The entry of private equity into public accounting has raised a lot of hopes and expectations and concerns — not all of which can pan out. Bob Lewis of the Visionary Group examines the opportunities, what it will mean for your firm, and how it will play out in the future.
Transcription:
Dan Hood (00:03):
Welcome to On the Air with Accounting Today. I’m editor-in-chief Dan Hood. Few things have roiled the waters of accounting in quite the same way as the entry of private equity money into the pool, and as with all big splashes, there’s a lot of noise and confusion, but not much clarity. Here to help give us some clarity and give us some insights into what PE is doing. And what it looks like is Bob Lewis of the Visionary Group. Bob, thanks for joining us.
Bob Lewis (00:24):
Thank you, Dan. It’ll be a ton of fun because just get off the phone in the last two days with several different private equity conversations. Yeah,
Dan Hood (00:33):
Exactly. So listen now, because everything we’re saying could change in the next 15 to 20 minutes, a, it’s a fast moving area, but we’ll try to give a picture of where it is and where it’s going. And maybe we’ll start with what are they doing here? What do the private equity firms want from accounting? What are they doing in the profession?
Bob Lewis (00:48):
Well, let’s see. First I want to spend a lot of money. Let’s start with that. Spending money is an integral part of this entire process. So my own personal opinion was I was extremely non-private equity when I first heard about the constant and they really didn’t know enough about it. Now I’m looking at this going, okay, this is a repeat and required business. So the interesting part about private equity, when you talk to these organizations, they’re buying a business that it’s mandated that the service gets done. It happens every year or with other frequency. So they’re buying into a steady stream of business, which is lucrative. The other part of this too is there’s a giant untapped client base. So in most firms, while they’re really good at what they do with accounting, tax assurance work, they really good to handle their clients’ fault. They aren’t always as great about handling the advisory side, the upside, the other additional needs the client needs. So when you look at that in addition to the repeat business and it’s fairly lucrative business, because right now, Dan, unless I’ve missed a boat here and I’m sure you can fill me in, I think accountants are making more money than they typically have ever made in their lifetime.
Dan Hood (01:58):
Ridiculous sums. Ridiculous sums of money,
Bob Lewis (02:00):
Ridiculous sums of money. Not for all firms, but for some. But it’s a good model to be in, good place, to be in a lot of money, a lot of opportunity to sell other services. And on top of that, I’m going to put a little cherry on top of the whatever the ice cream here. We’ve got a lot of aging professionals that have a staggering amount of deferred compensation, and the next wave of professionals are not sure if they want to take on that debt. So this provides a vehicle for some of these firms to find a way out. Also provide a vehicle for the younger generation to come in without being saddled with the debt. And one of the considerations I came across the other day on my own business, this was well over talking to people, is I’m a fairly entrepreneurial individual. I’ve had my own company for 27 years, debt-free, never had any debt, no profits either, but no debt. So yeah, those things are coming to mind. The thing is, when you look at this, ow, most firms, like most businesses, they run it to some degree really, really well, but they really aren’t professionally managed firms. I’m an entrepreneur who manages my own company. If somebody came in and managed my company and did it really effectively, they’d probably do a much better job and have a better company. I think the same can be said over a lot of these firms.
(03:15)
So there’s an evolution occurring and that’s a good thing.
Dan Hood (03:19):
Yeah, no, things are changing and in all kinds of interesting ways, and as you say, some of the things that PE is doing is very much an answer to problems that accounting firms are staring down the face of at one of those being that big overhang of deferred comp. But we’re going to talk about that in a little bit. For now, I want to talk about who are they looking to work with, what kind of firms. I mean, it’s pretty clear as we look around that this is not every firm that they’re looking at. Is there a typical firm that they’re thinking of?
Bob Lewis (03:46):
Okay, so again, they add a little more confusion to the marketplace. There are a lot of private equity firms calling accounting firms, many different firms, not just the accounting firms. I mean just a lot of different private equity people approaching the market. There are names coming out of the woodwork we’ve never heard of, which would be understandable. Private equity is fairly still new to this whole venture. There’re small companies, large companies, the starting point was 20 million. I know obviously the larger you can go, the better everyone wants to buy the a hundred million dollar firm. That was the first conversation out of the gate with everybody. Well, it’s a short list, Dan. I don’t have the inside public accounting list in front of me. I don’t think the a hundred million dollar firm club is very deep getting larger as firms continue to roll up.
