The hidden risk in accounting's PE boom: culture

An increase in private equity acquisitions has made odd bedfellows of once-disparate, competing accounting firms. But while these deals are often sold as a straightforward path to scale — shared resources, new technology, expanded footprints — the make-or-break factor for firms after the sale is how well they can maintain and meld their company culture, without destroying what made them a valuable acquisition in the first place.

Private equity's aggressive push into professional services over the past few years has upended the previously steady landscape of accounting firms. In the last three years alone, private equity has taken stakes in five of the top accounting firms and rolled up dozens of others as they look to establish their portfolio funds.

While practically, these deals can take many forms — whether it's a minority investment, platform acquisition or a multifirm roll-up — the reason that private equity firms are looking to the accounting industry for deals is essentially the same: Accounting firms offer a steady revenue opportunity, with business models that could be improved through effective deployment of capital and technology — assets these firms may not be able to access without PE's help.

The tradeoff for achieving these aims, however, is that firms that once operated independently must now subsume themselves to the collective. Firms are almost inevitably expected to operate slightly differently than before, whether it's hitting new success metrics, adopting a different practice-management system, or adjusting the size and structure of their team.

Once a firm takes on a private equity stake, it becomes a part of something larger, and the changes they make, however small they may seem at the time, can have enormous implications for the most valuable asset of all for any accounting firm: their people.

Accounting firms are operating in a different market environment than most of private equity's other target industries right now. Compared to other private equity hot spots like hospitality or veterinary medicine, the accounting industry faces a massive talent shortage. Fewer young people are training to become accountants, even as the industry's seasoned professionals are leaving the field or preparing to retire. Technology can help employees operate more efficiently, but in the world of accounting, where accuracy and precision are paramount, humans are still a vital part of the equation. Whether it's fully appreciated or not, human talent is a massive part of PE firms' investment in the accounting industry.

What this means for accounting leaders (and the private equity firms that have invested in them) is that cultural integration is as critical an integration to get right as any technology or management system. However minor some of these PE-led changes to operations may seem, they can create huge ripples that ostracize a firm's workforce, creating the risk of staff attrition, burnout and disengagement. If acquired teams don't feel they belong on the new platform, they disengage or leave — and in an industry where client relationships are often tightly tied to the individual, losing staff can mean significant cuts to the bottom line.

It's one of the biggest mistakes companies make in any M&A environment, let alone a PE roll-up: underappreciating their team's culture and the role it plays in daily interactions among team members. Culture is built upon the mission, vision and values of a company — and a truly effective culture shows up in every aspect of a business's operations.

It's why, instead of being an afterthought, culture must be part of standard due diligence a firm performs when taking on a new stakeholder. They should be able to document — honestly write down and define — what culture means for their company and its people, and how it shows up in both big and small ways.

Having a physical document like this is critical on multiple levels. From an investment perspective, this sort of document helps a team define the red flags they're looking to avoid in a partner, as well as the non-negotiables they're not willing to change, regardless of where they fall in a PE portfolio. Defining those cultural elements clearly helps firms find the right partner before an LOI is issued.

It's not that a PE firm (or other M&A partner) will be a perfect cultural match right off the bat. Still, a clearly defined cultural document makes everything from due diligence to post-transition integration clearer. With a document in hand, leaders can go into interviews with PE firms able to ask the right questions and understand more clearly the cultural gaps they'll need to share, evolve or teach. Having these goalposts for the first 30 days, 60 days, 100 days, etc., allows teams to assess how they're doing and adapt if things aren't going well.

This sort of culture diagnostic process can help teams recognize their strengths and weaknesses and build a culture that adapts as the team shifts.

Especially in accounting, understanding and fully valuing the human element of these PE deals is vital. Both firms and private equity need to treat culture integration with the same rigor they're bringing to other aspects of these deals. Numbers may justify a transaction, but it's culture that will determine whether these firms can be part of a durable, high-performing platform.