The New Era of Private Equity Investment

Today, our guest is Allan Koltin. Allan honestly doesn’t really need to be introduced in my mind, but I am going to highlight some of his achievements and recognitions, and just what he does in the industry. This is the short version, so take that for what it means there—there’s gonna be a lot more that I don’t say.

So Allan is a nationally recognized and highly sought after speaker. He’s an author, and a consultant to the professional services industry—and this is where it gets pretty interesting. He’s been named by Accounting Today as one of the top 100 Most Influential People in the accounting profession for the past 21 years. You heard that right—21 years. He’s been named by Inside Public Accounting, as one of the ten most recommended consultants for 18 straight years. There’s a theme here. He’s been named by CPA Practice Advisor as one of the top 25 thought leaders in the profession for seven straight years. They must have just started this seven years ago, because I don’t know why that wouldn’t be in the 20s. He is in CPA Practice Advisors’ accounting Hall of Fame, and he was one of the first to be inducted into the Accounting Marketing Hall of Fame. That’s where I’m going to stop. There’s a lot more I could say. I’m thrilled to have Allan here. Allan, welcome to The Unique CPA.

Randy, thank you so much. Thank you for those kind words. I wish my kids could be on. They think I’m the biggest loser! But thank you.

That’s no problem. Believe me. I got to meet you, I think the first time was probably seven or so years ago. And I had heard of you before that. So it was great to meet you then and really I’m honored to have you on the show here today.

And to that end, we could—I honestly could sit and talk to you for, you know, 12 hours, you know, probably 12 days, on a myriad of subjects. But what I really want to concentrate on today is something that’s been going on for a while, but it’s in the news lately the last couple of months—private equity investment and public accounting. This came back into the industry in August with EisnerAmper, a top 20 CPA firm, getting a private equity investment. And then a month later, I think Shellman out of, I think they’re Florida, 65th largest firm, I think, according to Accounting Today, actually sold a portion of their firm to private equity.

And so this is happening, and I’ve seen you quoted saying that’s going to continue to happen, you’re gonna see more of this. And before we get into all the—this is a long question!—before we get into all the whys and positives and potential negatives, I want to talk about structure. Because this is the first thing that popped into my mind is, how is this? How’s private equity owning a public accounting firm? And I know there’s this alternative practice structure. So can you kind of give us an idea of what this looks like after this money comes in?

Yeah, I think, you know, there’s a history here, and the history probably of outside ownership, we have to go back to the late 90s. You know, when firms like American Express Tax and Business, H&R Block, CBIZ, Centerprise, UHY. They’re all these different versions of outside ownership.

You fast forward to today, and there’s the new breed of PE firms coming into the market, you know. You identified EisnerAmper and Schulman. There’ll be a third one coming out, another top 20 firm, probably in the next week to ten days. I mean, it’s being communicated internally right now to clients and staff. In addition to that, I’m working with two other PE groups that we are sort of, if this were a baseball game, we’re somewhere in the third to fifth inning of discussions with two other top 30 CPA firms.

You know, what’s fascinating with this, and I was warned of this, is as soon as one sort of unlocks the code, many will come in. I mean, the history here is this party started back in 2007 and got to the bottom of the ninth but unfortunately that summer of 2008, you know what happened.

Oh yeah.

And we had the great recession and that PE group and that CPA firm backed out.

Fast forward about five, six years, a handful of firms tried again. The big difference from 2011 to 2021, and it’s huge—in 2011, the large CPA firms said to PE, “Thanks but no thanks. You want to get a double digit return on your investment? I can go to the bank and borrow money at 1%. They’re practically giving it away.”

True.

What changed in 2021 is the need, the thirst for capital. And if you look at the metrics of CPA firms, revenue per equity partner is going up. That means that there’s fewer partners to put capital in. Number two, unlike 2011, we’re in this fourth industrial revolution, and trying to get compliance practices to be consulting, advisory outsource practices, the investment in technology, the investment in the insanity of the war on talent, recruiting, retaining people, at a time where the supply of accountants is not matching up with the demand. As you know, Randy, most accounting firms today will tell you getting business is not a problem. Now how to get the work done is darn near impossible.