(04:31)
So they’ve kind rolled down to like 20 and 10. Now we’re seeing some private equity firms looking at five. Now five, we’re finding it harder to do a transaction because the ebitda, which we can get into later, isn’t quite the position it needs to be is it’s more leverageable as you get larger. But the other part list too is what we’ve heard and what we’ve talked to from these private equity companies is they’re going to establish platforms first, different regions of the country. So I’m going to take your 20 million firm, Dan in the southwest. I’m going to take your 40 million firm in the northeast, pop ’em together, have different platforms, and then I’ll start tucking in smaller firms into those locations. So once I have an established platform, it’s easier to do a tuck-in. The tuck-ins probably won’t have the same value that a platform gets. And the mystery here is if this goes on for several more years, will the multiples remain the same or start to drop as market penetration occurs?
Dan Hood (05:27):
Well, I was going to say, it’s interesting because you talk about that they’ll buy that one firm or those two firms and maybe combine them. And then really the rest of the acquisitions are being done by those firms. The PE firm acquires the platform firm, and this isn’t true of all deals, but it seems like a pretty common model that they acquire the platform firm and then the platform firm uses the money, uses their money to go out and acquire other firms, which is just say that’s going to lead to a different kind of deal.
Bob Lewis (05:53):
So the PE firms themselves are not actually running the accounting firm, which is also one. The myths you need to break here is they think they’re going to come in and tell me how to treat a tax item or how to do an audit. They have absolutely no desire to do that. The leadership team in place is going to be the one doing that. And the tuck-ins that are going to, they could come through the private equity entity or they could come through the C P A firm, but it will be the private equity company to my knowledge, who will be funding those tuck-ins as well. And then there’ll a whole issue of ownership, which I’m sure is going to be one of your questions coming up. How much do we bite but far away
Dan Hood (06:29):
We don’t. We need to set aside two or three days to efficiently do this when we’ve only got about 25 minutes. So we’re going to have to do some of these things. We could talk about all those different things in a lot more detail. But I want to ask a wildly unfair question. Given our time, is there a typical PE deal? Is there a typical sort of structure for it? What does it look like?
Bob Lewis (06:49):
Okay, so I can answer the percentage and the deal structure all in one shot here.
Dan Hood (06:53):
Alright.
Bob Lewis (06:54):
Okay. So most firms are looking for anywhere from 51 and some are a hundred percent ownership. I want to buy a hundred percent of your firm or Dan, I may be looking to buy 60% of your practice. So what happens is we come up to an established value and I can kind of hit how we get to that value from what our experience has been so far and what the firm is worth overall. And it’s a question from buying a hundred percent of your firm or 60%. Another emerging market, which we’re seeing and I haven’t seen a lot of yet, is more of a smaller bite, like 30%,
(07:26)
But the private equity people are really looking to have controlling interests. That’s why the 51% on up is kind of a better play. But the structure seems to be very simple. We work basics of ebitda. So let’s just take a $10 million firm for easy math, 35% profitability before any equity partner compensation. So I’m making 3.5 million on that particular firm. Then you have to look at add backs. Like say they’re paying out some retard partner fund or something else that may make the EBITDA go up. Then you have to take the EBITDA back down to go, okay, what else do we need to continue to invest in a firm or ongoing partner comp? What would that be reduced to? So let’s just say for argument’s sake, I’m going to take the 3.5 on the 10 million at a 35%. I’m going to leave that at 3.5 million. I’m going to take 1.5 million for ongoing partner comp needed equity partner comp going for it. So I’ve got a $2 million revised ebitda, very, very loose numbers I’m shooting out. So everyone just don’t sit there and go, oh, these aren’t the right numbers. I’m shooting very loose numbers,
Dan Hood (08:29):
Lots of fingers on lots of calculators right now going, oh no, that’s, no, that’s not right. So
Bob Lewis (08:35):
I’m going to take the $2 million in revised EBITDA, which is probably not the exact term everyone uses, but it’s the one we’re going to use for this conversation.
