Doug Lewis on PE in Accounting: Opportunity, Risk, and What Comes Next

Thinking about selling your accounting firm or taking outside capital?

In this follow-up Q&A episode, Doug Lewis breaks down the most common accounting firm deal structures, including cash at close, earnouts, rollover equity, and what actually happens after a recapitalization.

You will learn:

• How accounting firm M&A deals are typically structured
• When earnouts and clawbacks show up, and how often they are enforced
• What “rollover equity” really means and how to evaluate its quality
• The difference between private equity buyers and CPA-backed strategic buyers
• What drives valuation multiples, client concentration, niche focus, tech stack, leadership depth
• How buyers assess scalability and operational maturity

If you are a firm owner, managing partner, or practice leader exploring succession, growth, or a liquidity event, this episode will help you understand both the upside and the risks.

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Transcript

Doug Lewis (00:05)
thanks again for joining the recent webinar, everyone. You brought the questions, great energy. We loved it. For anyone who's new here, my name is Doug Lewis. I'm the managing director of the visionary group. And since we couldn't get to all of the questions during the live session, the wonderful team over at Canopy was nice enough to take all the questions we couldn't quite get to, organize them a little bit, and we're going to dive through them right now. So we're just going to take them one by one and see where this thing goes.

All right, question one. And the good news is I think we kind of put these in different buckets. So first question, what deal structures are most common, including cash rollover equity and earn outs?

I love starting with a really difficult question right out the gate because there are so many different answers than a part of this. most transactions out there are going to have some form of all of these together. It's pretty rare when we see a transactions that's all cash at closing. Those happen on the smaller firm level occasionally still. Subsequently, it's also very rare when we see a deal that's all earn out based on retention over time. You know, those are, those are kind of the old ways of doing deals. So most of the deals that we do see now,

will have a portion of cash at closing regardless of the size, some level of earn out, anywhere between two years on the short end, we've seen five, six years on the higher end and the earn outside of things. And then the rollover equity is huge. And rollover equity, I want to clarify, the quality of equity is paramount in any transaction. Not all rollover equity is treated equally based on who the acquirer is or the structure and size of that transaction.

Another question, how common are earnouts and clawbacks in accounting firm transactions? Earnouts are generally a part of pretty much every deal out there. Like I mentioned before, all cash or all earnout deals are pretty rare. There's usually some type of mixture based on the transaction and who the acquirer is. Clawbacks, they're out there. They usually don't...

get enacted after the transaction. Most of the deals I've been involved in, I've personally been a part of anywhere between three and 400 transactions over the years. I believe I've had one clawback that actually happened post transaction. So they're out there, they do happen, but they're a little more of a rarity than people would really recognize.

Another question, how often does rollover equity fail to meet expectations or lose significant value? So I mentioned this in a previous question. The quality of rolled equity is paramount in these transactions. Not all acquirers are treated equal when it comes to their equity in any deal. So when we look at rollover equity,

If you're a newer formed firm, it's difficult to put a value on that equity versus firms who have been doing this for five, 10, 20, 30 years. So not all equity is treated equal. It's really easy for me to sit here and say, I'm going to acquire your accounting firm. You're going to roll a portion of your equity and that equity is going to appreciate it. 10, 15. I've seen people say as high as 20 % year over year. So, you know where I'm getting that from.

I would question that and everything. Track record means a lot when we look at rolled equity, well as the leadership team and what the liquidity event they're looking to do in the near future really looks like and who that will be with.

This is a fun question. How frequently does the second liquidity event deliver meaningful upside? So, you know, the term second bite of the apple is thrown around quite a bit. And I believe that's what this question is really getting towards. And the interesting piece of where we are right now in the accounting firm &A landscape with all of this infusion of private equity, it's pretty early to tell.

the second buy to the Apple hasn't happened much. There's been a handful of transactions that firms have actually done this with, and those have been at the very large firm level. So when we look at middle market or even downstream market firms, that second buy to the Apple or that second liquidity event,

We're just too early in the game to really see how that's going to play out. Everyone has, of course, very rosy projections of what this could look like, but I think we're going to really understand what that second bite of the apple in the liquidity market looks like over the next 12 to 24 months when we see more and more firms enter that stage.

Now we're gonna move into a couple different sections here. we're start with risk, failure, and downside scenarios. We're starting off on a really positive note here. First question, what examples exist of accounting firm rollups that failed or lost value? That's a tough one to answer publicly.

I don't like to name names and share everybody's business out there. There have been a couple of roll ups over the past decade that have not gone well from an exit perspective. I won't again won't name names, but we've seen this cycle before with outside capital coming into the accounting world. Some have done well with it. Some not so well. I think we're a little bit too early in the game to really see how that's going to play out. Very similar to that second bite of the apple conversation and what is the quality of the equity.

inside these different groups out there.

