{"id":133468,"date":"2024-10-25t04:27:47","date_gmt":"2024-10-25t08:27:47","guid":{"rendered":"\/\/www.g005e.com\/?p=133468"},"modified":"2024-11-10t17:06:38","modified_gmt":"2024-11-10t22:06:38","slug":"alex-drost-firms-must-be-scrappy-to-compete-with-pe-backed-competitors-gear-up-for-growth","status":"publish","type":"post","link":"\/\/www.g005e.com\/2024\/10\/25\/alex-drost-firms-must-be-scrappy-to-compete-with-pe-backed-competitors-gear-up-for-growth\/","title":{"rendered":"alex drost: firms get scrappy against pe-backed competitors | gear up for growth"},"content":{"rendered":"<p><strong>as private equity gains momentum in the accounting industry, firms face a decision: embrace external investment or double down on independence.<\/strong><\/p>\n<div style=\"padding: 56.25% 0 0 0; position: relative;\"><iframe style=\"position: absolute; top: 0; left: 0; width: 100%; height: 100%;\" title=\"alex drost: firms must be scrappy to compete with pe-backed competitors | gear up for growth\" src=\"https:\/\/player.vimeo.com\/video\/1019022821?h=7af3be9393&amp;autoplay=1&amp;&amp;muted=1&amp;loop=1&amp;autopause=0&amp;player_id=0&amp;app_id=58479\" frameborder=\"0\"><span data-mce-type=\"bookmark\" style=\"display: inline-block; width: 0px; overflow: hidden; line-height: 0;\" class=\"mce_selres_start\">?<\/span><\/iframe><\/div>\n<h6 style=\"text-align: center;\"><span class=\"ac-designer-copy\">click to subscribe anywhere: <\/span><a class=\"ac-designer-copy\" href=\"https:\/\/cpa.click\/apple-podcasts\" target=\"_blank\" rel=\"noopener\" data-ac-default-color=\"1\">apple<\/a><span class=\"ac-designer-copy\">,\u00a0<\/span><a class=\"ac-designer-copy\" href=\"https:\/\/cpa.click\/youtube-podcasts\" target=\"_blank\" rel=\"noopener\" data-ac-default-color=\"1\">google\/youtube<\/a><span class=\"ac-designer-copy\">,\u00a0<\/span><a class=\"ac-designer-copy\" href=\"https:\/\/cpa.click\/spotify\" target=\"_blank\" rel=\"noopener\" data-ac-default-color=\"1\">spotify<\/a><span class=\"ac-designer-copy\">,\u00a0<\/span><a class=\"ac-designer-copy\" href=\"https:\/\/cpa.click\/iheart-podcasts\" target=\"_blank\" rel=\"noopener\" data-ac-default-color=\"1\">iheart<\/a><span class=\"ac-designer-copy\">,\u00a0<\/span><a class=\"ac-designer-copy\" href=\"https:\/\/cpa.click\/deezer\" target=\"_blank\" rel=\"noopener\" data-ac-default-color=\"1\">deezer,<\/a><span class=\"ac-designer-copy\">\u00a0<\/span><a class=\"ac-designer-copy\" href=\"https:\/\/cpa.click\/amazon-podcasts\" target=\"_blank\" rel=\"noopener\" data-ac-default-color=\"1\">amazon music and audible<\/a><span class=\"ac-designer-copy\">,\u00a0<\/span><a class=\"ac-designer-copy\" href=\"https:\/\/cpa.click\/playerfm-podcasts\" target=\"_blank\" rel=\"noopener\" data-ac-default-color=\"1\">player fm<\/a><span class=\"ac-designer-copy\">,\u00a0<\/span><a class=\"ac-designer-copy\" href=\"https:\/\/cpa.click\/audacy\" target=\"_blank\" rel=\"noopener\" data-ac-default-color=\"1\">audacy<\/a><span class=\"ac-designer-copy\">,\u00a0<\/span><a class=\"ac-designer-copy\" href=\"https:\/\/cpa.click\/gaana\" target=\"_blank\" rel=\"noopener\" data-ac-default-color=\"1\">gaana (india)<\/a><span class=\"ac-designer-copy\">,\u00a0<\/span><a class=\"ac-designer-copy\" href=\"https:\/\/cpa.click\/boomplay\" target=\"_blank\" rel=\"noopener\" data-ac-default-color=\"1\">boomplay (africa)<\/a><span class=\"ac-designer-copy\">, or\u00a0<\/span><a class=\"ac-designer-copy\" href=\"https:\/\/cpatrendlines.podomatic.com\/rss2.xml\" data-ac-default-color=\"1\">rss<\/a><span class=\"ac-designer-copy\">.\u00a0<\/span><\/h6>\n<p><iframe loading=\"lazy\" style=\"border: none; height: 205px; width: 100%;\" src=\"https:\/\/www.podomatic.com\/embed\/v2\/podcast\/5781641?episode_id=10813572&amp;theme=dark\" width=\"100%\" height=\"205\" frameborder=\"0\"><\/iframe><br \/>\n<strong><em>gear up for growth<\/em><\/strong><em><br \/>\nwith jean caragher<br \/>\nfor 卡塔尔世界杯常规比赛时间<\/em><\/p>\n<div>\n<p>in this episode of gear up for growth, alex drost, managing principal of connection builders, discusses the growing interest in private equity in the accounting sector. hosted by jean caragher, president of capstone marketing, the conversation delves into the driving forces behind pe investments, the challenges investors and accounting firms face, and how firms can prepare for the evolving landscape.<\/p>\n<\/div>\n<blockquote><p><strong>gear up for growth<\/strong> spotlights the best strategies for smart and efficient growth in today&#8217;s competitive landscape. <strong>more<\/strong>\u00a0<a href=\"\/\/www.g005e.com\/tag\/gear-up-for-growth\/\">gear up for growth every friday here.<\/a>|\u00a0 <strong>more<\/strong>\u00a0<a href=\"\/\/www.g005e.com\/tag\/capstone-conversations\/\">capstone conversations with jean caragher every monday<\/a> | <strong>more<\/strong>\u00a0<a href=\"\/\/www.g005e.com\/author\/jean-caragher\/\">jean caragher here<\/a> |\u00a0get her best-selling handbook, <a style=\"background-color: #ffffff;\" href=\"\/\/www.g005e.com\/shop\/the-90-day-marketing-plan-for-cpa-firms\/\">the 90-day marketing plan for cpa firms, here<\/a> | <strong>more<\/strong> <a href=\"\/\/www.g005e.com\/category\/podcast,video\/\">卡塔尔世界杯常规比赛时间 videos and podcasts here<\/a><\/p><\/blockquote>\n<div>\n<p>the accounting profession is no stranger to change, but according to drost, recent shifts are reshaping the industry more dramatically than ever before. \u201cwe\u2019re seeing changes not just in technology but in the makeup of the profession itself,\u201d he says. \u201cthe aging partner base and different generational approaches to firm ownership are creating gaps that private equity sees as opportunities.\u201d<\/p>\n<p><!--more--><\/p>\n<p>drost highlights the demand for advisory and consulting services as a key growth area, noting that clients are increasingly looking for more than just traditional accounting services. \u201cthe client we serve is changing. middle-market businesses have increasingly complex needs, and firms that can expand their service offerings will be in a stronger position to grow.\u201d<\/p>\n<p>private equity firms are capital allocators, seeking to grow businesses for future sale. in the accounting world, they see the opportunity to consolidate fragmented firms and bring in capital to expand service lines and improve profitability. \u201cprivate equity is attracted to the accounting industry because of the growth potential,\u201d says drost. \u201cthey\u2019re looking to invest in firms with strong potential, make them more efficient and profitable, and then monetize that investment.