(08:42)
And I’m going to put a multiple on that. The multiple could be six, it could be seven, it could be eight. Let’s be clear. I’m not putting the multiple on it. The private equity company’s putting a multiple on it. So let’s just go with seven for argument’s sake. They’re take the two times a seven. Now I’ve established a $14 million value for that $10 million firm. If we look at it the old school way, that’s 1.4 times revenue. They’re paying 1.4 times revenue. If they put an eight times multiple, that’s going to be 16 million or 1.6 million, 1.6 times multiple revenue, which is very different than they can get in a traditional deal. So the other part is I’m going to take that multiple. Now let’s go crazy. We’re going to make that at 14 million. We’re going to leave the value of the firm at 14 million for this argument.
(09:26)
I’m going to take a hundred percent, I’m going to buy a hundred percent in this particular bite, so I’m going to pay them $14 million for that firm. I’m likely going to give them half of that money upfront cash, the other half over a period of anywhere from three to four years depending on how everyone negotiates their transaction that I’m also going to have in there’re a lowered comp and part of that transaction may be a percentage of ownership, a small percentage of ownership in the actual private equity company. That’s one option. The other option is I’m going to take and buy that 14 million firm. I’m going to take 60% of it. So I’m going to take roughly seven and a half million dollars, put that into the formula I’m going to buy. So I’ll give them half of the seven and a half million in cash. The other spread over three to four years plus a lower partner comp, but they still own 40% of distributions and 40% of the firm. That’s a typical structure. The question becomes what’s the quality of the firm location has to do with it type of clients staffing, so many variables that impact the multiple decision. And that’s where everyone is a little confused, hanging multiples, I can get 10 times multiple, maybe you could and yet to ever see that anymore. But then you have to look at 10 times multiple of what EBITDA.
(10:37)
So if the EBITDA is low, and I could give you 50 times multiple of a really low EBITDA Dan and you could be worse than six times. So again, would you like to know what could make a difference in getting a high EBITDA versus a high multiple? So let’s look at it this way. There are some organizations out there that we’ve learned charge a preferred dividend. So if I’m going to give you 10 million in cash or say I’m going to do a value of 10 million on the acquisition, okay, I’m going to charge a preferred dividend of maybe four to five to six to 7% of that 10 million every year. Okay? So that’s going to come off the top of profitability before there’s any split. Second thing is I may put a management fee in place. So we’ve seen management fees a couple hundred thousand dollars.
(11:28)
So if I’ve got that and a per dividend in place, all of that’s coming out. So I could give you a much higher multiple, but the end result is going to be lowered because they’ve got all these other costs coming out the backend. So you have to look at the numbers, the numbers. It’s a little bit of a tricky equation right now on how this thing works. But once you get all the numbers kind of in line, go through all the add-backs, all clawbacks that would be needed to required to run the firm and come down to really looking at the quality of that EBITDA, then you have to look at what the multiple is. And there is some negotiation that’s involved here, but the reality is I don’t know what the border’s going to be. I don’t know how much somebody’s going to pay, but when I do hear stories all across the board about high multiples and the numbers often have a backstory that don’t always hit the street, and this has been pretty much closely held to the vest from people on actually the details of these transactions. But then we get back to that percentage of equity, big factor in this equation. How much risk do I want to give, do want to give? I have ’em sell all of it and they get no second bite of that Apple. Did we hit the second bite of the apple yet? Dan? Can we
Dan Hood (12:34):
Talk? No, we’re going to talk about that because we’re going to spend the second half of our little conversation here and I think a little bit more detail on all kinds of things around partner comp and what kind of money an accounting firm partner might be or a potential partner. A big part of the private equity money coming in is the option to give younger, high potential staff a little bit more money upfront. So we’re going to talk about that in more detail. But I’d still like to stick with the deal structure a little bit because laid out a lot of the details about, call it the financial aspects of the deal, but you mentioned the concerns about control and we spoken to all the firms that have done PE deals, but we’ve spoken to a number of them and they all seem very comfortable about the control they have, the levels of control that they’ve maintained, and these are firms that have often sold significant way more than 50% of their firms, but they’re all super confident about control and particularly what happens in whatever the five to seven years when the ownership window for the PE firm or whatever their version of it is, and they start to look to sell out, they’re particularly comfortable with who it’s going to get sold to because that’s got to be an issue.