So you have the perfect storm. You have firms in need of capital. You have a generation of baby boomers, as you know, this decade more are gonna retire than the last three decades combined. You have a major transformation of the platform of public accounting, just called simply compliance to consulting. And in that compliance, not only is there going to be an evaporation of compliance due to the bots, machine learnings and blockchain and all those things, the marketplace is saying, “I’m only going to pay so much for compliance work, but I will pay a lot of money for value added type services.”

Yep.

So private equity, the one thing I think they learned is, “We’re not going to buy your whole business. A, we can’t because, as alternative practice structure, non CPAs can’t own an audit firm.” So similar to what H&R Block did with RSM, similar to what American Express did with some of the firms they acquired, similar to what CBITZ did. You know CBIZ, to me, of those three public companies, was the lone survivor. It’s 25 years later. If you’ve looked at their stock price recently, and you bought CBIZ stock five years ago, at six, I think it closed yesterday at 36. They have figured out how to have outside ownership within an accounting firm.

Now, all that said, what private equity is looking to do is, they break the companies apart. Audit, you know, we’ll call it in the case of EisnerAmper—EisnerAmper, LLP. And then tax and consulting is, you know, EisnerAmper Advisory or something like that. Everyone in the organization has business cards and is a part of the tax and consulting, unless you’re just strictly audit, then you’re going to be on the other side of the house. Candidly, it’s what gives the comfort to the regulators, just because of impairment of independence. You know, truth be known, many of the people that are going to do the work on the audit, are at least from the advisory practice over to the audit practice. 

That’s what I thought.

There’s a management fee, then, that goes from the audit practice, back to the tax and consulting business.

Do they leave profits in the audit? Or is all that distributed out to the new alternative practice?

You know, there’s some level of profitability maintained. And you know, I want to be sort of careful on the wording of this, because I don’t want to upset anybody that’s a regulator or things like that. But I think what we have here is, you know, the old days of substance over form. This is a structure that has to happen. My guess is all of the people that work for the organization, understand that looking at a P&L of the attest company is not the end all. You know, it’s probably not that different than when you have a separate entity for cyber, when you have a separate entity or wealth management, when you have a separate entity for a technology business.

You know, at the end of the day, things all sort of back to the mothership.

Alright.

So in the old days, because it was so foreign, it was talked about so much. In today’s world, honestly, if I had a partnership with you, and I had a, you know, a business card that said Tri-Merit, I’d say look, “Here’s my company, but for purposes of doing this type of work, we put it through this entity.” And as the client is going to decide, “Is it a fair price? Do they have the technical competence to deliver the work? And do I actually like these people?” That carries the day.

Alright, so then this investment and then just to summarize the the alternative practice structure—the PE firm owns that or a portion of that?

Right. They owe the tax and consulting side they have zero ownership in the attest company.

And then is there a normal percentage of this new entity that you own?

Yeah. So very precisely, it’s going to be more than 51% but it’s probably not going to be more than 70%. And the reason—and there’s some debate on this, but—when you buy an entire organization, there’s nothing left for the young ones. Everybody cashes out, that’s a good thing. But what they create, really, is Newco. And they say, they give a disproportionate amount of the shares to the younger partners, and they say, “Look at—the old ones are going to retire and go to the beach. We’re going to build a business, you’re going to get a check on day one, you’re going to get a second bite of the apple, maybe three, four years out, if we can hit certain benchmarks. And in years four to seven, understand that, you know, as we grow even up together, we’re going to probably sell this to a bigger fund, a bigger PE group. And don’t worry about it, because you’ll have a significant say in who that is. You know, we’re not going to be selling you out without your permission, you’re our partner. We’re in this business together. And when all is said and done, if the history is correct here, you should 2x or 3x what you would have gotten, had you stayed as an independent firm. Number two, where are you going to get that capital to build all these ancillary services? With us, you have it the day after. Oh, and you also don’t have to use current comp to make that happen. And lastly, you know, if you’re 35 or 40 years old, think about it, you’re not going to get a dollar Until you’re 65, then you’re going to get paid until you’re 75. It’s ordinary income, it’s paid without interest. It’s, you know, one-tenth a year. Did you ever take out a Texas Instruments calculator and do the present value calculation of what that is today? And think about the check you’re gonna get at closing, think about the check you’re gonna get three, four years later, think about the check, you’re gonna get in years four to seven.”

