As the European private equity market matures, accountancy firms are working to increase their involvement with the industry, which now reaches far beyond their traditional role of due diligence. Although transaction support is the oldest role for accountants in PE transactions, their corporate finance services see them climbing higher in the advisory league tables each year.
More than just kicking the tyresAs accountants now offer much more than straightforward financial due diligence the term itself is becoming less prominent. It is increasingly replaced by transaction services or transaction support; a concept encompassing a range of services all geared to making sure PE houses get the best service. These include advice on commercial, legal and even environmental due diligence, tax structuring, pensions, assurance, sale and purchase agreements, buy & build situations and merger and integration issues such as IT and human resources.
All of the firms point to the fact that the size of their organisation enables them to pull experts in from different departments to work on deal services. The consensus seems to be that transaction services, which often comes under the corporate finance heading, and corporate finance can co-operate on an increasing level. The distinction between the two business areas is blurring, although to what extent varies from firm to firm. Simon Creedy-Smith, European head of transaction services at Deloitte & Touche, says: “There is less over lap between transaction services and corporate finance on larger deals. Transaction services don’t do deals less than GBP50 million, the largest at GBP1.6 billion being Whitbread, whereas corporate finance work on deals between GBP20 million and GBP200 million.”
One of the changes in due diligence practices is the length of accountants’ involvement. Creedy-Smith says: “We tend to get involved more often at an earlier stage in auctions. But the degree of involvement will be lighter.” KPMG also reports that it is looking at an increased number of proposals and pre-deal evaluations. In the current market where deals may be thin on the ground this approach is one way to make sure you pick up plenty of business. It allows accountants to be involved in more bids, but to a lesser extent, as the chances of the deal completing at that stage are lower. Accountants make themselves useful after deals have completed as well. Creedy-Smith says: “Due diligence also involves asking questions which will help grow investments, looking for opportunities for cost-cutting, financial engineering and arbitrage. It’s important to make sure these opportunities are followed up, whether the suggestion came from us or the private equity house.”
While the most basic premise of financial due diligence, likened by one accountant to kicking the tyres on a car before you buy it, remains the same, some aspects are evolving.
David Ascott, a member of Grant Thornton’s lead advisory team who spent 13 years with Gresham Trust, highlights the importance of getting the reporting style right. “Different VCs prefer different styles when it comes to due diligence.
It can be as concise as a PowerPoint presentation, easily digestible so you can get what you need to know faster.” The due diligence report also depends on the role it plays, this can be a type of insurance policy on an investment or it may primarily be used as a tool in price negotiations.
In addition to financial due diligence, many firms of accountants provide increasingly sophisticated commercial due diligence, which looks at and analyses the market position of a company and the competition. KPMG has invested heavily in its strategic commercial intelligence unit and Ernst and Young has a similar offering. Deloitte & Touche and Grant Thornton are more cautious in this area, Creedy-Smith says: “We only do commercial due diligence for a sector where we have experience. What private equity firms like is to be advised by industry experts, just analysing public information doesn’t add much value.” None of the firms want to do commercial due diligence in an amateur way. They are aware that they are exposing themselves to increased risk, they may employ additional consultants, but ultimately it is their responsibility to make sure nothing falls between the cracks.
Accountancy firms have a wealth of capital and human resources, and well-recognised names, which make it relatively easy for them to extend their service offerings. Another add-on service complementing existing transaction support is legal work, which many firms are already involved in on the continent. Andersen has a strong legal practise in Spain and is hoping Garretts, its UK law firm, will be able to penetrate the market here in the same way, although Rustom Kharegat, head of European transaction advisory services at Andersen, admits its’ early days yet. While Andersen isn’t alone in pushing its multidisciplinary approach to deals, David Spence, chairman of international corporate finance at Grant Thornton, says:
“We made a positive and strategic decision not to start doing legal work. We would be setting up in competition to law firms who provide work for us, it’s not sensible in the UK.” Both the accountancy firms and the private equity houses can benefit from this wider range of services. In addition to the extra fees cornered by the accountancy firms, the number of links in the communications chain can be cut, hopefully making deals faster and leaner.