(13:42)
I mean, at this point, you could be selling it to sovereign wealth funds, you could be selling it to Hamas, you could be selling it to, who knows if the private equity firm can sell it to whoever they want. But firms seem to be comfortable about that and about their general levels of control. How do you maintain that in a deal?
Bob Lewis (13:57):
Well, there’s two types of control. It’s the comfort level of what I’m going to maybe be sold into at a later date. That’s one. But the other is right now the control of actually the operations. So they’re not coming in and saying, you need to change your tax software, all your processes. They don’t really want to do that. Now, eventually if they get four firms want to unify them under one probably. But for right now, no. And if I’m a larger firm that’s already done private equity and then buying acquisitions, yeah, I’m going to make ’em change the names and software, everything along that line, we looked
Dan Hood (14:26):
At that, which you would do in a regular standard accounting firm
Bob Lewis (14:30):
Acquisition
Dan Hood (14:31):
Anyways, right?
Bob Lewis (14:32):
Exactly right. If I merge an A, B, C into X, Y, Z, it’s going to become X y Z’s name, all their systems, all their processes. So that really isn’t that much different. I would call it more the discomfort, more than the comfort. The wild card here is I don’t know where I’m going to solve my practice. So the private equity company could literally buy you tomorrow, sell you the week after if they had the opportunity because it’s
(14:56)
An asset in play. I hate to say that, but it’s an asset in play. And the reason you made that sale in the first place is to diversify your risk, shift risk to the private equity company. I don’t want to use the word cash out. You’re not really always cashing out. You’re just shifting risk and changing how your compensation works. But I think that’s the biggest mystery still is how much is this thing actually worth when we sell it and who do we sell it to? But you know what, it’s no different. So let’s go one step further. Let’s assume I merge my company into A, B, C right now, bigger firm, and three years later, a, B, C merges himself into X, Y, z. I still have no control over where I’m going to end up at X, Y, z anyway. And the reality is, what I don’t know yet is, and I probably never will, to be perfectly blunt. So when a large firm is going to sell to another entity, and is it going to be another private equity company? Is it going to be a foreign accounting firm that wants to buy us presence? Would that be even legally allowed? That one, I hate to say, is above my judgment zone. Legally, I operate on the thin edge of my legal expertise. Gotcha.
Dan Hood (16:08):
This is not the improper exercise of law. No one’s a lawyer here. But it’s interesting because you talk about that the potential to being sold to just about anything is opening up much more than it ever has in the past. I mean, wealth management firms are buying accounting firms and private equity firms. And you start to say, well, the one thing we could be sure of is that the potential audience for people who might want to buy an accounting firm is bigger than we ever thought it could be.
Bob Lewis (16:35):
Yes, it is. And the wealth management is another large arm. We’re getting more inquiries from RAAs about buying firms. And the reason they why buy ’em isn’t so much for the cross-sell that’s secondary. So they can bring integrated tax and accounting right into their client base trying to put it in so that they’re high net worth clients they already have in place are serviced properly. And it does make a lot of sense when you look at it, the cross-selling, that’s a plus and just a bonus, it’s a factor. But that’s not seems to be the core factor on why they’re doing that, by the way. The trend is it’s all about customer service on the r a side.
Dan Hood (17:11):
Interesting. Alright. All right. Good to
Bob Lewis (17:12):
Know.
Dan Hood (17:14):
We should have a whole other conversation about that, about that, that there are unique things like that about that whole area. But what I want to talk about in more detail is cashing out. I think we all want to cash out. No, I’m kidding. But it’s an important aspect of this and it’s going to require a great deal of time. So we’re going to take a brief break beforehand to recruit ourselves and then we’ll come back and dive into comp.
Bob Lewis (17:38):
I’ll hit the a m.
Dan Hood (17:44):
Alright, and we’re back with Bob Lewis of Visionary Group. Bob, we talked about cashing out, we talked about, you mentioned cashing out and saying let’s not call it cashing out. It may not always look that way. And you had briefly mentioned one thing that you talked about was they’re buying their stake in this and what that’s going to mean for some partners comp is that in many ways it may change significantly from one year to the next. And then we would just talk about how does partner comp, or how should a firm that’s acquired by a PE firm expect its partner comp to change?
