Private Equity Uncovers the Money in Money Management

Kay Lynn Mayhue knows a little bit about addition.

As president and partner with Merit Financial Advisors, a wealth advisory firm, she knew that her firm’s ambitions didn’t square with its resources. She envisioned a sprawling array of growth initiatives: hiring scarce professionals, building the technology that financial advisors need to streamline number-crunching and amplifying the firm’s market presence.

Like most financial planning firms, Merit was a partnership structure—and that partnership wasn’t likely to support the future she and her colleagues wanted.

So, four years ago, she answered when an outside investor called. Getting everyone up to speed on the “the industry, the models and the opportunity” was arduous, she recalls.

A lot has changed since then for both the financial advisory profession and its sibling, public accounting. At an investors’ conference in late 2023, Mayhue found her appointment calendar oversubscribed by four-to-one.

“Ten years ago, even finding a lender to finance an internal succession plan was challenging,” she says. “Now we have a bunch of smart people and a bunch of smart money getting into financial professional services.”

Money in Money Management

There’s money in money management. Large accounting firms and wealth management firms are riding a crest of private equity interest. Though regulatory and structural requirements dictate some aspects of the deals, investors say that there’s plenty of runway to buoy long-term gains. And some thorny barriers to growth are being solved in the process of incorporating investors’ perspectives, say firm leaders.

Allan D. Koltin, CEO of Koltin Consulting Group, which works with CPA and wealth management firms, has overseen more than 160 CPA firm mergers and acquisition deals in the past 12 years. Much of that has occurred in the past four years, he says.

Nobody formally tracks the amount of private equity flowing to CPA and financial advisory firms, but Koltin estimates that in the past three-and-a-half years, about 10 “foundation” deals have equipped big firms with enough private equity capital  to acquire 40 smaller firms. He consulted on about half of those deals, he says.

While distinctly different professions, accounting and financial advisory share similar traditions: highly credentialed professionals who traditionally support a partnership business model and corresponding career paths, a client-focused culture now challenged by tech demands and a dearth of young professionals able or willing to buy in.

Related content: Delivering Dividends: Investing in Accounting Firms

Accounting firms long ago added wealth management and financial advisory divisions. Meanwhile, independent wealth management firms historically have operated under the umbrellas of large RIAs (registered investment advisors), which provide back-room operational and technical support. The similarities between the two professions, and often interlocking ownership, have opened the way for a common approach by private investors.

Transformation Through Capital

This recent surge in investor interest can be traced back to several long-simmering trends boiled over in 2020. Pandemic-induced workforce turmoil was the last straw for accountants who were already struggling to persuade quant-minded college students to pick their profession over more lucrative, sexier options like tech and financial services. The talent dearth undermined the profession’s cherished partnership business model, which relied on a steady stream of new grads willing to grind for years before ascending to firm ownership, higher pay and career autonomy.

Worse, says Koltin, rapidly evolving client demands for tech services and platforms, especially AI, clearly outpace the resources of most CPA firms.

“They’re moving to value-added services, but to get to those services and that talent, whether through M&A or transplanting a practice from one firm to another, you have to pay a healthy premium, and CPA firms don’t have that capital,” he says. “PE is here because firms need capital for talent, tech and transformation.”

The numbers dissolved resistance from tradition-bound partners, Koltin says. “On average, retiring partners get twice their annual compensation spread out over a few years. PE disrupts that by putting a valuation of 8-10x EBITDA and pays up front,” he says.

Mayhue observes that large wealth management firms are claiming valuation multiples in the low-20s with smaller firms in the 6-10x range.

Reengineering Firm Structure

For CPA firms, the dam breached in 2021 when storied CPA firm EisnerAmper took an infusion of equity from TowerBrook Capital Partners.

EisnerAmper CEO Charles Weinstein says he fielded discussions with investors for 20 years prior to the 2021 deal. “PE never really figured out the right ownership structure so there would be next generations and so that the business would thrive,” he says. “The time was right because the ownership model for these PE transactions changed. The industry has been attractive to PE for a long time but now PE is attractive to the accounting profession.”

The industry has been attractive to PE for a long time but now PE is attractive to the accounting profession.

Charles Weinstein

EisnerAmper

But before private equity could scale the CPA firm gold rush, they had to re-engineer firm structure.

Regulators ban private investors from owning the audit and accounting functions that confirm the financial status of corporate clients, says Koltin. The very characteristics that appeal to investors—steady work that yields steady cash—had to be insulated from any implication of inappropriate influence.

The workaround separates the audit function into a standalone firm that contracts to a parallel entity running longstanding practices like tax accounting, and fast-growth practices such as virtual CFO services and tech consulting. The format is known as the “alternative practice structure.”

The same plot is playing out in the financial advisory category, which largely shares the partnership model and faces nearly identical demands for technology spending.

Long-Term Potential

Mayhue and Koltin observe that the biggest opportunities for private equity lie in midsized to larger CPA and advisory firms that have an appetite for acquiring small firms and need cash to fulfill those goals. That growth feeds greater investment in technology and practice innovation, they say, which in turn attracts additional up-and-coming practices who want to join market leaders.

But investors and firm leaders are adamant that working with tradition-steeped partnerships is an acquired skill.

“You can’t be a tourist in this industry. You have to be very deep and have expertise in financial advisory firms,” says Max Rakhlin, a managing director with Lightyear Capital. The private equity firm has invested in in six financial advisory firms since 2010 and, in 2021, backed one large CPA firm.

The tech expansions that firms crave reach from backroom operations to client services and outreach tools necessary to find and keep clients. Firms seek capital so they can build “an ecosystem that helps managers grow from startup to large platform,” Rakhlin says.

Further, Rakhlin and others say that the chronic talent shortages that plague both accounting and advisory firms may ease as career paths realign with the wider opportunities offered by firms that broaden “up or off” partnership ladders.

A new dynamic—career liquidity—is rapidly replacing the lockstep of partner succession. That alone refreshes the appeal of both accounting and financial advisory to young professionals who don’t want their careers to look like their parents’.

Rising professionals are excited by expanded career vistas, such as new lines of business fostered by an infusion of equity, bursts of innovation and the chance to sell ownership stakes every few years—rather than once, at the point of retirement, says Weinstein. “The long-term potential is enormous and private equity shines a spotlight on that,” he says. “Over time, PE’s participation in the profession will draw more people, because of the value creation.”

Joanne Cleaver has been covering entrepreneurship and business growth for over 30 years for national media, as both a staff and freelance journalist.

Middle Market Growth is produced by the Association for Corporate Growth. To learn more about the organization and how to become a member, visit www.acg.org.