Navigating Opportunities: Private Equity’s Growing Focus on the UK Audit and Accountancy Sector

The growing interest of private equity (“PE”) firms in the accountancy and audit sector in the UK has sparked significant debate and media attention, presenting both opportunities and risks for the industry. Traditionally focused on industries such as technology and healthcare, PE is now targeting accounting firms – an area previously dominated by independent, partner-owned practices. This has prompted increased scrutiny from UK regulators and professional bodies concerned with preserving the quality and independence of the audit process. 

The Appeal of Accounting Firms to Private Equity

In the past decade, PE interest in professional services, particularly audit and accounting firms, has significantly increased. PE investment in audit and accounting firms has largely been concentrated in the United States; it is estimated that PE firms could own as many as 10 of the largest US accounting firms, with the latest example being Blackstone’s acquisition of a stake in top 20 tax firm Citrin Cooperman. 

Nonetheless, interest in the UK's accounting sector is also gaining momentum, with smaller firms and multi-disciplinary practices comprising audit, becoming targets. For instance, PE firm, Cinven, recently outpaced a rival offer proposing a US merger by announcing an agreement to make a majority investment in Grant Thornton UK. This was swiftly followed by British PE firm Apax acquiring Evelyn Partners' accounting arm for £700 million after a bidding war with its PE rival firm Bridgepoint.

Several factors account for PE’s interest in accounting and audit firms. Primarily, the sector’s stable, recurring revenue streams attract investors looking for consistent returns. Even with stability, the audit and accounting industry might still experience transformation due to advancements in artificial intelligence, which could offer substantial opportunities for firms that make strategic investments.

Investment is also driven by the substantial capital expenditure that professional services firms must allocate towards systems, including technology with capital funding serving as valuable support. The fragmented market also presents opportunities for consolidation, enabling PE investors to achieve economies of scale. Growing global regulatory complexities have increased demand for non-conventional and specialised accounting services, creating new growth avenues. For example, to navigate regulatory restrictions, particularly in the US, investors often focus on firms' non-audit arms, which provide administrative services to the audit units for a fee.

This interest is not limited to large firms; smaller tax and accounting practices, often facing capital constraints, are also appealing to PE. PE provides essential funding and expertise, enabling technological investment, competitive enhancement, and talent attraction through revamped incentives. PE investment helps smaller firms modernise, expand, and effectively compete with larger entities.

Regulatory Guidance in the UK: The FRC, ICAEW, and Ethical Independence

As PE investments in accounting firms increase, UK regulators are stepping up oversight. The Financial Reporting Council (the “FRC”) has raised concerns about potential risks these investments pose to audit quality and independence, the latter focusing on avoiding or managing relationships and activities that could comprise objectivity. In a recent letter to UK audit firm leaders, FRC CEO Richard Moriarty acknowledged that PE could bring benefits, such as access to capital and operational know-how, but warned that it also brings risks.

A major concern for the FRC is that PE ownership could threaten the fundamental principles of audit independence and objectivity, which are essential for public trust in financial reporting. There is a perceived risk that PE firms might indirectly influence audit practices, for example, through interlocked boards or management service fees, which could compromise the integrity of audits. The FRC emphasised that safeguarding independence, as mandated by law, is a fundamental ethical priority for both it and auditors. Failure to comply with the FRC’s Ethical Standard in this regard may result in financial penalties, such as an unlimited fine or the waiver of client fees, as well as non-financial penalties, such as exclusion from a professional body.

To address these issues, the FRC recommended that accounting firms exploring private capital engage with regulatory bodies early in the process. This is to ensure that ownership changes meet the regulatory expectation of providing ongoing assurance that these firms will support the public interest and uphold the independent ethical values vital to the audit and accounting sector. The FRC has also welcomed engagement from investors to explain the regulatory framework and expectations to ensure that PE firms fully understand them. 

Furthermore, the Institute of Chartered Accountants in England and Wales (“ICAEW”) has issued its own guidance on the ethical independence challenges posed by PE funding in certain specific circumstances. The ICAEW outlined that, when a PE firm invests in an audit firm, the audit firm is prohibited from providing services to the PE fund or its portfolio companies, as this would create a conflict of interest that violates the FRC’s Ethical Standard. The ICAEW has also highlighted the risk of the PE fund or its employees becoming a ‘covered person’ in a position to influence the conduct or outcome of the audit. As a covered person, the PE Fund itself would be subject to independence requirements under the FRC’s Ethical Standard. This highlights the potential conflict between PE's profit motives and the accounting profession’s ethical duties. 

The amendments to the ICAEW Audit Regulations, effective 1 October 2024 with compliance by 1 April 2025, require audit firms to have decisions on policy or constitution controlled by ICAEW qualified persons, with majority voting rights. If a higher approval percentage is needed, this too must be managed by ICAEW qualified individuals. Private equity investors need to structure the audit part of the business so that control is maintained by ICAEW qualified persons, potentially necessitating changes in management or voting. They may need to reassess strategies if certain controls can't be retained. Investments should include reviewing constitutional arrangements for compliance, as non-compliance could affect audit registration and reporting.

Other Implications of Private Equity Investment 

Traditionally, accounting firms were partnerships controlled by accountants, ensuring alignment with auditors' professional duties, however PE challenges this ownership model. 

Due to these challenges, regulators may be particularly concerned about the risks posed by PE investors in audit practices who are not directly under their regulatory purview and can exert substantial influence over these firms. Such investors could influence changes in business strategy, operational priorities, or resource allocation. While these changes might create new opportunities, they also present potential challenges to the status quo, which may require some adjustment within the industry. Another potential issue is the conflict of interest between PE’s investment strategies and the stability required in audit services. PE firms generally exit their investments within a few years, either by selling the firm or taking it public which contrasts with the long-term commitment to quality and public interest that audit services demand. There is a perceived risk that the pressure for rapid returns could create misalignments with the societal need for high-quality, unbiased audits.

Looking Forward: Striking a Balance

PE offers the prospect of valuable investment and innovation in the accounting sector. However, this must be balanced with the ethical and regulatory obligations central to the profession. Regulatory bodies such as the FRC and ICAEW are proactive in providing guidance, yet the swift pace of change demands ongoing vigilance.

Accounting firms considering PE investment should engage early with regulators to ensure adherence to standards of independence, integrity, and public trust. Regardless of the outcome as the trend evolves, the challenges introduced by PE’s interest in accounting firms will remain a pressing issue for regulators, firms, and investors alike.

As a firm, we have extensive and long-standing experience working with professional services firms, particularly concerning PE investments in the auditing and accounting sectors. This includes navigating the various structures employed in such transactions. In addition to this, we have considerable expertise in handling the largest contentious regulatory mandates within the audit and accountancy space.