Bob Lewis (18:12):
Well, it is really cashflow. So when you get down to it, it’s no different than when a merger firm up into another firm or sell a firm into another firm. You don’t continue to have partnership comp and get the sale price. It just doesn’t work. So the private equity group is going to negotiate what they think is a fair price for the partner to be vested enough to still want to continue to work. So let’s assume I’m making $600,000 a year as one of the equity partners, and I realize that’s widely, that number’s all across the board for people. Some people are like, who would work for $600,000 a year? Others are like, I make a third of that right now. So
Dan Hood (18:49):
Not getting out of bed for less than a million a year.
Bob Lewis (18:51):
Yeah, I know Dan, you’ve got a high lifestyle. You’re definitely in the million dollar plus.
Dan Hood (18:55):
I got a lot of bills. I got a lot of bills.
Bob Lewis (18:57):
So look, the equity partners are going to be receiving the bulk of the distribution of the cash. They’re going to see their comp probably cut at least in half. And again, that’s a wide number. So 600, I’m making 600, I’m probably going to go forward making three. But what some of the partners are like, were saying, well, why would I want to make 300,000 a year when I can make six? Well, I just gave you 5 million in cash, and when you add the cash in and then the future cash in, you’re actually making probably four to five times that amount in the first year and probably at least two times plus for the next four to five years. And the question becomes, do I still own part of the firm or not in that equation based on how much of I sold? So it works really well. The argument has been there’ll be nothing left for the younger partners.
(19:42)
So let’s demystify this one right now. First of all, the smarter private equity firms are coming in with programs for ownership stripes for the younger potential partners. So they’re carving out some of that funding to be able to allocate that down to make an incentive for, I won’t say for me because I’m, I wouldn’t be younger partner, but let’s put me back 30 years, a younger partner potential who would get paid. What I think is going to happen too is the equity partners who receive the cash and had their income go from, in this example 600 to 300 I is the younger emerging or newer equity partner that comes in, I guess it’s not equity partner, it’s a different name now, but because of the ownership. But as a new partner that comes in, I may make 400
Dan Hood (20:25):
Where
Bob Lewis (20:25):
The mature cashed out equity partner only makes three because they’re making all their money on the investments and all the backend and the rest of it. So I may get paid more and I think that’s the methodology just going to work because the PE company can’t open up and put all this money into an investment and then not have people there that can run it. So the vested interest for the ones that are being purchased and bought out early is you’re going to this string of cash that’s going to come over time upfront and over time and whatever ownership on a second bite that would occur, but the younger professionals are going to be able to make more money. They’re going to be incentivized to have to run this place. There has to be a reason to run it. So there’ll be some ownership, but I think it’s going to be driven.
Dan Hood (21:02):
Gotcha. And it’s probably worth two things worth. One, you made this point that private equity firms, they have interests. I think for a lot of accounting firms, they tend to think of when they do these deals, do any kind of deal, whether it’s a regular m and a or something more like this. They tend to think of their own, who’s going to buy me out or who’s going to pay me for my stake or who’s going to do this and forgetting that the other side has interests, they’ve got things they’ve got to do so that it’s important to remember that they’re not here just to fund your retirement. They’re here for their own purposes, which means the firm’s got to make money, it’s got to have a bench of upcoming partners, however we want to describe them, upcoming leaders and the firm’s got to keep money. You can’t just take your money and run kind of thing. So it’s always worth reminding accounts in this kind of thing that, yeah, the deal isn’t about you getting out, it’s about you getting out and them getting something valuable from it
Bob Lewis (21:52):
And your younger professionals are just vital. They’re really not a really good transaction. If there’s no younger professionals incentivized to take over, it just won’t work. The interesting thing too, Dan, if you want to flip this thing, I was really curious on why the private equity companies are willing to give me 10 million in cash or whatever the number is.
