PE Partner Reveals the Real Reason Private Equity is Going Crazy For Accounting

The quotes you’re going to read below were shared in last Friday’s Footnotes but we thought it prudent to give the topic its own post because private equity is quickly gobbling up accounting firms at an increasingly rapid pace and surely we’ve all been asking what’s going to happen to these investments in the long-term.

Jason Berg, a partner at Lovell Minnick Partners (who made a minority investment in #47 firm Cohen & Co. in October), spoke to a publication called Mergers & Acquisitions recently and pretty much put it all out there. So, why is private equity so interested in accounting?

“It’s an industry that’s very large. It’s got a massive, addressable market. It’s an industry that’s highly fragmented,” Barg says of the 45,000 accounting firms, most of which remain founder-owned. “It’s a recurring revenue model. It’s mission-critical and it’s an industry going through some changes.”

In particular, many accounting firms use antiquated technology and offshore tasks that can be done more cheaply and efficiently with tech upgrades.

Yes, you read that right. Offshore tasks can be done more cheaply. Hiring a bunch of people offshore for a fraction of what US-based talent costs (often while laying off said US-based talent) is cheap but having technology do it is no doubt cheaper. In other words, robots aren’t taking your job. Robots are taking the job of the Indians who took your job.

To be clear, that’s not the endgame. Private equity’s endgame has always been an exit. That’s why we’re seeing these PE-backed firms making a bunch of acquisitions, often targeted ones that bolster existing service lines within the firm or add additional revenue streams from someone else’s book of business. Invest, grow, reduce the debits, offload. That’s the plan.

Said M&A:

[F]or PE firms playing in the middle market there’s the added benefit of ready-made exits in the form of big shops’ growing appetite to build large-scale accounting platforms.

In 2023, total private equity exits across the world were around $460 billion. Things have slowed for now though. For January 1 to June 30 this year, global private equity exits totaled $155.3 billion, a decline of 26% from the same period in 2023. Read more here from S&P Global: Private equity exits pacing for 5-year low after slow H1

Here’s an interesting bit from that S&P Global article that might give us an idea of when we’ll start seeing PE firms offloading their newly-streamlined accounting practices:

Remember we’re only three years into the private equity frenzy. There’s no roadmap for the private equity firms that got in early to follow when it comes to exits so they might hold on to their accounting investments for even longer once they realize that offshoring 60% of work to India isn’t the genius solution they had hoped and that completely revamping a mid-market accounting firm’s technology with the goal of streamlining the practice is actually hard to do.

Although we should still be in the rollout stage, at least across the pond we’re starting to see private equity selling accounting to other private equity. A firm founded in 1926 made a deal with a private equity firm in 2021, made ten “strategic acquisitions” following the investment, and just last week this press release dropped:

IK Partners (“IK”) is pleased to announce that the IK X Fund has signed an agreement to invest in Dains Accountants (“Dains” or “the Company”), a leading provider of accountancy and business advisory services in the UK, alongside the management team who are significantly re-investing. IK will succeed Horizon Capital as the majority shareholder. Financial terms of the transaction are not disclosed.

Richard McNeilly, CEO of Dains, said: “We are very excited to be partnering with IK, who we believe possesses the necessary track record and expertise required to successfully support us in this next phase of our development. The team’s experience in both the Accounting and Professional Services sector, as well as in executing buy-and-build strategies in the UK and Ireland will be especially important in a fragmented marketplace like ours, where we are looking to drive consolidation and reinforce our strong position as the acquiror of choice. We would also like to take this opportunity to thank Luke and his team at Horizon Capital for their unwavering support over the past three years.”

Should we speculate as to whether or not Grant Thornton will be buying some Voltron-like firm that got duct taped together by PE in the next few years? Or do we just not care?

How about we end here with an excerpt from a piece in The Guardian titled “Slash and burn: is private equity out of control?“:

It’s not just that hundreds of millions of us interact with at least one private equity-owned business every day. More and more people, especially the relatively poor, may live almost their entire lives in systems owned by one or another private equity firm: financiers are their landlords, their electricity providers, their ride to work, their employers, their doctors, their debt collectors. Private equity firms and related asset managers “increasingly own the physical as well as financial world around us,” the scholar Brett Christophers writes. “All of our lives are now part of their investment portfolios.” This is true not only in the US, where private equity has been on a spree since the late 1970s, but increasingly in the rest of the world, too. In recent years, private equity firms have spent hundreds of billions of dollars snaffling up businesses from Canada to Cambodia, Australia to the UK.

As private equity has spread, so have dire warnings about its effects. The vultures and vampires of the industry have been decried almost everywhere in the media that isn’t already owned by private equity. In the span of a single week last year, two major and almost identically titled books were published in the US – Plunder: Private Equity’s Plan to Pillage America and These Are the Plunderers: How Private Equity Runs – and Wrecks – America. Private equity is “greed wrapped in the American flag of efficiency, looting justified by solid investment returns”, the authors of Plunderers write. “The marauders answer to almost no one.”

This is where the baby root canals come in, as a grotesque epitome of the industry’s modus operandi. According to multiple media investigations and a US Senate inquiry, in order to drive up profits, private equity-controlled dental chains have induced children to undergo multiple unnecessary root canals. “I have watched them drilling perfectly healthy teeth multiple times a day every day,” a dental assistant in a private equity-owned practice told reporters. One child even died as a result. To its many critics, private equity is a shining example of “asshole capitalism”, but baby root canals make one feel even that label is a touch too kind.

What could go wrong!