\u201d<\/p>\n<p>one of the biggest challenges, however, is building trust. \u201cthese are human businesses,\u201d drost emphasizes. \u201cpartners in accounting firms are not just shareholders; they\u2019re deeply involved in the day-to-day operations. convincing them to trust an outside investor can be a hurdle.\u201d<\/p>\n<p><strong>key takeaways<\/strong><\/p>\n<ol>\n<li>private equity is rapidly gaining traction in the accounting industry, offering growth opportunities for firms.<\/li>\n<li>technology and demographic shifts are reshaping the market, creating new opportunities for firms that can adapt.<\/li>\n<li>pe firms are interested in consolidating smaller, fragmented firms to create more efficient, profitable businesses.<\/li>\n<li>the key challenge for pe investors is building trust with accounting firm partners who are heavily involved in operations.<\/li>\n<li>pe investment is not for every firm\u2014firms should carefully consider their long-term goals.<\/li>\n<li>mid-sized firms are often stuck between growth opportunities and the limitations of their structure, making them prime targets for pe.<\/li>\n<li>pe investment can help firms expand their service lines and improve technology to meet evolving client demands.<\/li>\n<li>for firms that choose not to pursue pe investment, staying competitive will require strategic planning and investment.<\/li>\n<li>the accounting industry is likely to see continued consolidation, with the largest firms growing even larger.<\/li>\n<li>firms should start positioning themselves for growth\u2014whether through pe or other strategies\u2014now to stay competitive in the future.<\/li>\n<\/ol>\n<p style=\"padding-left: 40px;\"><em><strong>more about <b>alex drost<\/b><\/strong><\/em><\/p>\n<figure id=\"attachment_133469\" class=\"thumbnail wp-caption alignright\" style=\"width: 201px\"><img loading=\"lazy\" decoding=\"async\" class=\"wp-image-133469 size-thumbnail\" src=\"\/\/www.g005e.com\/wp-content\/uploads\/2024\/10\/alex-drost-headshot-201x201.jpg\" alt=\"\" width=\"201\" height=\"201\" srcset=\"\/\/www.g005e.com\/wp-content\/uploads\/2024\/10\/alex-drost-headshot-201x201.jpg 201w, \/\/www.g005e.com\/wp-content\/uploads\/2024\/10\/alex-drost-headshot-100x100.jpg 100w, \/\/www.g005e.com\/wp-content\/uploads\/2024\/10\/alex-drost-headshot-24x24.jpg 24w, \/\/www.g005e.com\/wp-content\/uploads\/2024\/10\/alex-drost-headshot-48x48.jpg 48w, \/\/www.g005e.com\/wp-content\/uploads\/2024\/10\/alex-drost-headshot-96x96.jpg 96w, \/\/www.g005e.com\/wp-content\/uploads\/2024\/10\/alex-drost-headshot-150x150.jpg 150w, \/\/www.g005e.com\/wp-content\/uploads\/2024\/10\/alex-drost-headshot-300x300.jpg 300w\" sizes=\"auto, (max-width: 201px) 100vw, 201px\" \/><figcaption class=\"caption wp-caption-text\">drost<\/figcaption><\/figure>\n<p style=\"padding-left: 40px;\"><em>alex drost is a growth-minded consultant with a proven track record of success in driving innovation, leading strategic initiatives, and championing tactical execution. he has nearly two decades of entrepreneurial experience and continually demonstrates his ability to navigate dynamic business environments. he is adept at managing complex projects, simplifying core objectives, and motivating teams to achieve their best work. <\/em><\/p>\n<p style=\"padding-left: 40px;\"><em>beginning his career in financial services, alex most recently served as vice president of middle-market investment banking with\u00a0cascade partners. with 10+ years of m&amp;a and private capital markets experience, he has successfully led capital raise, buy-side, and sell-side transactions in various industries, including consumer-facing healthcare, multi-site retail, manufacturing, and professional services. <\/em><em>as the managing principal of\u00a0connection builders, alex consults with middle-market advisory services firms on setting and attaining strategic initiatives to unlock growth potential and maximize value creation opportunities. <\/em><\/p>\n<p style=\"padding-left: 40px;\"><em>his work includes strategic planning, retreat facilitation, and growth enablement services. <\/em><em>as a recognized middle-market expert, alex has served as a board member and strategic advisor for the\u00a0association for corporate growth\u00a0(acg) and an executive committee member for the\u00a0great lakes capital connection\u00a0(glcc). he is also an\u00a0association for accounting marketing (aam) business development advisory board member.\u00a0<\/em><em>alex earned a bachelor of business administration from\u00a0<a href=\"https:\/\/www.northwood.edu\/\" target=\"_blank\" rel=\"noopener\">northwood university<\/a>, concentrating in accounting and finance. he also holds an m.s.f. from\u00a0walsh college, with an emphasis on corporate finance, and is a registered cpa in the state of michigan.<\/em><\/p>\n<\/div>\n<p><strong>transcript<br \/>\n<\/strong>(produced by automation. not edited for spelling or grammar.)<\/p>\n<p>jean: hello, thank you for joining gear up for growth, powered by 卡塔尔世界杯常规比赛时间. i&#8217;m jean caragher, president of capstone marketing and your host. this episode is focused on private equity as a growth strategy. our guest is alex drost, managing principal of connection builders, who consults with middle-market professional services firms on strategy and growth. he has more than 10 years of experience in m&amp;a and private capital markets. alex, welcome to gear up for growth.<\/p>\n<p>alex: jean, thank you for having me.<\/p>\n<p>jean: alex, you and i met at the annual association for accounting marketing summit, where you gave a presentation on the impact of private equity in the accounting profession. what are your thoughts about the surge in pe investment in accounting firms now?<\/p>\n<p>alex: i think it&#8217;s important to step back first and take a look at two things. one, what private equity is and what they&#8217;re trying to accomplish. and then the other side is what&#8217;s happening in the accounting industry. so, let&#8217;s just start quickly around the accounting industry. there&#8217;s a lot of changes happening in the market, and one of them most notably technology, the advancement of technology. another key factor is demographics, the aging partner base, and the difference of generations and their interest and appetite in owning a firm and what that career path has looked like. and then on top of that, one of the really, i think, sizable changes we&#8217;re seeing is the demand for both advisory and consulting style services that pair well with the existing staff, the existing team and talent. and then on top of that, we&#8217;re seeing an expanding aperture of what fits inside of an accounting firm today, whether that be technology, risk, or managed services, other types of service lines that, again, all come back to one core need, and that&#8217;s serving the client. that&#8217;s fundamentally what service providers are doing.