What Private Equities need to know
and look out for

In recent months, there’s been much discussion in reputed business journals¹ about potentially separating the Consulting businesses of the Big Four firms (Deloitte², PwC, EY, and KPMG) for multiple reasons, including regulatory and financial. More recently, the Wall Street Journal’s reporting on PwC’s Global Mobility divestment and E&Y’s Project Everest³ have brought the shape of the Big Four into sharper focus. As potential acquirers of the carved-out business, Private Equities have the opportunity to acquire a select part of the Advisory arms, as well as carve-out specific service lines within Advisory to unlock their high growth potential, unburdened by Security and Exchange Commission (SEC), or Public Company Accounting Oversight Board (PCAOB), independence and compliance restrictions.

The Advisory lines of business for each of the Big Four firms are of significant size, revenue diversified, and complex (see the revenue chart below). Potential acquirers, whether individual funds or a consortium of funds, need to factor the operational complexity to determine the right valuation of these service lines and ensure that they are able to deliver investor value.

In a post-Sarbanes Oxley world, the Big Four have leveraged their Network-of-Firms model and limited liability structure to minimize risk and tax exposure across the geographies in which they operate. As a result, each country runs almost entirely independently across sales and operations, while leveraging common brand identity and marketing. This creates a network that operates with a small, central, global leadership and oversight function to provide direction. That said, its decisions are often driven by the largest territory markets (US, UK, Germany, and China), or larger revenue clusters like Western Europe. This current operating structure works well to limit liabilities and tax exposure, while avoiding major top-down decisions across the network.

Revenue of the Big Four in 2021 (by service line)
Source: Statista

Lessons learned from the carve-out of the Big Four’s business lines

Over the years, the authors have restructured and carved-out business from the Big Four firms. Here’s what they’ve learnt.

Legal Entity and Corporate Structure

Carving-out an entity requires untangling the current legal entity and cross-holdings to determine the simplified, post-separation new legal entity structure that covers dozens of territories in more than 100 countries. This results in potentially significant tax exposure and demands multi-country tax expertise and knowledge. In select instances, closing down a legal entity might lead to a loss of tax revenue, which may attract additional scrutiny from country-specific regulators.

Infrastructure Separation

In each country or territory, the vendor footprint, application landscape, and tools, which are shaped by country preferences, and often, client relationships, also vary. Driving an integrated, standardized, flexible, scalable model takes time, and requires convergence with several internal and external stakeholders. The firms have integrated common infrastructure across their three core lines of service (Assurance, Tax, and Advisory) over time. Untangling it requires intimate knowledge of the environment and internal negotiations. Unlike traditional, corporate M&A transactions, acquiring a business from the Big Four requires factoring in this country-by-country negotiation, and consequently, change management, into the deal timeline.

Decentralized Decision-Making

Each country or territory has an equal vote on every decision – from agreeing to the separation, in principle, and the structure of the separation, down to transition service agreements, hardware or software options, service delivery locations, etc. Coming to an agreement with each country or territory can be a Herculean task. Country-specific privacy, security, and independence requirements only add to the complexity. We estimate that it will take about 15-20% longer, on average, than comparably complex M&A transactions.

Cyclical Financial Performance

One of the biggest benefits of the Big Four model has been the synergies it created, minimizing seasonality and revenue variability with three unique lines of service. Separating one or more lines from the whole puts the Big Four’s ability to weather economic headwinds at risk. Buyers also need to factor in incremental sales and marketing costs for building new relationships, fending off increased competition for existing or new business, sustaining current clients and acquiring new logos.

Operational Complexity

Attempting to carve-out of a Big Four network makes managing security, accessing controls, data and client consents, data and technology migration, technology infrastructure, branding and rebranding, among other challenges, more complex. The time sensitive nature of these transactions needs to be considered carefully when making critical decisions. These operations were not designed for M&A, and over the years, the Big Four have tightly integrated using technology to create a “closed” environment. The buyer, consequently, needs to use the Remain Company for Day 0 and Day 1 activities, which results in higher one-time separation costs.

Valuation Erosion
Illustrative, based on client experience (not to scale)

For Private Equities and other buyers looking to carve-out portions of a Big Four firm, there are many factors to consider while developing the valuation model – the structuring of the Sales Purchase Agreement (SPA), the cost to separate and stand-up an independent entity, TSA arrangements, and operational investments needed to run a truly global and independent organization.

