The £277bn golden ticket: Why private equity is so interested in professional services

Private equity interest in the professional services sector has skyrocketed, especially for those with accountancy arms, with major deals being announced nearly every week, including the recent £700m Evelyn Partners deal.

Last month, British private equity firm Apax came out successful after a bidding war for Evelyn Partners’ accounting arm, which it secured for £700m.

This came after Bahrain-based private equity group Investcorp and Canadian pension fund PSP Investments announced they would buy PKF O’Connor Davies, the 25th largest accountancy firm in the US by revenue back in mid-November.

At the same time, Alabama-based Carr, Riggs & Ingram, the 23rd largest firm said it would sell a majority stake to a group led by Centerbridge Partners.

This trend is far from slowing down with the news that the UK arm of Grant Thornton has been positioning itself for private equity backing, with CVC Capital Partners tipped as one of the interested bidders.

Why are these PE firms circling professional service firms like birds eyeing up their prey? Plainly, the sector is struggling with flat profits and partner pay, with cracks starting to show at the bigger firms.

Even at the Big Four giants the cracks were visible, with headlines all year regarding swarms of layoffs across the businesses. This cold feeling inside the Big Four has yet to settle; their most recent batch results revealed each firm has a profitability problem.

Why is PE trying to shoulder in on this sector?

What are the PE firms getting out of it? According to the Department of Business and Trade, the professional and business service sector accounts for 12 per cent of the UK’s total economic output, with a collective turnover of £277bn.

“The sector is attractive because they are stable, non-cyclical businesses providing reliable workflows and revenue streams,” explained James Paton-Philip, a partner at Hill Dickinson told City AM.

They added that these firms can be “consolidated and merged with other businesses”.

While James O’Dowd, managing partner at Patrick Morgan added the sector has “established brands and long-term client relationships”, noting that this provides “a solid foundation for growth and value creation”.

Another area the investment vehicles are looking to transform is in technology. The majority of professional services firms, especially the Big Four, are pumping extra financial resources into building out tech, with a spotlight on AI.

“Private equity firms are keen to invest in professional services firms that have a big potential to be transformed by investment in technology,” explained Fiona Czerniawska, CEO, Source Global. She added that “AI has significant potential in areas like audit, tax, and parts of consulting, and private equity firms.”

The bumps in the road

While private equity firms are leaping into this sector with pound signs in their eyes, like every transaction there can be downsides to buying into an industry you don’t operate in.

The “main issues often stem from cultural and operational clashes,” noted O’Dowd.

He explained that when private equity comes in, it introduces “a more streamlined, profit-driven model that can sometimes clash with the traditional, client-centric culture of professional services”.

While from a legal perspective, most professional services firms are structured as limited liability partnerships (LLPs). Sean Lightfoot, Paton-Phillip’s colleague at Hill Dickinson, highlighted that “LLPs are generally not an appropriate business structure for private equity investment.”

He noted a key step is to often ‘convert’ an existing LLP into a more appropriate vehicle for investment, such as a private limited company.

“It is not possible under UK company law to simply convert an LLP into a private limited company; instead, the assets and liabilities of the LLP are transferred to a newly incorporated private company,” he explained.

Additionally, for the firms it targets because of its audit capabilities, Czerniawska noted that there is worry that quality of audits could potentially fall, as these investment machines focus on increasing profitability.

A recent study by Source Global Research revealed that almost all audit clients (90 per cent) are very positive about private equity firms’ involvement in the audit industry. Despite that, the study noted that clients want to be able to choose whether their auditor is PE-owned.

The data stated that almost all (98 per cent) said that if their current external auditor was bought by a private equity firm, it would make them more likely to change auditors.

Audit quality needs to be ‘enhanced’

Those with audit practices operate with a lot of red tape internally due to the heavier level of regulation for this type of work.

Recently Richard Moriarty, the chief executive of the audit watchdog, wrote to the top accounting firms stating that the Financial Reporting Council (FRC) was not against private equity investment in the sector in principle, but there were risks that needed to be managed in the process.

Speaking to City AM last month, Moriarty stated that “we’re also keen to make sure that audit quality is not just maintained, but enhanced with that change of ownership.”

“The important point is audit isn’t just like any other service market, it has a keen public interest dimension, and that’s something that we’re keen to work with firms and work with potential investors to make sure that everybody understands it,” he added.

What is next in this space?

Not many see this trend slowing down any time soon, but instead, as O’Dowd believes, it will actually accelerate. He stated these funders “are targeting firms with significant growth potential and a high return on investment.”

Czerniawska agreed, pointing out that this increase will continue “if the cost of capital continues to fall alongside interest rates and the return on investment from emerging technology becomes clearer.”

However, as O’Dowd added, with this will come disruption in the sector.

He suggested that private equity will be “reshaping professional services with leaner, more agile firms that offer better compensation, more meaningful equity, and a greater say for their partners and employees.”