<\/p>\n<p>and so then you ask yourself, not only do we have, again, the technology shift, some of the other shifts changing the business model, but the client that we&#8217;re serving is actually changing a lot, too. and if we think about the client that we&#8217;re really serving, for most firms, are businesses, right? a lot of their business clients and those businesses are tend to be what often is called a middle market company. what that means, typically privately held, typically less than a billion in revenue, that those clients have an increasingly complex business need happening. the marketplace becomes more complex, increased demand there. and then to layer on top of all of that, this is, i think, was a trend, but the, if you will, the covid effect, we broke down barriers and what it looked like to service. and so you all of a sudden saw a industry that had a projected, a sizable increase in need and demand. you had a industry that was fragmented. you had an industry that had changes from technology coming and then ultimately you had a shift in how the buyer buys the product or the service. all of that creates a really complex business environment.<\/p>\n<p>now behind that, and everyone that operates a firm knows, those are all probably dynamics that you&#8217;ve thought about and dealt with in recent history here. if you look at private equity, what private equity sees, and private equity is really nothing more than capital allocators. they&#8217;re investors of capital. and so they take the private dollars that they have, they invest them in a business and the entire objective is to grow that business, grow that investment to become a more valuable investment before they eventually sell and monetize it. in the accounting space and the accounting industry and why this surge, i believe, is starting to unfold is going back to, we&#8217;ve got shifting market dynamics, we&#8217;ve got growth opportunities, a need to bring an investment of capital in many cases, and a need to change the operating structure or the government structure in many cases to be successful in navigating that. and private equity sees an opportunity to put dollars into the industry and to consolidate some of the fragmentation to expand those service lines and ultimately build a better, more profitable business that becomes a high return on their investment. that&#8217;s the fundamental thing that&#8217;s playing out here.<\/p>\n<p>jean: right. so i&#8217;m going to go off script a little bit. what do you see as the biggest challenges that the private equity investors are seeing in the accounting firms themselves? because so far, it&#8217;s really been the leaders of firms that are perhaps more risk-taker personalities and are willing to be the first in the market to do something different. so give me a challenge there on the side of the pe investors.<\/p>\n<p>alex: you&#8217;re saying if i&#8217;m private equity, what challenges am i having entering the market? so the challenge, and this is going to be for private equity investors, pretty much in any market, the number one challenge is building trust in that, like getting someone to think it makes sense, but also being at the right place at the right time and having a willing seller that is looking for a willing buyer. that&#8217;s fundamentally their challenge.<\/p>\n<p>in accounting, there&#8217;s two, the specific things that make that ever more complex is, one, they&#8217;re human businesses. they&#8217;re very people-based businesses. this isn&#8217;t a manufacturing, this isn&#8217;t, and all of those people are, many, many of those people are highly involved in the day-to-day work. some of them, a good chunk of them are what we call partners and owners, and they are a part of that kind of senior element of that, of the organization. so that means that those people have to want to do it, trust it, and want to be a part of it. and that is, that&#8217;s absolutely, i can assure you the number one challenge that an investor is having is trying to find the right fit and the right match. but at the same time, i want to be clear, that&#8217;s not accounting-specific, that&#8217;s any industry. you&#8217;re just talking about a business, and this maybe is a place to talk about it a little bit. the difference is, most businesses that are 25 million in revenue don&#8217;t have five equal owners. they have one. and so now take that, and as you get bigger and bigger and bigger, that becomes even more so. and so that&#8217;s complicated. and that, i think, is probably their biggest hurdle, is getting over that comfort and trust level, just given the sheer number of participants in that conversation.<\/p>\n<p>jean: right. and generally, cpa firm partners are accustomed to having a vote. and they feel that all their votes are equal, which makes that managing partner job even that much more difficult, because that person needs to be able to lead their partner group and come to a decision for the future of their firm so that everybody is on board with what whatever the decision is.<\/p>\n<p>alex: i would argue, i would even add in there, that one of the core characteristics, i think, that you&#8217;ll see a private equity firm bring over time that will be a value driver, is doing what you just said. and there&#8217;s two parts of it. one, it is, as you said, and i had it for the presentation that you and i met at, talked about where you had 30 partners that each had an equal slice, and then what it would look like if all of a sudden you had one partner own 70% and the other in the 30%. and that voice change allows for better strategic decision making.