investment. Furthermore, decisions on the details of the separation could have major ramifications, such as how to split teams that serve both the audit and consulting sides of the business. EY’s separation move is a bellwether among the Big Four, and competitors in the industry will need to determine how they will respond to, or capitalize on, this disruption.
Prime Opportunity for Private Equity
There are growing opportunities for investors to create value in the accounting sector. The number of companies offering non-audit accounting and financial services continues to grow, providing significant consolidation and platform-building opportunity. “Many of these firms need growth capital for acceleration of service line development, strategic acquisitions, technology, and talent,” says Walker. “It’s an industry where success is very dependent on high-caliber talent, and it is difficult to recruit and retain these individuals. It takes capital.”
Companies that are feeling the pressure to separate audit and non-audit services are also prime opportunities for private equity investment. The growth potential for newly separated non-audit services firms is strong, since they can pursue customers that were previously not approachable due to their firm’s audit relationship. Once separated, non-audit firms are well positioned to pursue adjacent services that provide expansion opportunity—such as in IT services. Companies can potentially bring many additional services with a similar value proposition to their accounting customer base.
“In any of these scenarios, investors should consider the potential growth and sustained profitability of the accounting assets they are considering, as well as the companies’ ability to attract and retain talent,” summarizes Walker. “Private equity interest in the accounting services sector is not new, but current market dynamics make this sector even more appealing for investment now and into the future.”
Conclusion
The business services landscape is fast-moving, dynamic, and diverse, and serves a rich variety of end markets. Our Business Services Group, led by senior professionals with extensive industry experience, partners with investors and high-growth companies worldwide to help them navigate the M&A market and unlock value in their businesses.
We have a long-standing track record of working with companies across subsectors within professional and tech-enabled services, IT services, commercial and industrial services, and specialty distribution.
Contacts
Derek Lewis
Group Head
Managing Director
Bryce Walker
Managing Director