Another good question, we get this quite a bit. What risks do acquired firms face if the buyer later sells or recapitalizes? So that's a difficult conversation and something that all sellers or anyone looking to transact with a larger firm should be talking about throughout the process. Once I sell my firm or majority stake in my firm, you kind of lose control when it comes to that next liquidity event, selling or merging the larger pie.

But I think something that's really important to talk about here is you just don't know.

We have had firms of all sizes, 10 million, 50 million, a hundred plus million dollar firms who have said for years, we're not taking outside capital. We don't like private equity. We're never going to do that. Many of those firms over the years have transacted since saying that. So you can't really predict the future. This is going to be a part of the accounting profession for a long time. So there are some firms out there who will remain independent and that traditional partnership model. If they're out there, there are less and less.

especially at the mid and large firm level. But I think when we look at risk and risk tolerance in these transactions, it's something that we do see a lot of acquirers out there talking about right now going, right now, here's our stated three to five year plan. That could change at any given time. Now, whether that includes additional capitalization from an outside perspective and or taking on different investor groups, that's each acquirer's persona, essentially.

But having those conversations throughout the process, if you are a seller or looking to transact is paramount because if you know that you either want this to happen or don't want something to happen down the road, you have to really hit those conversations early.

How important are true operating synergies versus financial engineering? My God, that's my favorite question I've seen on this list so far. So everybody always says it always starts with culture. I couldn't agree more. When you look to combine two firms, regardless of size or anything else, culture is always number one.

And a big part of that culture is how the firm operates. Not only from a technology stack or workflow or this, that or the other, but how they truly approach client service and how they treat their employees and other staff members. That is absolutely paramount in these transactions.

The numbers can be worked out in pretty much any transaction. If you're looking to take your firm to market right now, you'll likely get a pretty comparable offer based on all the different acquirers out there from a financial perspective. But from an operational perspective, from a culture, from a fit, from a vision perspective, that's much more difficult to sniff out in these transactions. And honestly, it's the number one thing we always start with. When we have two firms on the line, we always start with a 30 minute conversation

to see if you even like each other before we start going in non-disclosure sharing financial information all that fun stuff because at the end of the day fit and culture and alignment should trump everything else in any transaction

So this next section kind of covers some differences and similarities, I believe, in the private equity firms versus the CPA-backed or the hybrid strategic type of buyers out there in the marketplace. The first question, when valuations are similar, how do outcomes differ between pure private equity buyers and CPA firm buyers with a capital backing or a capital sponsor?

Valuations shockingly come in pretty close when we see different types of acquirers at the table for the same opportunity. Whether it is a traditional accounting firm out there in the marketplace in that partnership model, whether it's one of the pure private equity consolidated groups out there, or whether it's one of these hybrid groups, which is a larger regional or even a national firm who took a capital sponsor. From a valuation standpoint, most of them are pretty close these days. Now how they structure that,

Bit of a different flavor there, but we're looking at total enterprise value of any transaction Most buyers are trying to get pretty close to each other from a competitive standpoint Which again feeds back into it's not always about the number the numbers can work themselves out in just about any transaction But the culture fit and alignment are absolutely key

So we're gonna move into a fun section here or what I hope will be a fun section anyways. Marketability and firm characteristics. Kind of the category that some of these questions are really pumped into. First question, how does client concentration affect valuation and marketability? Pretty big, it's a pretty big impact on the valuation and marketability of any firm.

Honestly, the overwhelming majority of buyers out there, they don't want generalist practices that do a little bit of everything from a service and an industry standpoint. Firms who have a defined niche from an industry or service perspective generally do command a little bit more from a valuation standpoint than firms that do a little bit of everything or dabble in a lot of different areas out there.

Does geographic concentration increase risk compared to multi-state presence? So this is a tough one. I'm gonna just, I'm gonna pick, we have some producers on the line that no one can see here. I'm gonna ask one of them to just give me a size for a firm.

Give me a revenue size for a firm.

All right, so I asked one of our beautiful producers here to give me a revenue size for an accounting firm as an example. So I didn't have anything predetermined here and they chose a $5 million firm. Love it. Right up the alley, right in the middle market there. if you're a $5 million firm and you have one single office location versus a competing $5 million firm in a similar geography, but they have two or three different offices to get to that 5 million mark, it's a bit of a red flag when we see multi offices at that level.

Now if you're a $5 million firm and you have two offices, one in one state and one in a surrounding state or a different geography or whatever it might be, you have a little more size, you have a little more bulk. So that necessarily isn't a downside or a red flag for most of the acquirers out there in the marketplace. The thing that I would recommend avoiding if you're a firm, whether you're $5 million, $15 $20 $50 $100 million firm is entering into new geographies or new markets with very small, small presence firms.

in common for us to see a 20, 30, 40 million dollar firm that has 10 to 15 office locations and some of the office locations might be a little bit bulkier, a little bit less and we have a couple that are million dollars, sub million dollars.