<\/p>\n<p>but what it also actually does, and this is probably the broader question in accounting that i think is shifting. as a partner, your income is typically given to you and you take your draw, your partner comp, and you know what your partner comp. it&#8217;s kind of all lumped together. and what the reality is, that&#8217;s two types of income. one of those dollars are the dollars you earn from being an employee, working, delivering products and showing up every day to run the business. some of those dollars are returned on your investment as an owner of a business. and that dividend, if you will, component, that&#8217;s typically when private equity comes in, that&#8217;s some of the change in compensation structure that will happen, is that portion will become what is typically referred to as ebitda, will flow into the cash flow calculation.<\/p>\n<p>and that chunk, that difference, what is really happening when you go to that single owner, that private equity investor owning 70% of that equity, you&#8217;re shifting and allowing that person to bear the bulk of the risk appetite for the business. and the reason that matters is because you talk about in the accounting industry is one that is commonly thought to be a very risk-adverse set of individuals. right? they operate that way. the finance 101 tells us greater risk equals greater return. and that doesn&#8217;t mean you take absolute maximum risk, but it does mean that at times you have to take greater risks if you want to achieve greater returns.<\/p>\n<p>private equity is there in fundamental business model is taking dollars to go achieve greater returns. and they&#8217;re going to do that by taking taking greater risk, by investing dollars into projects, acquisitions and in infrastructure in a way that the current ownership base may have some individuals that might have a risk appetite for that. but it&#8217;s very rare that you would get 30 individuals that all had a risk appetite and were willing to make that investment. and that that i think is where we&#8217;ll see one of the biggest changes in how firms operate from private equity.<\/p>\n<p>jean: right. so you&#8217;re kind of dovetailing into my next question. allan koltin of koltin consulting, sure you&#8217;ve heard of him, has been quoted as saying that more than half of the cpa firms in the country won&#8217;t qualify to be part of private equity. so my first question there is, do you agree with that, with alan&#8217;s statement?<\/p>\n<p>alex: i guess i don&#8217;t know necessarily qualify. and let me let me give it from my perspective. so, one, in say every firm in the country, let&#8217;s let&#8217;s just talk the the ipa top 500, if we will, top 500 list, some so that we know like we&#8217;re not talking about the single producers or people that are out there and they&#8217;re all but like the firms that are 5, 7, 10 million or greater in size.<\/p>\n<p>jean: let me interrupt for one second. so just for the convenience of our listeners, let&#8217;s clarify that ipa is inside public accounting.<\/p>\n<p>alex: i&#8217;m sorry. yes. yep. so the top 500 list. now, if we&#8217;re looking at that list and we think about who would qualify, there&#8217;s there&#8217;s two types then. one, in private equity, you have two types of primary investments. and so what you have is called a platform investment. and that is when as an investor, i&#8217;m looking to buy my first accounting firm and i&#8217;m going to use that as a platform. and then i&#8217;m going to do what&#8217;s called a roll up or a bolt on strategy where i&#8217;m going to look to acquire additional businesses behind that and add it on to mine to create, continue to create growth through that acquisition arm. right? and so that buyer, the difference is, is that the first time platform, that is going to be there. in this industry, every investor will have a slightly different view on this or every private equity investor. but five to seven million in ebitda cash flow is probably the low end of where anyone will look at getting into a platform because otherwise there&#8217;s just not enough juice in the business to really have to support the debt, to support the cash flow that you need to really make the investment. right?<\/p>\n<p>so firms that are of that size or greater, and it depends on where you look, let&#8217;s just say 7, and we assume a 12% profit margin, call it 60 million and up in revenue are the firms that are fairly in there. and i know we&#8217;ve seen some transactions below that. and so, again, it doesn&#8217;t mean it can&#8217;t work elsewhere, but those firms will be looked at from a platform to begin with. outside of that, the other way you can be looked at is an add-on a bolt on an acquisition behind a platform. right? and at that point, then there becomes two different types of buyers available for you. buyer one is what we would call a financial buyer, which would be the private equity backed platform acquires you. so you&#8217;re the bolt on. and then oftentimes it can also be called or a separate type of buyer can be called a strategic buyer. and that&#8217;s typically a corporate buyer.<\/p>\n<p>accounting industry is interesting because that doesn&#8217;t necessarily exist. it looks a little different. but some of the bigger firms like a bdo buying a $5 million firm kind of looks like a corporation buying a small business. so it has a similar sense. but what that means is that the &#8220;qualification&#8221; has a lot more to do with the buyer than it does the seller, because at the end of the day, i mean, all assets will have some value in the market, depending on what they&#8217;re worth. even businesses that go bankrupt get sold and there are fire sales and like everything has a buyer at the right price. now, there may be an absolute mismatch between the sellers and their willingness to sell it what the buyer is willing to pay. and the buyer will always be willing to pay more for the platform than they will for the bolt-on more typically, because the argument is that you get the platform, there&#8217;s more value because it&#8217;s a larger business, that&#8217;s your starting point. and then you can do the acquisitions behind that.<\/p>\n<p>so i guess as i talked to them a lot, i don&#8217;t i don&#8217;t believe it&#8217;s a qualification. i think any business could qualify. there&#8217;s typically a willing buyer for any willing seller out there for almost anything in the market. and so that that is a dynamic. but the qualification to be a platform, totally different. and then the other layer behind all of this is when i look to make an acquisition, especially as an investor, i need to be conscious of my capital and investing it in the right way. so i want to do deals, investments that make sense. and some of that is i need to buy, i need to get, expand my market. so i&#8217;m looking broadly at what i&#8217;m willing to accept. but what i&#8217;m not going to accept is something that won&#8217;t work out in the long run. so i don&#8217;t care how great a firm is, if you have 50% or 40% of the partners that say, &#8220;oh, no, no way. i would never do this. i can&#8217;t make a transaction with you because i can&#8217;t get comfortable with that.