For those tax & accounting firm leaders considering seeking a private equity investment, here are 5 key items to think about before they do
Growth is top of mind for many tax & accounting firms — or at least among their top four priorities, according to more than 500 tax & accounting firm leaders surveyed in the Thomson Reuters’ 2023 State of the Tax Professionals Report.
Growth, however, may mean different things to different firms; and some tax & accounting firms may decide that they need an infusion of private equity money to reach the level of sustainability and operations success their leaders envision.
But how can you tell is your firm is ready for just a big financial step? Below are five key items that should be strongly considered when a firm is thinking about getting a private equity investment and whether such an investment is best for the firm.
Some tax professionals have strong feelings about getting private equity investments and believe the tax firms’ business model integrity may be at stake. Like all decisions that can impact the business, private equity infusions could dramatically alter how the firm has operated, including its basic structure. Therefore, much thought must be given to how the business raises cash and what impact that financial decision may have on the business.
Private equity — the investment of an amount of capital into a private company or firm — is how private equity firms deploy their capital on behalf of their partners. Leveraging a private equity investment to expand operations or purchase needed technology can be a viable strategy for tax & accounting firms looking to grow their business. Often, the capital that private equity firms provide to companies or firms can help those businesses expand and increase their value over time.
Before a tax & accounting firm leaders decide to partner with a private equity firm, it’s essential they weigh these pros and cons carefully and vet potential partners thoroughly.
Overall, a tax & accounting firm has many advantages in partnering with a private equity firm. It is a straightforward way to access capital, especially if acquiring financing in more traditional ways, such as through a bank, may be challenging. Private equity investments also allow firms to gain expertise in operationalizing the business, since often private equity partners will join the firm or its board and offer their significant expertise. In addition, working with a private equity firm can give tax & accounting firms access to business strategies and efficiencies, especially if the private equity firm can leverage its expertise and reputation to attract additional clients for the tax & accounting firm.
Below are five considerations where it may be most beneficial for a tax & accounting firm to seek out private equity investment into its business:
- Financial distress — While a definition may not be necessary, a firm in financial distress may be facing significant financial challenges that are affecting its ability to operate effectively. These difficulties may derive from an economic impact, such as an increase in overhead costs; not charging clients market rates; holding large amounts of account receivables that aren’t closing; loss of clients or employees; and an inability to get enough work done to bill clients. Firms that continuously experience financial distress can be faced with bankruptcy or the dissolution of the business. Working with a private equity firm can provide the capital needed to weather economic difficulties and reposition the company for future growth.
- Growth through expansion — For tax & accounting firms looking to expand into new geographical regions or additional service areas, significant capital may be required. In addition to expanding independently, a more expeditious way to grow is through a merger with another firm or by acquiring another firm. Either strategy requires some capital, and receiving a private equity investment may be the best way to go.
- The need for modernization — There isn’t any question about whether tax & accounting firms need to be modernized. The changes, including the digitalization of taxation, require firms to ramp up their technology solutions to not only keep up with the competition, but also to be able to serve their clients in the most effective and efficient way possible. Such modernization often requires a significant capital infusion, which can be provided by private equity.
- Firm legacy and succession planning — For firms that may not have obvious heirs or succession plans and that wish to continue their business may consider selling their practice to a private equity firm. This can provide a profitable exit strategy for the firm owners and other partners.
- Scaling and leveraging industry expertise — For those tax & accounting firms that are considering the addition of a specific industry to their practice offerings and may not have the expertise in that area, finding private equity professionals that can provide that expertise could give the firm both the knowledge and strategic guidance to achieve needed operational improvements.
Before deciding whether to get involved with private equity firms, tax & accounting firms should contemplate all angles. For example, the tax & accounting firm leaders should understand that they might have to give up control. Quite often, any private equity firm that invests will require a say in the business it runs. Depending on how much capital is invested into the firm, the private equity firm may have a more significant voice in the strategic direction of the business. Indeed, tax & accounting firm owners should work with attorneys or financial advisors to smooth out any changes to the firm’s ownership structure.
It’s also crucial for tax & accounting firm leaders to remember that a private equity firm’s objectives are often to maximize its investment within a specific timeframe, typically five to seven years. So, their strategic decisions will be made with a timeline of how to increase profits within the short-term, even if it comes at the expense of long-term profitability. Naturally, this may create tension with the firm’s previous leaders, who may be worried about firm sustainability in the long run. Further, if the tax & accounting firm cannot perform up to the private equity firm’s expectations, there might be issues in repaying the debt to the private equity firm.
So, before a tax & accounting firm leaders decide to partner with a private equity firm, it’s essential they weigh these pros and cons carefully and vet potential partners thoroughly. The goal should be to find a private equity firm that provides capital and aligns with the tax & accounting firm’s strategic vision and company culture.