So when we look at geography, think concentration and geography and revenue mix and spread across it is important. I wouldn't necessarily say that people would value or devalue a firm too much if it's a relatively even spread, but something that can impact a firm's market value in a negative fashion would be having a lot of extremely small locations, whether they're close geographically across states, you name it.

This is a good question. Should overseas or low cost back office staff be included in revenue per head metrics? You're gonna get different opinions on this one. When we look at calculating the revenue per head inside a firm, we have a couple different cuts. But ultimately, what it really boils down to is revenue per professional head inside the firm.

And if you take a back office team or an offshore team, what we'd recommend doing is taking all of the costs of that labor and converting it back to a full time equivalent cost here for that specific labor pool in the U S. So if you have, let's just say five offshore staff, that might be the equivalent to one onshore staff here in the U S the five offshore staff would likely count as one full time equivalent here. When we look at calculating revenue per head.

There's a lot of different opinions there. That's a pretty safe way to do it is really look at the labor cost overall and trying to equate it back to the full-time equivalent from a labor perspective.

Interesting question here coming. How much does a firm's tech stack impact its valuation multiple in today's market? That's a tough question. And I think it's a valid point because we do see a lot of vendors out there saying, Hey, if you implement my software, your firm's going to be worth more. Now that might be true.

in some scenarios, but it's not necessarily because you implemented that software. It's the outcome of it. So the technology stack will really drive the profitability inside the firm. All deals are going to be based on the profitability, your net adjusted EBITDA, and that's what a multiple is going to be applied to. How you get there? There are a million different ways.

Now having a very well organized and efficient technology stack and workflow, if that increases your profitability on the bottom line, so be it. It might actually help, but simply saying, you use X, Y, Z as a technology tool. Your firm is immediately worth more. I think that's a bit of a dangerous assumption and not one that's uncommon. do hear that quite a bit. ⁓ I get pitched a lot on partnering with software vendors out there in the marketplace. So, I would say there's a, there's a little bit of fiction.

in that.

I got a bit of a story question here it looks like, so this one will be fun. If two firms have similar EBITDA, but one has a fully integrated workflow and a modern technology stack with strong reporting, does that firm command a higher multiple? Back to my previous ⁓ point on a similar question on technology stacks and multiples and valuation and all that.

I think if you're looking at two firms of similar size and one is significantly more streamlined, however they got there, the more streamlined firm will likely command a higher multiple in today's marketplace. That being said, there are so many factors that are not being taken into account there. We have age of leadership. What does the professional bench look like? know, geography still does play a piece in this size of clients, ⁓ industry niches, service niches.

you have a wealth management practice, there are a million different things that do ultimately impact the value of the firm. But if we're looking at two firms that are pretty much the same across the board, and one has a significantly more modernized technology stack and work workflow, they're likely going to get a little bit of a better transaction.

Let me know if I'm

How do buyers evaluate a firm's ability to scale without adding proportional overhead?

So most buyers out there in the marketplace, especially the smart ones, understand that if I already have tools, service lines and capabilities that I can immediately offer to an existing firm's client base overnight, that they're not currently able to do so. Obviously that's a huge, a huge upside for everyone involved, especially if you're sharing the upside in the transaction and you have some vested or rolled equity in that deal. So I think how buyers necessarily do this is

They not only break down the performance of the firm, but the smart buyers are digging into the client base themselves. What size entities are there? What opportunities exist inside that base? Whether it is a I T H R consulting service line that they can offer today is insurance and they have an insurance company. Do they have a wealth management practice? Do I have an R A in house? All these different pieces really factor into what a firm is willing to pay to acquire somebody out there and a firm with a

rich client base that might be slightly underserved from a service perspective, not from a quality or customer care perspective, but just from a, a available service perspective. Those can command premiums out there in the marketplace. So if you were evaluating, you know, your own client base and trying to figure this all out, understanding how to tell that story about all of the opportunity that does exist inside your base today to a prospective buyer will certainly help you in the long run during negotiations and ultimately structuring a transaction.

So this is a bit of a one-off question here. We didn't even have a whole full category. It didn't quite fit anywhere else. But I think it's a fun one we should dive into it. Should private equity ownership in accounting firms be subject to additional regulation or oversight? Now we're being recorded here. I'm not a lawyer, thank God. Sorry if any lawyers are watching this. I do love you, you're great, but I could never hack it in that world. There's been some rumblings that the alternative practice structure and the...

explosion of private equity in the accounting firm world might be facing some tighter regulations moving forward. But I think we're a little bit a ways away from ultimately seeing that play out and what those regulations might look like.