&#8221; so that may that may disqualify them from being a candidate to sell. but from a buyer&#8217;s perspective, you want fit, those things matter. but if it&#8217;s really i think the disqualification comes far more from the seller other than in the case of the platform. does that make sense?<\/p>\n<p>jean: it does make sense. and i think your answer is very interesting because it&#8217;s opposite of each other, which i find intriguing. right. that&#8217;s why i just enjoyed having these conversations with really smart people. in a recent issue of inside public accounting, you talked about what you called shredding of the industry. tell us what you mean by that. and is that part of what&#8217;s happening with pe investment or were you referring to something separate?<\/p>\n<p>alex: no, i think the pe investing investment is what&#8217;s going to accelerate the trend from happening. so think back and if you think back to the history of accounting and some of the transitions, the big 8 to the big 4 and think about where we are in the market today, big 4 versus number 5 through 10, there&#8217;s a pretty sizable gap there. and we continue seeing, think about in that those top firms, there are two top firms that are top 10 firms today that did not exist a couple of years ago. and so that continuing to see larger and larger firms on that upper end. and if you look at, say, the top 100 list, you&#8217;re seeing more of them continue to become larger and larger. beyond that, completely separate side to this conversation, is if you if you look at the if you were to take, again, the top 500 list and you looked at the data and broke it out by number of firms at what revenue size, what you&#8217;ll see is that firms, there&#8217;s a cluster and a concentration of firms that struggle somewhere between 15 and 25-ish million, depending on where you kind of bucket the data. but let&#8217;s just say broadly 20 to 30 is an easy bucket.<\/p>\n<p>and i&#8217;m sure there&#8217;s a lot of people listening right now that are either that may be at a firm that are on the cusp of 20 or they&#8217;re stuck somewhere between 20 and 30. there&#8217;s not as many that are at 50 and it actually dissipates very quickly. it falls off very fast when you break out past that 30-ish million mark. and that&#8217;s that&#8217;s the no man&#8217;s land in a business and especially professional services. goes back to my comment earlier, i&#8217;m doing 25 in revenue and i have five voices, five business owners. it&#8217;s hard to like drive a business that&#8217;s, i don&#8217;t want to say small because it&#8217;s still a sizable organization, but it&#8217;s not an enterprise and driving that with five owners is hard in that. and more importantly, the difference of how a business has to operate between 25 and 75 is huge. it&#8217;s a very different operating. it&#8217;s different infrastructure. it&#8217;s it has to run and be thought of differently. it has to cover different geography. and so many firms have struggled to get across that.<\/p>\n<p>and what i when i say shredding, we already have some of a shred, right? it&#8217;s already a barbell, if you will, weighted industry, not by revenue volume, but by number of firms. and what i believe we&#8217;ll continue to see are more and more firms that are the big ones at the top are going to get larger and they&#8217;re likely to continue to acquire. it&#8217;s hard because there will always be a top 100 list. there&#8217;ll be a bigger gap between what those look like. and that&#8217;s the shredding that i think will happen. now behind that, i think it means the way they operate, the clients they serve, how they play in the market, it&#8217;s not going to look alternate reality different, but it&#8217;s going to look different.<\/p>\n<p>just like today, if i am at a top 25 firm, it looks different than if i&#8217;m at a firm that&#8217;s in the top 200. right? and so i just think you&#8217;re going to continue to see that separating in it more and more. i kind of i always think of it as a vacuum where the big firms are going to continue to vacuum upward. right? and i don&#8217;t think we&#8217;ll see any firms fall apart. we&#8217;ve seen that historically. it has happened at times. it might at some point. but the reality is big firms don&#8217;t tend to get smaller other than through maybe falling apart or fraud. and so they they tend to stay sizable, which means that the smaller firms, that gap, i think will continue to to remain there. and it&#8217;s just going to continue to change that market. but i do think especially in that top 100, north of 100 in revenue is where you&#8217;re going to see a decent amount of consolidation.<\/p>\n<p>jean: right. interesting. so, listeners who may be in that, you know, 15 million, 20 million, maybe smaller, but they&#8217;re looking to get to that next level of growth. they&#8217;re considering pe investment now to get that capital to create those new services or enhance their technology or pay their people more, right, or the other things that accounting firms need to do in order to continue as a profession that people want to work in and want to have careers in. so, what&#8217;s your advice about firms getting what i&#8217;m saying, you know, pe-ready? what kind of factors need to be in place so if they are being considered by a pe investor, there is a better chance for the firm to receive that investment as opposed to not receiving the investment?