So this is built with young partners in mind.

Really.

And I think that’s why in these three scenarios that have already cleared customs—that’s why you had unanimous votes from not just the old but the young partners as well.

Yeah, the three you mentioned there was what? A CFO firm that brought in private equity as well?

Yeah, I mean, there’s been other one offs. You know, yes. Martin associates.

Oh, yeah. Right.

There was a CFO group in Northern California. I’m forgetting the name for a second. I think you had Sanford Miller in Indianapolis, that took some outside ownership into their group. You know, there’s different things that have gone on. But, you know, when you have two top 20 firms, with revenues over 300 million doing it, this is hitting mainstream pretty quickly. And I would guess if we sort of repeated this podcast a year from today, I would not be surprised if two more top 30 firms went the way of private equity.

Alright, we’re getting a teaser here! Look for more! But we’re actually gonna teaser that by the time this comes out, there may be another top 20, it sounds like.

All right. Well, that’s interesting. I’ll be interested to look at that. It’s just this, this is something I just, I am intrigued with the whole deal. And so I want to talk a little bit about what you were just mentioning.

You know, you get this investment. A portion is going, and I don’t know what that portion is, to the current partners. You know, I don’t know if a larger portions go into the older partners—that’s what it sounds like—because the bigger portion of ownership and the new structures go into younger partners? Is that kind of the makeup? But before I go there: how much is actually going to go into the partners’ hands, how much is going to stay in the business, and then what’s that makeup between older, almost retired partners and the 35-year-old you mentioned?

Yeah. So if you think about it, in most firms, if they just went to the finish line as independent firms, the older partners, by definition, have more nest egg, right? They’ve been around longer, years of services as a partner, age requirements. In a lot of CPA firms, normal vesting, you really need to be there no less than age 55. You probably got to, you know, to get full best things, some firms 60, or even 65.

Right.

The second is not to suggest that firms use lockstep compensation. But in most firms, the older partners are earning more than the younger partners. And you know, many, many firms, as you know, use a multiple of compensation as a method to determine retirement benefits. So because of all that, simply stated, the older group would see more. But it’s not because they’re being put in some special class, it’s just the way the firm operates.

So they want for the most part, what they’re really doing is, they’re, as you know, how private equity works. They sort of go and borrow debt. They lever up the balance sheet. And day one is a day of celebration. Everybody’s paid their deferred comp, everybody gets their capital back. It’s sort of like starting over. And for the old ones, they say like, “Look, this is not about me, I’m fine.” And the younger ones say, “You know, I want those shares. I want those units. I want incentive stock or compensation. I’ve got a new business, and we’re going to drive this and grow it, and we’re going to partner with PE.” So it’s a different model going forward.

Okay, and then, so let’s, based on that, you mentioned, you know, they look to grow, you know, PE comes in, you know, it looks to create a value and get out. So these younger, this 35 year old partner, they could go through this three times in their career, or even more, where we build it, we increase EBITDA, we sell to the next private equity firm, we do it again, do it again, do it again. So in reality are the younger partners in the long run gonna end up with the potential greater benefit?

Yeah. So that’s really, Randy, that’s the question of the day. And I’ve facilitated a lot of meetings with the younger partners, where the old partners are in the room. And here’s what I’ve said to them. I said, “Look, if you’re a steady Eddie, and you don’t want risk, and you want to slow boil, let’s not do this deal. Because if you do this deal—I will tell you, there is more risk, there is a lot more upside. But part of why private equity is getting in is to provide the capital and resources to take this business to a whole other level. That means grow it, but more importantly, it means grow it profitably. And we will have to make some tough decisions that in a partnership structure, we historically have either kicked the ball down the road, or we’ve watered down an answer so everybody is okay with the decision, but it wasn’t a great decision. Our life is about to change. Do you want that? Does that excite you? If you look at the history books, and you look at companies, you know, whether we call them and I’m Navigant, Accenture, Huron, AlixPartners, a couple of the executive search firms. I mean, there’s a long list of professional service firms that have gone the way of private equity, and have lived to talk about it. The model works. But it is going to be different. Are we okay with that?”

