By the end of 2025, more than half of the largest 30 U.S. accounting firms will have either sold an ownership stake or part of their business to private-equity investors, up from zero in 2020, said Allan Koltin, chief executive at advisory firm Koltin Consulting Group.
—Mark Maurer, “Private Equity’s Ties to Companies’ Auditors Have Never Been Closer. That Worries Some Regulators.”[1]
Persistent market volatility, high inflation levels, and lack of investor confidence have challenged, among other things, mergers and acquisitions processes and the debt capital markets over the past few years. Private equity sponsors have responded in part by seeking to penetrate new sectors for platform acquisitions. Professional services firms have become one such target, driven by large profit margins, sustained growth, and strong cash flows. This article focuses on accounting firms, a subset of professional service providers and a popular target of sponsored investment via leveraged buyout (or “LBO”). As competition to acquire quality assets and accordingly, provide related financing, remains fierce, this article will discuss material considerations for lenders in connection with the financing of audit and accountancy businesses.
A Rising Trend
According to S&P Global, November 2024 “saw a surge” in private equity– and venture capital–backed transactions in the accounting and audit sector.[2] In fact, in the period from October 1 through November 30, 2024, seven deals were done in the sector, compared to six deals for the entire fourth quarter of 2023.[3] By way of further example, according to the Financial Times, in 2024 alone, Hellman & Friedman agreed to purchase a controlling portion of the equity interests in Baker Tilly; New Mountain Capital purchased the U.S. operations of Grant Thornton; Investcorp and PSP Investments purchased PKF O’Connor Davies; and a Centerbridge Partners–led consortium of investors purchased a majority of equity in Carr, Riggs & Ingram.[4]
Attractive Targets
Accounting firms are attractive targets for private equity investment for several reasons. The “fragmented”[5] character of the professional accounting industry presents consolidation opportunities as well as the potential to scale business, a hallmark of private equity’s investment thesis. Furthermore, private equity sponsors may be able to strategically acquire and roll up current and future targets, often centralizing shared services and functions, thereby lowering costs and maximizing profits, which, in turn, ultimately maximizes limited partner returns. Accounting firms’ business is also fairly reliable and stable, usually with predictable income streams and the potential to expand into advisory services to augment profits.[6] Some industry observers predict private equity investment in the accounting sector may allow firms to deploy capital into new areas like enhanced technology and artificial intelligence, each of which theoretically might, consequently, promote consistency, efficiency, and lower costs.[7]
Top Three Considerations for Lenders and Their Counsel
In light of popularity of accounting and audit firm acquisitions, we offer the following top three considerations for lenders considering financing the same: (1) structuring, (2) auditor independence and regulatory considerations, and (3) management services agreements (“MSAs”) and/or administrative services agreements (“ASAs”).
1. Structuring
The alternative practice structure is ideal for businesses looking for external investment. Firms governed by alternative practice structure regimes are typically split between the advisory arm (“AdvisoryCo”) and the accounting business (“AttestCo”). Under a credit facility, AdvisoryCo is usually the borrower and AttestCo is a non-guarantor restricted subsidiary. It is therefore crucial for lenders and their counsel to appreciate how transactions between AdvisoryCo and AttestCo are governed and what rights and restrictions apply to targets’ partners and/or employees.
Importantly, accounting firm employment and partnership agreements often contain non-compete, non-solicitation, mandatory retirement, and other similar restrictions on partners and employees. As alternative practice structures may vary from firm to firm, a thorough review of relevant partnership and employment agreements, operating agreements, and other governing documents should be undertaken—most crucially, the MSA and/or the ASA (discussed below).
2. Auditor Independence
Accounting firms are typically subject to the U.S. Securities and Exchange Commission’s (“SEC”) and Public Company Accounting Oversight Board’s auditor independence rules and other similar regulations. Due to the broad reach and scope of such rules, financing arrangements may impair independence. Company and sponsor’s counsel should conduct a thorough independence analysis and confirm no issues; lenders’ counsel should expressly inquire about this during legal diligence. Lenders should push for credit agreement representations and warranties to the effect that the financing transaction does not violate the SEC’s Rule 2-01 under Regulation S-X or other applicable laws, as it may be detrimental to the underlying financing to have AdvisoryCo deemed an “associated entity” of AttestCo.
3. MSAs/ASAs
Alternative practice structures and the two entity silos are governed via MSAs or ASAs. The MSA or ASA, as applicable, spells out the agreements between AdvisoryCo and AttestCo. For example, such agreements will provide that AttestCo provides only accounting services and that AdvisoryCo provides—importantly, for a fee—administrative and “back-office” services to AttestCo (think personnel management, information technology and other tech services, billing and accounts, and so on).
It is imperative that lenders and their counsel obtain, review, and understand the relevant MSA or ASA. Key focus areas of such review include the following:
- Fee for services: What is the scope of the fee and related services? When is such fee paid?
- Termination fee: To which party is it payable? Are there any exclusions to payment of such fee?
Because MSAs/ASAs are key strategic assets of AdvisoryCo borrowers, credit agreement provisions should be tailored accordingly. For example, lenders should consider appropriate representations and warranties as to the effectiveness of MSAs/ASAs, fulsome events of default for termination of MSAs/ASAs, and a covenant restricting modifications of MSAs/ASAs adverse to the interests of the lenders. Lenders may also wish to consider restrictions on transferring MSAs/ASAs outside the ring-fenced loan party group and include reporting requirements.
Conclusion
As accounting firm LBO financings become increasingly commonplace, the body of relevant credit documentation that may serve as precedent for future transactions is growing. Sponsors, wishing to preserve their forms and ensure consistency across their portfolio companies, may resist bespoke constructs. Yet, lenders must be wary of cookie-cutter approaches and not lose sight of the fact that accounting firms (and other professional services firms) are no ordinary targets. Credit documentation must be diligently negotiated and be grounded in a firm understanding of the often-complex corporate and partnership structures and complex web of regulations to which each unique accounting firm is subject.
Mark Maurer, Private Equity’s Ties to Companies’ Auditors Have Never Been Closer. That Worries Some Regulators, Wall St. J. (Oct. 30, 2024). ↑
Karl Angelo Vidal & Shambhavi Gupta, Fragmented Sector Lures Private Equity Investment into Accounting Firms, S&P Glob. (Dec. 4, 2024). ↑
Id. ↑
Antoine Gara & Stephen Foley, Private Equity Buyers Snap Up Two More US Accounting Firms, Fin. Times (Nov. 18, 2024). ↑
Vidal & Gupta, supra note 2. ↑
Sridhar Ramamoorti & Paul J. Herring, Private Equity Acquisitions of Accounting Firms, FEI.org (Dec. 9, 2024). ↑
Vidal & Gupta, supra note 2. ↑