<\/p>\n<p>alex: you&#8217;re asking an absolutely great question. i will, i guess, shamelessly plug, reach out to me. have a conversation. let&#8217;s talk about why. so here&#8217;s what it needs to be understood. so, number one, let&#8217;s just we&#8217;re going to use $25 million as the number. that&#8217;s the size for it. but we&#8217;re talking in that range and we&#8217;re talking about going back to this idea, this no man&#8217;s land, it&#8217;s very difficult to get past there. there are a lot of firms that are somewhere in that revenue ban and they&#8217;re trying to figure out what to do, where to go from here. for those firms, there&#8217;s a couple of options for them. let&#8217;s go at it from this angle. so if i&#8217;m trying to think about private equity and how what i want to do, what i need to understand is two things. what what is my long term objective? am i trying to retire? and when i say i, i really mean who owns the equity, because that&#8217;s what matters at the end of the day.<\/p>\n<p>there&#8217;s a business structure, a strategy that matters for &#8220;the business,&#8221; the collective unit. but it&#8217;s the equity owners that matter because they own the business. and so that&#8217;s who really matters in that. and if they are looking for a retirement, then what they should be thinking about is setting their business up to be able to maximize that value in a shorter period of time than a longer period of time. and part of that is the tactics of how you do it at that point is far more about just polishing up what you have, getting a good advisor involved, and working the marketplace until you can find an appropriate buyer. and that may take some time, especially if you want to be thoughtful of it and you want to try to maximize the enterprise value that you can obtain. there&#8217;s also part of&#8230;<\/p>\n<p>jean: yeah, i&#8217;m sorry. it&#8217;s my understanding that just like cpa firms are different and they have different personalities or different industry specialties or service areas, there are different types of pe investment companies. and some get the rap of just being a very hard, annoying sell and others, you know, maybe not. so i think the point you&#8217;re making there is that it&#8217;s really important for the cpa firm owners to have that same level of comfort in the pe investment company as the pe investors need to have in the cpa firm.<\/p>\n<p>alex: arguably, it&#8217;s far bigger for the seller. and the reason it&#8217;s bigger, the seller needs that comfort, is because at the end of the day, you are right. there&#8217;s different attitudes. private equity, there are a lot of varieties and a lot of different investment strategies. i always chuckle a little bit because everyone you talk to that works in business development for private equity will tell you, &#8220;well, you know, we&#8217;re a little bit different. we&#8217;re more flexible.&#8221; and it&#8217;s like if you all say it, maybe you&#8217;re not. if any of my friends that are listening do pebd, i hope you&#8217;re laughing. but the reality is they have a similar goal, which is to maximize return on their investment. but behind that, so that&#8217;s the dollar. that&#8217;s the economic component. they give dollars in. they get dollars out when they sell, maximize that return.<\/p>\n<p>the difference is from firm to firm is the humans, the managing partner that&#8217;s dealing with it. right? and audit at three different firms can look exactly the same in terms of what that final number is. but you can have very different experiences depending on who you&#8217;re working with as that auditor. right? so that is where personality matters.<\/p>\n<p>and that&#8217;s where i go back to my as an advisor, particularly when talking to firms that are exploring a sale or exploring any kind of an opportunity, what are my options? so much of this comes down to really dating and getting to know who that investor is. but the challenge becomes you can&#8217;t go date until you know what you&#8217;re looking for. and oftentimes, i think firms aren&#8217;t certain what they&#8217;re looking for. and that&#8217;s where most of the time when i&#8217;m working with the group, we tend to start off with really understanding and having kind of an educational piece of what are you trying to achieve and what are your real options? because it goes back to, depending on where you&#8217;re at, you want a retirement, you&#8217;re looking at a way to get out of the business and sell at a time that the market is paying a premium, then you really need to just start polishing things up and going to market and really focusing more on finding that buyer because it can be a long process.<\/p>\n<p>on the other hand, if you are a younger firm or have a younger leadership team and you&#8217;re saying, huh, this is really interesting and i think we&#8217;re in a really good place. how can we turn this thing up a level and find a way to bring a partner in that can can pour gasoline on the fire? right? the idea is they&#8217;re dumping dollars in to give you the capital to go grow. and then somewhere between those two scenarios is the firm who says, you know, i think we would be open to going to sold into another firm, but i&#8217;m not sure now is the time. but what i do know is it&#8217;s on our radar and we want to start taking steps to make where we can gain more value before we sell. right?<\/p>\n<p>jean: and, alex, what are some of those steps?<\/p>\n<p>alex: so that&#8217;s really the key here. so number one, part of it, goes back to same for the very first group that just trying to get out. polishing up what you have and presenting the information right is a huge part of that because you have to help the buyer see the value. in all businesses, they ultimately are going to do a financial analysis and it&#8217;s going to come back. someone&#8217;s going to talk about a multiple of ebitda. but ultimately, it comes down to how do you position how interesting you are, how unique you are. what is your value proposition? and part of that&#8217;s doing analytics and using data and metrics to show improve that and how you compare to your peers or other cohorts, but also being able to highlight for yourself in doing some of that analysis.<\/p>\n<p>and this goes back to that. if i&#8217;m just trying to get out, if i see a pig, i put lipstick on it. if i have some time and i see a pig, i&#8217;m going to go make bacon because if i can figure out how to get this cleaned up a little bit and i do some analysis and those things that might be, it could be profitability margin. you could be looking at, right, trimming off clients that are not generating as much profit in, or it could be looking at different growth initiatives. what growth initiatives can you take or take the example and i had no direct involvement in this. so i&#8217;m speaking just for my own, what i hear in the market or see in the marketplace. aprio who recently took down a private equity investment, for the last couple of years before this, aprio was on an acquisition spree. they were buying firms left and right because that&#8217;s a good way to grow your revenue, show a high growth rate, demonstrate that you know how to do acquisitions, demonstrate you have a playbook to do it and show that you can integrate them and drive value.