(22:10)
And it started to do the math thinking, okay, the math looks too one-sided for the accounting firm. These deals have been very lucrative. They’ve been pushed out on the table and there’s a whole thing in emotional thing of do I give up ownership and whatever I’m selling out? And PE is horrible. PE has horrible companies in it, just like there’s horrible accounting firms and there’s horrible new employees that you hire, all kinds of things that can occur. So you just have to sort out and find the right PE partner that makes sense and see if this whole application works the right way for you. And for some firms it’s not a fit, but I started to look at the money side going, what are they getting out of it? So let’s assume this flat lines, it doesn’t work out okay. They’re still getting a percentage of return on their cash because they’re taking that 50 60% ownership distribution piece every year, so they’re still getting a return to cash. It’s not the return they probably want and they’re really banking on the fact that this firm will grow so we can grow the EBITDA and then sell it at a higher pitch. They’re going to probably be covered no matter what. Just a question of whether it’s an okay investment or a great investment for them,
Dan Hood (23:13):
Right? Yeah. These are low risk for them because they’re used to having, say they’ve got dogs in their portfolios, they expect to have some firms that are not firms, some businesses that they invest in that’ll go south, that won’t pay off at all. So a risk where you’re like, well, they could grow really well or they could just pay me a comfortable dividend for five years until I can get out. It makes accountants, accounting firms seem like a good risk.
Bob Lewis (23:35):
Yeah, I am looking for flaws in the model. The flaw in the model is it’s not right for me. I want to retain a hundred percent control and ownership. That’s okay. That’s a decision. We actually have a firm that was looking very hard at private equity. They’re a sizable firm. They had an offer, it was a good offer, and they opted to go a more traditional route. They said, look, we want to retain it for now. We want to retain a traditional route. We think this makes sense and they’re looking at alternatives in the market, but not private equity and alternatives. So it’s not right for everybody, but for those it is. It’s a great option. Great option to look at.
Dan Hood (24:15):
Right. Well, and this is the other thing. It’s not going to be available for everybody. I mean, I can’t imagine that there is an appetite in private equity for all the accounting firms that might potentially want to be bought by private equity, but I could be wrong about that. What’s your take on that? Is there enough money in private equity to soak up all the firms that would like to be bought?
Bob Lewis (24:32):
Look, it is going to be, to me, it looks like a sliding slope. I’ve got the mountain top I put in place and then I start picking up smaller firms that lower multiples as I keep going through. The reality that I have trouble reconciling is I’ve heard a few private equity deals that are being done where the i’ll use of the platform firm is a five or 6 million firm, and if it’s got assurance in there, I need an alternative practice structure. If you’re buying a five or 6 million all tax and accounting firm, well, Dan, I know you’re probably a great accountant just like I am anymore, but you and I could both own an accounting and tax firm. No problem. We could have our psychology degrees or whatever degree we got
Dan Hood (25:13):
Degrees who has a degree.
Bob Lewis (25:15):
I wast if you get a psychology degree, I got already business degree, but any event, I could still own that firm. I cannot own accounting practice that does assurance work. So it’s possible that some of these other firms could be acquired and tucked away. The other part too is I’m really curious on when they’re going to start doing, I use the word some of these private equity firms have insurance businesses and wealth management and all the things they want to bring into the table, and I think that’s where it really starts to juice it up on the backend for the private equity companies when they’re able to utilize their other assets and bring ’em into the accounting firm space. But I think that’s chapter seven that will be coming out chapter one,
Dan Hood (25:52):
Right? So many chapters. There is a lot to talk about and we’re not quite running out of time yet, but I do want to make sure that we cover this because there’s a phrase you hear a lot talked about in all these deals and that’s getting a second bite at the apple, and you alluded to it earlier and I was hoping we could spend a little time to explain what that is. You hear about it a lot and I don’t think people are always clear about the definition of it.
Bob Lewis (26:14):
Well, for clarity that it’s not Apple computer systems or the actual piece of fruit, the second bite, the apple is really simple. So let’s go with the example. I sell a hundred percent of my firm. There really is no second bite to that apple. The second bite, the apple could be if I have a small percentage ownership and the private equity company, I get whatever the growth is in that. If I sell 60% of my firm, I retain 40%, right? So Dan, I’ve sold you the 60%, you’re the private equity guy coming in. So as this continues to grow, when you go to take it to market now for
(26:48)
The next round, I’m still going to participate with whatever 40% of that sale is going to be. That’s my second buy. So if I take the firm and let’s say the firm’s worth, I liked it. We use 10 million. It’s just so easy to use math, come at $10 million firm right now and we sell it and I still own 40% and now we’re 20. The valuation of 20 now I’ve got 40% of that 20, so I’m going to get a huge second injection of cash. If that thing starts to roll, that’s where that second bite, will it be a third bite I would guess yes, because what may happen is let’s say we’re holding it for five years, we sell it and maybe instead of me owning 40%, now I stole only 20, so maybe I sold a part of that as part of the transaction deal. Who knows how those terms are going to be, but there could be a third part of the apple, I don’t know. And that brings us to the real question, Dan, is how many licks does it take to get to the center of a Tootsie roll pop? I think that was three.