That’s what you have to decide. If you’re a risk taker, and you want tremendous upside, and you’re looking at two, three times more earnings and money in the bank today, let’s go for it. Let’s put our hands in the middle. But if that’s not us, don’t sign up for it. If we want predictability, if we want zero risk, stay as you are, but you know, the business is changing. So you’re going to have to take current comp, and you’re going to have to go build out those areas we don’t have, and how long is that going to take? How much money is it going to take? And what if we don’t get it right? Do we want to spend the next ten years investing in something only to come up on the short side of that and say, “I wish we could roll the clock back?”

Right. Right.

Eyes wide open.

Yeah. Well, I mean, yeah, that’s obviously a good point. And it’s, I completely see that, the upside can be tremendous.

So I guess to kind of start to wrap it up: What’s the endgame? Because I mean, we can’t keep flipping this to a new private equity firm indefinitely, right? I mean, so is endgame we go public with this? Is endgame the whatever the partner base is 30 years from now buys it back? What is the endgame?

So I would say—it’s a great question. The endgame, the most logical outcome is that a four to seven year period, that Newco will be sold to a bigger PE group.

Okay.

The second possibility, and you know, I’ve learned never say never, an IPO is not crazy. You know, the truth is, we can’t predict anymore our profession in five or 10 years. It’s on a roller coaster ride, and it’s in a dark tunnel. We have no idea where this is going to go. The only advice I have for firms is do not put your head in the sand and pretend transformation isn’t happening, because you will be left behind.

No, I agree with that completely. I’ve heard some firms that go to a lot of conferences and that they’re naive about that. And I’m like, “Oh, boy, you can’t be thinking that way. It’s, this is… you’re going to be passed by and you’re not going to survive if that’s the outlook.

And Randy, you know this from your work with accounting firms. Change in these firms only happens when the change itself is deemed to be better than the status quo. And right now, the status quo, call it earnings, in 2020 and 2021 are as good as it’s ever been. So you talk about change, when you know, they look at you like, “Did we do something wrong? Why are we doing this? We’re making more money than we’ve ever made. 2021 is going to be better than 2020. This is going to continue forever.” No, it’s not.

You know, in your earnings, you’ve got PPP dollars in your earnings. You didn’t spend any money on travel and entertainment in your earnings. You don’t do any out of state travel for conferences. You’re not making deep investments. No, stop believing your press clippings.

Yep, yep. So look forward.

Yep. Yep.

All right. Well, I have about a thousand more questions. But I think we’ll wrap it up there. We can do a phase two or a second one—though I know, you’re swamped—sometime if it works out. But yeah, it’s just such an intriguing area for me. So any final thoughts on this before we wrap up?

You know, “Be real.” And that’s my message to the firm. Let’s think strategically, not where we are today, but what the next three, five, seven years is going to look like. And let’s have an open mind. And that’s not a pitch for private equity, because you know, Randy, at the end of the day, 97% of accounting firms don’t qualify for private equity. You have to be a super highly profitable firm, because private equity is about EBITDA. And if you don’t have excess earnings to give back to the house, which helps to determine the purchase price, it’s not for you. 

So I think it’s more about eyes wide open about the transformation and the opportunities of our industry, where it’s going.  

I appreciate you, you know, sharing your insights on this. I couldn’t think of anybody better. I mean, I don’t think anybody could think of anybody better to comment on this. 

Thank you, Randy.

So I appreciate that. If anybody wants to find out what you’re doing there, get ahold of you, is there any place they can search you out?

Yeah, it’s real easy, and thank you for asking. It’s just Koltin Consulting Group.

Get to the website. 

Yep! 

Although I know you’re on Twitter, LinkedIn, any other big places?

I’m sure there’s some embarrassing family pictures on Facebook, but we don’t have to go there.

Alright, well, thanks again for being here.