What Private Equities should consider

Prospective investors would do well to think through:

• Valuation
• Role of the Independence function in operational separation of the carved entity
  
• Role of Parent Company/Remain Company personnel in carrying out separation activities
• Separation timelines, including timely availability, competing priorities, and the price points at which these services are available to the Private Equity buyer
• Achieving the standardized operating structure and model
  
• Culture and Change Management
  

Acquirers should expect much higher one-time separation costs, and longer time to close given the regulatory, structural, and infrastructural complexities. Getting third parties to handle separation depends heavily on support from the Parent Company, who will charge a premium for it. Similarly, simplifying the Network-of-Firms business model into a single firm requires significant management, and Private Equity mindset reinforcement, to get all the territories to buy in and implement the New Company vision, while ensuring strict adherence to time-consuming independence requirements and complying with dozens of regulatory bodies. All said and done, success depends heavily on the New Company’s ability to develop synergies beyond the Big Four’s ideas, personnel and processes, so they can create a collective, new vision for the future.

The upside for Private Equities

While there are several challenges, significant value can be generated by separating Big Four Consulting and Advisory services from the Assurance or Tax businesses. Specifically:

• There’s significant value potential to be unlocked for revenue and lower G&A costs by restructuring a complex and diversified operating model, bringing in synergies, and accelerating change with streamlined decision-making structures.
• Without audit-related regulatory pressure, the stand-alone Advisory business can unlock clients and markets, define new offerings, and go after white spaces and businesses that were previously restricted⁴. Private Equities will bring the discipline, running a tight ship and reviewing opportunities for operational efficiencies (getting rid of regulatory compliance functions, aggressively leveraging global service delivery models, smart automation, etc.) that the Big Four may not have pursued due to their over reliance on a people-centric, linear revenue generational model. For example, one firm was able to develop products and charge their clients a SaaS subscription license fee, resulting in a 7% improvement in SG&A over the time-and-materials-based revenue for similar services.
• Private Equities can take advantage of insights and preferential fee arrangements between the New Company (Advisory business) and their other portfolio companies, driving new business to the New Company through warm leads in their portfolio.
• Buyers have the opportunity to leverage an existing world-class Advisory brand and avoid the significant investments required for any new entrant in a highly competitive and inundated consulting market.

Value Capture
Illustrative, based on client experience (not to scale)

Bottom Line

The limitations of the Big Four’s current operating structure are significant, but not unsurmountable, challenges for the acquirer. Carving-out the business lines on a global scale requires different considerations, from the due diligence to the value capture stages of the transaction, to deliver investor value. That said, the prospect of carving-out a business line from the Big Four presents considerable opportunities for Private Equities.

Altius Strategic Consulting

Founded in 2019, by Big Four and Technology consultants, we are a global management consulting firm that advises Mid-Market Private Equity funds and their portfolio companies, from due-diligence to value-capture, and from strategy through execution. Altius delivers value with velocity, precision and expertise at every stage of the process. We are thought leaders in SG&A optimization, IT Carve-Out, Zero-based design and Budgeting. Currently, we serve clients in asset-intensive and information-intensive industries in America, Europe and Asia with a global footprint of practitioners.

Notes

      ¹ Michael O’Dwyer, “How to split a Big Four firm – and keep 13,000 partners happy,”
‍Financial Times, June 17, 2022,
https://www.ft.com/content/d715734c-701c-4c97-b0b3-44050f48f6b1.

      ² Jean Eaglesham and Corrine Driebusch, “Deloitte Explores Splitting Auditing, Consulting Arms, Following Ernst & Young,” Wall Street Journal, June 8, 2022,
https://www.wsj.com/articles/deloitte-exploring-splitting-auditing-consulting-arms-following-ernst-young-11654709024.

      ³ Jean Eaglesham and Mark Maurer, “EY Split-Up Plan Exposes Rift Among Accounting Firms,” Wall Street Journal, May 22, 2022,
https://www.wsj.com/articles/ey-split-up-plan-exposes-rift-among-accounting-firms-11653669979.

      ⁴ MichaelO’Dwyer, “EY boss targets $10bn boost from Silicon Valley tie-ups after break-up,” Financial Times, July 20, 2022,
https://www.ft.com/content/4b544040-8cf1-454a-823f-63077f068a42