Dan Hood (27:37):
So three, if you’re a crunching owl, that stupid owl — sorry, old commercials; for people who don’t remember those commercials, look it up on YouTube,
Bob Lewis (27:46):
Right? I mean that’s really the second bite. That is what you need. Get on the second round when this thing goes through if you still have ownership. That’s why firms free on how much do I sell.
Dan Hood (27:54):
And there’s also a potential option there, particularly I think they talk about in terms of younger partners or proto partners that we’ve been talking about. If they get an ownership stake, they get that bite of the apple potentially in five years. And then again, as you say, potentially in another five or seven years or whatever, the new rhythm of sales becomes.
Bob Lewis (28:12):
If I’m running a compliance focused c p a firm right now and somebody buys my practice and it starts to become more advisory focused and more profitable and different avenues, not as dependent on accountants, that second bite of the apple could be massive because we could see profitability rise a lot. I think we’re the really successful firms that I look at that we work with really we put some really smart people way smarter than I am. I will admit that right up now. So
Dan Hood (28:39):
Don’t tell them
Bob Lewis (28:40):
That to take their compliance firms and make them compliance and advisory and they’re making so much more money, and that’s what I think is going to happen as this thing continues to evolve with or without pe, I think these firms are going to start to move this way. The difference with the PE is there’ll be more cash to make those investments to do the things they need to do. Again, it’s a comfort level of whether I’m willing to sell it or not and how comfortable I’m dealing with you if you’re going to be my partner. And I think that’s where the biggest trick is finding the right comfort level and then getting me over that hump of, look, I’m not really selling out. I’m really looking at the future of my firm with a different set of eyes and I’m not going to own a hundred percent of it like I used to.
Dan Hood (29:20):
And you’re converting your ownership stake into something closer to, I don’t call it stock, not really what it is, but it, it’s a much more flexible and fungible investment if you will. You can sell it again and again and again or buy it back. I mean, in theory, you could buy yourself back from your PE partner.
Bob Lewis (29:40):
You could, and we saw that happen many years ago with a very large entity, but that was just an experiment that kind of went bad. I don’t think that’s going to happen again. The other part too, when you look at this, I talked about hit walls. When you get to a certain point, you can only grow a practice so big and maybe exceeds my leadership skills because I’m really good at what I do, but I’m really not. I do believe there’s a sense of professional management that gets brought in with the private equity, which can help some of these firms get past the internal growth issue of both. I was really the person to get us to this point, but we’ve now started to expand either my bandwidth or either my interest to want to be able to do that. And there’s this skillset involved and just like these private equity people don’t have the skillset to deal with some of the things these accountants deal with. It’s different disciplines,
Dan Hood (30:23):
Right? Well, and different set of accountability. It is very different to be accountable to a group of partners who are all peers and all in the same firm and we’re all together and we sit in the office and to be then accountable to a PE firm that sits somewhere else and that has handed you $15 million and is like now we expect some things from you. It’s a different level of accountability might spur some firms right now. So far it seems like the firms that are getting into are into this are the firms that are sort of proactive anyways. As you say, they’re turning their compliance practices into advisory practices, that kind of thing. But for other firms, for firms that are maybe still struggling to make some of those management changes, this could be the kind of spur, the outside spur that makes it happen.
Bob Lewis (31:03):
Yeah, I agree. And by the way, I made the comment earlier about large unfunded deferred comp programs. That’s a driver, but that’s not the only reason why people are doing this. There’s firms that don’t have that problem doing this. So yeah, it’s really the driver pushed me to a different level. Look, this whole industry is hitting what we call a stage of evolution here, and there’s an inflection point that’s coming up inside all these firms. Can I pull off the succession? Do I look to be acquired who are bringing outside investment? Do I look to be the acquirer? All these things are on the table right now and each firm’s going to follow a different path. Some of the paths are going to be closed to them. I can’t pull off an internal succession that closes that door immediately, so now I’m going to be forced into different options. And I think that’s where a lot of firms are looking at now what to do because of the age issue, because of, unfortunately because of the labor issue, their firm’s still fighting outsourcing, which I can’t understand why they’re outsourcing. They’re fighting it mostly because they did it wrong in the first place and it doesn’t work
Dan Hood (31:58):
10 years ago. Yeah,
Bob Lewis (31:59):
You’ve got to get past that. It’s like hiring a bad employee. You’re going to hire a bad employee. That doesn’t mean you never hire another employee again. You just correct the process.