<\/p>\n<p>well, if you can do that, you can get paid more because you can prove that you&#8217;ve done that. right? and what&#8217;s fundamental, this is where my background is i&#8217;m a cpa, but my background is is heavily concentrated in finance and i think of everything in finance is there&#8217;s two principles, risk and return. more risk equals more return. and the other principle is the idea of return on capital. you put dollars out and you get dollars back into the business, right? and if you can look at cash flow because cash flow is what values an asset. so all assets are, are they&#8217;re essentially present value of cash flows. what can i do to increase cash flows? how can i make cash flow higher? right? and that seems simple. everyone knows that.<\/p>\n<p>but then what it really comes down to is margin reoccurring stickiness. how how reoccurring is that revenue? diversification and diversification of industry, diversification of customer because those are all risk points and the lower i can lower my risk, the better. and then the higher i can increase my cash flow, the better, profit margin. right? and so that&#8217;s those are the questions now again, the levers all look different. everyone has a different strategy. there&#8217;s a different way to go about it. truthfully, in a short period of time, it&#8217;s hard to really make much change and especially to get much credit for it, other than some kind of like new contract or sizable client acquisition or acquiring another firm. but there are other things you can do to start driving towards that over a longer period of time.<\/p>\n<p>jean: right. because i believe also the marketing strategy of niching and specialization is really important. i&#8217;m a big fan of there&#8217;s still lots of words out there that are would still be considered generalist. but i&#8217;d have to believe that if a firm can demonstrate strong industry knowledge that have leaders running those lines of business and having other areas of specialization, whether that is m&amp;a or wealth management or what a technology, whatever it is, that the pe investors are also going to look at that and say, gosh, like this firm, it may be a partnership still, but they&#8217;re running their firm like a business. and that would make a firm like that more attractive.<\/p>\n<p>alex: absolutely. and so i want to come back to running like a business and the two points you made. i&#8217;ll give you the finance terms around it. so when you say the&#8230; how do i word this appropriately? having a niche, building expertise, put you in a situation where you have a couple of things that happen. one, you can arguably charge higher rates because you have greater expertise. two, your clients in your opportunities are stickier because you are better than others and you&#8217;re more well known for it. and three, i can probably get a little bit higher profitability margin because i pick up efficiencies from being good at what i do, right, from working in one area. on the other side of that, so that again, that&#8217;s niching. right?<\/p>\n<p>the other one, and this is you hear more and more of this, some form of managed service. and this is reoccurring nature. tax prep in some ways has a kind of similar element to it because that&#8217;s something that i know will happen predictably that there is a constant force of like a buyer market out there that i&#8217;m selling to. and it becomes switching costs tend to be hard for people because it&#8217;s annoying to switch accountants. it&#8217;s annoying to switch things. and then that business model becomes a little more of a commodity, but that becomes far more about the operational infrastructure, whether it be out-shoring or the technology investments, different things you can do to create leverage there. and that&#8217;s niching in terms of a service line, if you will, versus just the industry side of it. but that goes back to if i have sticky reoccurring high-margin cash flow, i have a really nice business. and that&#8217;s what you&#8217;re trying to drive towards.<\/p>\n<p>jean: right. okay, so folks listening or watching, another blog about the importance of niche marketing and specialization. it&#8217;s music to my ears. okay, so two questions before we end. how can firms not receiving pe funding compete with those who are?<\/p>\n<p>alex: so a couple of things i would say is there&#8217;s going to be a difference in directly competing with a firm that has more capital, and the difference is they&#8217;re going to be more sophisticated over time and they&#8217;re going to become larger and bigger over time. what that means if i don&#8217;t want capital is a couple of things. i think i guess maybe first i&#8217;d say firms that say they don&#8217;t want private equity, again, give me a call. let&#8217;s have a conversation. not trying to convince anybody, but make sure you fully understand why you&#8217;re saying no, because i actually think many firms will be just fine being independent. i do not think it&#8217;s going to be where every firm has to sell by any means. and i think there&#8217;ll be a lot of great businesses that people will be able to build and make plenty of money off of running without having that investment. but make sure you understand why you don&#8217;t want it and why you&#8217;re going to stay independent.<\/p>\n<p>assuming that the answer is because we like what we have and we think we can remain competitive, then you have to ask yourself a couple of things because the changes that are going to happen is if my competitor is better capitalized, has more money to invest in growth, it&#8217;s going to make it harder to compete. so you have to figure out how you&#8217;re going to bridge that and maybe you&#8217;re going to be scrappier and you&#8217;re going to figure out how to maneuver in the market better with being bootstrapped. that&#8217;s fine. you can do it. but again, you have to know that they&#8217;re going to be more competitive. so you have to be thoughtful, strategic of what you&#8217;re going to do. i would argue for most firms, you&#8217;re going to have to invest some dollars. i don&#8217;t think many firms are going to go status quo without anything changing and remain competitive.