The attitude to vendor due diligence is also changing, particularly its role in the auction process. In the past vendor due diligence acquired a reputation of being a badly put together information pack and few transactions were completed without additional buy-side due diligence. As the audience is anonymous and you don’t know whose questions you’re answering, compiling vendor due diligence does present a challenge. But better understanding of the product, improvements in the quality of work and its widening acceptance, helps to preserve deal values and allows the timetable for deals to be tightened. Grant Thornton, having won a new client (Close Brothers Private Equity) on the strength of its vendor due diligence, points out it also gives firms a chance to impress buyers.
During the heyday of high tech each of the big five accountancy firms launched an incubator or accelerator initiative. As this space has become less appealing the emphasis of the majority of these vehicles has shifted. PricewaterhouseCoopers Incubator, which recently renamed itself PricewaterhouseCoopers’ Venture Partners, is the most visibly active of these. Funded from the firm’s balance sheet it can make eight to ten GBP250,000 investments a year, targeting early stage technology companies. There are also plans to include funding for later stage companies. KPMG’s incubator service takes a more advisory role and is focused on developing the disciplines associated with incubation, within the firm. There is also a focus on corporate enterprising, assisting large companies with internal ideas for spin-off businesses.
In recent years many UK and US buyout houses have moved into Europe, promoting the already expanding acceptance of private equity on the continent. The accountancy firms have followed in the wake of their clients. Despite investing heavily to increase their private equity services at home and abroad, the larger accountancy firms don’t have the same critical mass in Europe as in the UK. While the European market is undoubtedly developing, Kharegat, of Andersen, believes that as long as bank debt is syndicated out of London, it will remain at the centre of the industry.
While Germany and France are ranked by all as the key European markets there is also optimism about Spain and Italy. John Maxey of Anderson is confident a Spanish deal will top the EURO1 billion mark in the next 12 months.
Grant Thornton reports it is currently doing more deals in Europe than the UK, where recent deals have included acting for Close Brothers Private Equity in the Park Resorts acquisition and Benchmark Dental Laboratories, backed by ECI Ventures. Edward Turner, a senior manager in the firm’s international services group, recently carried out a survey of market confidence across Europe. He said:
“Spain and Italy are surprisingly confident, reflecting the development stage they have reached. The outlook is good for that region.” Beyond the more established European markets there is hesitancy, Kharegat at Andersen says: “Eastern Europe is a separate issue, the individual regions are developing at their own pace. It’s still hard to find something that’s worth our while outside of the G7 countries.”
One of the challenges Europe presents to accountants is how to harmonise the international standards of due diligence across the firm, while also taking into account the differences in culture and staff. David Spence at Grant Thornton believes it is important to balance cultural issues with market expectations. A popular way of tackling this is to have a flexible European staff. Oliver Tant, head of private equity at KPMG, says: “We’re seeing a lot more pan-European activity and we need experienced UK people to help develop local markets.” According to Creedy-Smith, Deloitte & Touche uses a common reporting methodology across its European offices, as staff receive the same training. Tant adds: “Local markets have different requirements but we’re aiming for standardisation, ironing out some of the local differences and raising the minimum standard to achieve satisfaction across Europe.”
Building relationships with PE firms Accountants are developing their relationships with buyout houses in a number of ways. Extended multidiscipline involvement with private equity houses during deals is accepted and portfolio companies offer plenty of opportunities too, such as M&A and IPO work for companies they first became involved with during a buyout. As well as extending the deal services they offer, accountants are also involved with the day-to-day functions of private equity houses, continuously developing their relationship. This includes audits of general partners, tax structuring of funds and profits, and investor reporting. As well as having more extensive relationships with their private equity clients, increasingly accountancy firms are working to personalise these relationships (although they add that they are also keen to develop new ones). But the idea of personalised relationships can only be possible to a point, in an industry where the number of players, and the number of markets in which they are active, is increasing.
Kharegat says: “Most private equity houses have narrowed down the number of accountants they use, from random use of the big five firms to having two or three preferred suppliers. But there are few exclusive relationships.”