Dan Hood (32:07):
I turning it all to artificial intelligence now, so I never have to have any employees. But I take your point. It is a fascinating thing. As accounting firms face both those huge issues you just mentioned, the succession issue and the staffing issue, one of the neat things about PE and a bunch of other developments is that they suddenly have a lot more tools in place to deal with these things, right? Five years ago, we didn’t have private equity to help with the unfunded overhanging. We didn’t have private equity to help turbocharge. And I think that’s your point is that some firms don’t have that problem at all, but what they like about PE is it gives them money to pursue an aggressive growth strategy that maybe they couldn’t before because they didn’t have the capital to buy up a bunch of firms or something like that.
Bob Lewis (32:48):
Do you know how stereotypes exist too, Dan? I’ve
Dan Hood (32:51):
Heard that
Bob Lewis (32:53):
Everybody goes to the negative, like the m and a deals, all those m a deals don’t work because three of a hundred blew up, but the other 97 were, okay, we’re in this market right now where the PE companies are horrible because I know a company that got bought by PE and it was just a horrible, horrible outcome. I got a client that did it, it will happen. You just got to vet it, right? But my understanding is private equity companies have been around for at least more than six months. They around for a really long time, right?
Dan Hood (33:24):
Yeah.
Bob Lewis (33:25):
It’s just entering in a market with a little bit of change in the dynamics there and it’s discomfort zone for a lot of people is you’re getting more comfortable. They’re looking at these deals differently and what’s interesting is it’s shaking up the traditional deal path. That’s where it’s interesting because if I’ve got a 15, 20 million firm now, the old path of me merging upward may not be the path I want to select. If I’ve been look at my private equity option and I think there’s going to be more deal structures coming out that are going to be very creative, talking to some firms that have very creative ideas on how to address both the private equity and a traditional enrolling it into one big sandwich.
Dan Hood (34:00):
Yeah, there’s so much change going on. We don’t have enough time unfortunately, to cover all of it or honestly any more of it, but I think that that notion that firms need to be thinking about their deal and deals will change. You mentioned private equity firms are all different. Firms are all different. There’s going to be a lot more private equity firms coming in and there’ll be a varying quality justice accounting firms are varying quality. Some of the late comers among private equity may well be not quite the ideal partners the firms look like. So as you say, really important to look at the deal, really important to look at your partner. Really important to make sure that both of those are right for you.
Bob Lewis (34:33):
I’m waiting for the PE company that comes in and snaps up the other four PE companies that bought kind of like that new movie, the Meg or the Meg.
Dan Hood (34:41):
I was just going to say like the big shark, eating the small shark, eating the
Bob Lewis (34:44):
Small shark.
Dan Hood (34:44):
You can’t see. I see our hand gestures, but go out on the internet and look for that. The poster for the Megan, you’ll see what we’re talking about. But yeah, and that’s potential down the line. That could absolutely happen. Very cool. Alright, as I said, we could talk a lot more about this and we probably will, but not unfortunately not on this episode. We’ve covered a lot of ground though, and I want to thank Bob Lewis, those Visionary group. Thank you so much. Great stuff as always.
Bob Lewis (35:08):
Appreciate the time, Dan, and it’s always fun talking to you. And remember three licks to get to the center of that twisty roll. Exactly. That’s the outcome of today’s session
Dan Hood (35:15):
And it’s somewhere online, you should watch it. It’s a great commercial. But again, thank you Bob, and thank you all for listening.
Bob Lewis (35:23):
Thanks, Dan.
Dan Hood (35:24):
This episode of On the Air was produced by Accounting Today with audio production by Kellie Malone. Ready to review us on your favorite podcast platform and see the rest of our content on accounting today.com. Thanks again to our guest and thank you for listening.
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