<\/p>\n<p>number two behind that is you have to know what you want to build the business into being. and if i take a $25 million firm that&#8217;s doing some tax work and doing some servicing some local clients and everyone in my firm is making fine money and they&#8217;re fine with it, it works. there&#8217;s nothing wrong with it. you might not have that valuable of an asset when you want to retire. and i know a lot of people say they don&#8217;t think about retiring, but realize that biology says we all have to retire sooner or later. so it is not forever. and so sooner or later, you might not have a pretty business if you just sat in that. but there&#8217;s also, i mean, think going back to these firms get bigger, there&#8217;s going to be some clients that fall down. there&#8217;s going to be firms that drop the ball and perform wrong. and there&#8217;s going to be perverse incentives within financially backed firms that maybe are more profit-driven than the others that mis-serve a client or so. right? that&#8217;s inevitable to happen. so there&#8217;ll be opportunities that can fall down that you can pick up and you can take and build.<\/p>\n<p>and so if you if you&#8217;re trying to build a business, what you fundamentally should be doing, if you&#8217;re trying to stay independent, this goes back to why i say make sure you understand why you&#8217;re staying independent. build a strategy and execute a strategy just like they are. right? do the same thing there. you&#8217;re going to be more bootstrapped. you don&#8217;t need as much capital. the single biggest, and this is probably for a little bit higher up in the market, but one of the changes that i speculate will come that will affect the market is both between esops, employee stock option plan structured firms, grassi, bdo, and i believe there&#8217;s a couple others that have done that already. and i think there&#8217;s more coming there. or these private equity backed firms that transition from that traditional partnership structure where everyone has a piece and you start seeing what looks more like incentive units or fractional shares or different warrants, stocks, options, right. even that publicly traded c-biz, you have different compensation structures that you can give to people.<\/p>\n<p>and this is where there&#8217;s a lot of, especially people who&#8217;ve been around the industry for a long time say, &#8220;well, i&#8217;m not sure that&#8217;s a good idea.&#8221; but i also can tell you that the 35 year old that&#8217;s working at the $25 million firm as a manager today looking upward and saying, &#8220;i&#8217;m not sure this is where i want to be. and i don&#8217;t know how i&#8217;m going to get to partner,&#8221; gets a call from the firm across the street that&#8217;s private equity backed and has an equity instead of option plan to help them move into a &#8220;principal role&#8221; where they have equity and they feel they have upside in their careers better, i have a good feeling where that ambitious high-performing individual might land. and so you&#8217;ve got to be ready to address that and figure out what you&#8217;re going to do around it. and that all comes back to fundamentally corporate governance and how the idea of having a lot of cooks in the kitchen that all share in the recipe and baking at the same time is a disaster. and that works when things are okay. it&#8217;s hard to be competitive, especially in a hyper-competitive market that i think we&#8217;re watching ourselves shift into.<\/p>\n<p>jean: agreed, agreed. okay. so, alex, the last question is a bonus question. what is your favorite sport?<\/p>\n<p>alex: oh, favorite sport. i like mountain biking. i&#8217;m a cyclist in general, but i love mountain biking. that&#8217;s probably i&#8217;d say reading, but i don&#8217;t know if that&#8217;s a sport.<\/p>\n<p>jean: yeah, that might be a hobby. i don&#8217;t know if i would call reading a sport. so mountain biking, i&#8217;ve never done that myself. and at this point, i don&#8217;t see me mountain biking. but i think that i mean, that&#8217;s i think it&#8217;s a sport that&#8217;s really gained a lot of popularity.<\/p>\n<p>alex: it&#8217;s fun. i enjoy it. it&#8217;s my release from my computer screen.<\/p>\n<p>jean: there you go. that sounds wonderful. well, i&#8217;ve been speaking today with alex drost, managing principal of connection builders. thank you, alex, for your time today.<\/p>\n<p>alex: thank you, jean. i appreciate it.<\/p>\n<p>jean: and thank you for tuning into gear up for growth. be sure to check us out the next time when we focus on another topic crucial for accounting firms, aiming for smart growth in today&#8217;s marketplace. i&#8217;ll see you then.<\/p>\n","protected":false},"excerpt":{"rendered":"<p><strong>as private equity gains momentum in the accounting industry, firms face a decision: embrace external investment or double down on independence.<\/strong><br \/>\n<img loading=\"lazy\" decoding=\"async\" class=\"aligncenter wp-image-133668\" src=\"\/\/www.g005e.com\/wp-content\/uploads\/2024\/10\/alex-drost_-firms-must-be-scrappy-to-compete-with-pe-backed-competitors-_-gear-up-for-growth-low.gif\" alt=\"\" width=\"250\" height=\"141\" \/><br \/>\n<strong><em>gear up for growth<\/em><\/strong><br \/>\n<em>with jean caragher<\/em><\/p>\n","protected":false},"author":1334,"featured_media":133668,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"_relevanssi_hide_post":"","_relevanssi_hide_content":"","_relevanssi_pin_for_all":"","_relevanssi_pin_keywords":"","_relevanssi_unpin_keywords":"","_relevanssi_related_keywords":"","_relevanssi_related_include_ids":"","_relevanssi_related_exclude_ids":"","_relevanssi_related_no_append":"","_relevanssi_related_not_related":"","_relevanssi_related_posts":"","_relevanssi_noindex_reason":"","footnotes":""},"categories":[1362,4742,2254,5,2734,2764],"tags":[4704,4439,4560,4657,3993],"class_list":["post-133468","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-featured-video","category-gear-up-for-growth","category-growth","category-outlook","category-podcast","category-video","tag-alex-drost","tag-gear-up-for-growth","tag-jean-caragher","tag-pe","tag-private-equity"],"acf":[],"yoast_head":"<!-- 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