This hasn’t happened by accident, private equity houses have made active decisions on how to manage their suppliers, based on their understanding and sector orientated industry knowledge. Some have organised beauty parades to decide on the firms of lawyers and accountants they will regularly use. Spence at Grant Thornton says: “It’s integral to our business to target the key players as preferred partners but an exclusivity relationship isn’t in our interest or theirs.”
This evolution is a case of cost efficiency on both sides. Developing a relationship with trust and integrity cuts down on briefing time and the investor gets a consistent quality of due diligence. At KPMG major clients have a specific relationship team which is overseen by a manager who liases with the PE firm and co-ordinates all of the work done on its behalf. This is also helpful in guaranteeing a consistent quality of work across Europe. Oliver Tant says: “KPMG has worked to change the reciprocity between accountants and private equity houses into more of a relationship. This preferred arrangement is more personal and closer to exclusivity.” The benefits are clear says Creedy-Smith: “Each client is different but you build a short-hand communication with each of them. You don’t need telling what to do all the time, you can just get on with it.” Europe has not gone far down this route but is heading there.
Target audience and deal origination
The larger accountancy firms may not all target the same type of deals, but they agree the short term prospects of the buyout market are less rosy than they have been in some time. Martin Aguss, head of private equity advisory services in London at Ernst and Young, which does deals from GBP10 million to GBP100 million plus, says: “In the coming months the market is still going to see a reasonable level of deals but the number of aborted transactions will be higher than before and the deals that do get done will take longer.”
Within the majority of accountancy firms deal sourcing is industry orientated. Sector specific industry knowledge, combined with a good knowledge of the players, seems to be the key to winning deals in more difficult times.
Nick Anstee, senior member of Andersen’s corporate finance team in charge of private equity, says 75 per cent of Andersen’s deals are self-sourced, i.e. from outside of Andersen’s network. He stresses the importance of sector knowledge, citing financial services, healthcare, engineeringand infrastructure as areas where his firm is especially active.
Although Andersen is the only firm that has set a minimum size limit (GBP100 million) for the deals its transaction services team looks at, this has not guaranteed it a monopoly of the mega deals.
PwC Transaction Services worked on the GBP2.15 billion Yell deal this summer and KPMG Transaction Services advised on the EURO2.7 billion Messer Griesheim acquisition. While in the long-term deal sizes are certain to grow, the current market, which has seen the collapse of Apax’s Mannesmann Plastics deal and the addition of get-out clauses for investors in the acquisition of Cognis, may prove to be less lucrative for those focused on larger deals.
Firms dedicated to the mid market also remain loyal. Creedy-Smith says: “It’s important to our culture and our strategy that both transaction services, and corporate finance, continue to serve the mid market. We want to service emerging markets as well but we won’t walk away.” According to Tant at KPMG, which caters for deals in the GBP50 million to GBP250 million bracket: “We like doing deals where people really want our advice, rather then just a rubber stamp on a piece of paper to show the banks. People say they always bring us their difficult deals!” He believes the number of large deals will down temporarily and investors will wait for deal prices to go down. Aguss said: “It’s becoming much more of a buyers market. We are currently seeing significant price reductions in many sectors of the market.” Tant says: “The summer months will be busy, I’m telling my staff to forget about summer holidays!” The attitude at Grant Thornton is also optimistic. The firm can see plenty of deal opportunities in the current economic climate, although they are of a different nature than in recent years. They include forced sales arising from distress situations where a quick sale is necessary, corporate recovery work and previously acquisitive US companies looking to dispose of their European assets. Edward Turner says: “Accountants are criticised for not capitalising on their client base, but we look at companies internationally and try and match them up.” The firm targets SME deals in the GBP5million to GBP75 million range and is trying to educate business owners about the options open to them, including private equity-backed buyouts. Turner is proud of the firms distinguishing features: “We’re not a wannabe-big-five firm, we cater to a specific market and that’s what people come to us for.” The firm’s deal sourcing, incorporating a carefully planned counter-cyclical business, also relies on an open dialogue with PE houses.
Different deal opportunities are available in the current climate, and you have to be nimble to take advantage of them. Add-on services and improved relationships streamline firms, enabling them to be flexible and innovative in response to their clients needs. All of which should place them on a sound footing in these unpredictable times.