Again, who's to say there are some people asking questions. there are some, ⁓ organizations sniffing around what this looks like, but as of today, I think there's been minimal additional oversight, you know, or regulation around private equity entering the accounting space. That's not to say that will change or won't change anytime soon, but I think a lot of questions are starting to be asked, especially when we start looking at the audit side of things.

this next section, capital use and growth strategy. Some interesting pieces that we kind of put together. First question here, is outside capital more often used for acquisitions or internal investments such as technology and staffing? That's a really, really good question. I think when we look at the majority of outside capital that's entering the accounting space right now,

Most of these players invest pretty heavily into the technology and staffing and all that fun stuff, those core pieces before they really start going deep into the acquisition side of things. Now it's a tough question because once you have a lot of these pieces already in place,

most of that capital we do see shift towards the acquisition side of things only because it makes sense to deploy more capital in that once I have a phenomenal system and backbone already built. So I would say the majority of outside capital in the accounting world right now is really focused on that first part.

of the acquisition target strategy growing in organically, but you can't really, you know, blow that area up until you have that backbone built, which is what some of the initial investment is utilized for again, across the overwhelming majority of acquirers we do see out there.

Couple questions here just about the &A process altogether. First question, do most firms use brokers when selling and when does that make sense?

So I think it's really important to talk about the difference between a broker and an and a advisor. A broker is somebody who generally will list firms for sale. There's plenty of them out there. There's a handful of big players in that space in the accounting world. When you look at a broker, the overwhelming majority of those brokers focus on the very small firm level. When we start graduating into that mid level and larger firm area, most of the people doing the type of work, especially like what we do here are more

and That's not our market. And there is a big market for that. I'm not saying that it shouldn't exist. I think it's a crucial player in the accounting world, &A landscape. as firms get larger and larger and larger, they generally return to an &A advisor who specializes in this space. So there's a little bit of a distinction, a difference there. &A advisors just won't list firms for sale. Most brokers, you can go, you can fill out the NDA, you can take a look at everything they have on the table. There is a place...

for everybody but generally the smaller firms are the ones that end up going to the brokers in the marketplace and shockingly when we look at the &A transaction in the accounting world most of the deals that take place you'll never hear about them you'll never see them they happen with firms that never hit the market

These are transactions that are sourced completely. No one even thought about doing a deal. That's how most of the deals do happen in the accounting world today. Very few of them actually hit the brokers or go to somebody like myself and say, can you find me a home? I have no choice. What do I do?

This is a good one too. We could probably spend 15 minutes here. Lord knows I can talk that long, but I'll try to keep it precise. What options and support exist for buyers who are pre-qualified and actively looking to acquire an accounting firm?

So when I look at the buyer pool out there in the accounting world, it's pretty big and it only seems to be getting bigger and bigger. There are some monsters in the room that are really good at acquiring firms. They have a system down, they've been doing it, they have the capital, they have the process, the people in place to really just...

scoop up everything they can find that fits what makes sense for them. We have some that are much more strategic buyers out there who are very selective in their targeting. So there's a whole host of options out there if you are looking to acquire.

If you're a sole practitioner and you want to acquire a book or a retiring, so, you know, so owner firm going to the online brokers might be a really good option for you. And there are some phenomenal SBA lenders out there that have great relationship with firms that might not be in the market as well. Happy to connect. ⁓ anyone who's interested in that, have a couple of friends that we fully recommend if you want to go that route. but if you're really looking to acquire understanding where you fit into the landscape is key because the competition

to acquire right now has never been more fierce in the accounting world. At any given time, there are between, I like to say, three and 400 different outside investment groups still actively trying to break into the accounting profession. So if you're sitting there going, want to potentially acquire for myself, whether you're capital backed, whether you're doing it on your own through an SBA, whatever it might be, just understanding where you fit into the landscape and how many competition or how many people that you might be in competition

competition

for these transactions. think understanding that before you just hit the market and start trying to look at firms and talk to buyers and figure everything out will certainly help you in the long run because it is extremely competitive right now and across the board from small practices to very large firms. Firms are selling at a premium right now and if you are looking for more of a value type of transaction out there in the marketplace, you're probably going to have to start at the very small firm level.

Well, that's a wrap on our follow-up Q and a really appreciate you guys sticking with me through the entire thing here. If you have additional questions, drop them in the comments and we'll keep that conversation going. If you haven't watched the full webinar yet, you can always catch it on demand at getcanopy.com. Thanks for joining me. And if you have a specific question for me, don't be shy, shoot me an email, pick up the phone. I'm happy to spend some time with you and see if I can help. Thanks everybody.