Accounting's Inflection Point: Private Equity, AI, and the End of the Billable Hour

0:00This is Why We Like It, a quick dive into the industries capturing our attention in the lower middle market in the United States. We're asking the questions that unlock why and where we see value in the lower middle market. I'm Sam, and each episode I'll share why a sector stands out. We're going to bring in the voices who know it best, and we'll point to where we think the future's moving.

0:25Welcome to Why We Like It. The global accounting industry is massive. It's projected to hit about a trillion dollars by the early 2030s, and the U.S. accounting portion of that generates over $140 billion annually. That serves hundreds of thousands of lower middle markets, keeping everyone on the straight and narrow. And right now, it's going through a real structural change. There's generational succession planning, there's rapid consolidation in the industry, and there's private equity capital entering the space all over the place. And that doesn't even start to hit on some of the technological changes we're seeing today.

1:08AI and automation reshaping all sorts of parts of the model and then the clients demanding far more than just that basic level of compliance. They really want a strategic partner to help them through it. There's few people in the industry who've had a better front row seat to that evolution than Frank Longobardi. And it actually doesn't do you justice, Frank, to say it was a front row seat. You were on the stage and directing the play. And Frank, during that point, was the former CEO of Cone Resnick, which is a 2 ,700 person plus CPA and advisory firm headquartered in New York. As CEO, Frank led that firm through consistent revenue and profit growth and built a one firm, one culture business with a strategic focus on innovation and diversity and prior to that and earlier on in his career which we'll talk about a little bit later today he co-founded his own firm before combining it with cone resnick so he's got that entrepreneurial blood in him that we love what makes this conversation so exciting today and i didn't think i would say that if i'm going to be honest about accounting and i don't think my accountant thought i would say that about this but it really is a hot topic.

2:25And that's that accounting firms today are facing the same pressures as the businesses they advise. By consolidation, professionalization, transformation, and the general rising expectations around leadership and culture. It's a super dynamic space and it's a space the private equity industry is fascinated in. So today, as Frank and I get down and talk all aspects of accounting, we're going to explore what durable value creation really looks like inside the professional services landscape. Welcome to Why We Like It, Frank. It's good to have you here. Sam, really happy to be here. And yes, the profession is going through so much change.

3:09It's just amazing watching it and knowing it as I do over the last 45 years. So incredible time. And where are you joining us from today, Frank? You're in Florida? Yeah, I'm in Jupiter, Florida. Retired here and play a little golf and do some consulting in my spare time. Awesome. Well, in the lead up to today, I've been doing a lot of research to look at the history. And the first thing I found was the accounting industry has been around for a century. And I thought, you know, there's no way that's true. This is one of the oldest professions. And as you look back through the annals of time, accounting records go back 5 ,000 years.

3:49You had the ancient Egyptians and Romans keeping record of taxes and spending and all the commerce. But it was basic bookkeeping. It wasn't a profession. The accounting industry as we know it today, heavily regulated, heavily compliant, and critical to the functioning of our economy has really been around for about a century. And it's had a pretty consistent model. Why do you think now is the moment where everything seems to be changing all at once? It's a great question because the accounting profession really, you know, I've been in it since 1977. And I could tell you not a lot changed in the first 30 years of my career.

4:35And, you know, what changed in the profession was a tax law change or new accounting pronouncements. But really, the way you did work, the way you serve as clients pretty much remained the same. What's happening now is that, you know, I think COVID was kind of a turning point. You know, I think COVID kind of allowed the profession to realize that we did not need bricks and mortar to do our work. and that we could have a remote staff or a partially remote staff and service clients from anywhere. And geography really became very less important because you could hire people in the Midwest to do work on clients in the Northeast.

5:22And what you're seeing is that it's really kind of made the profession a lot more mobile. The other thing that happened because of COVID is that you had what we call the great resignation, and it really forced the amount of turnover in the profession to increase dramatically. And many firms were seeing two or three times the turnover that they would normally see in a given year. I think that also is a wake-up call to the profession. And then the big change was obviously then private equity became interested in the profession. And I think what they saw was a profession that was ripe for change, that there were a lot of factors that led to why private equity felt that investing in accounting firms made sense.

6:12The biggest being recurring revenue, right? They love the recurring revenue model that accounting firms provide through their compliance work. The second thing they saw was an aging partner population. So there were a lot of partners of accounting firms that were looking for a way out. And most firms didn't value themselves very highly. And as private equity raised the stakes and increased the value of accounting firms with some of the multiples they were paying, partners now realized that they could actually get out of the profession and have a nice little retirement nest egg that maybe in the previous years wasn't going to be quite as large.

6:55The other thing I think that private equity has seen is that the capital needs of an accounting firm today are dramatically different than they were just 10 years ago. Accounting firms have to now be capital intensive. You know, the way firms operate it for years is you earned a dollar, you paid all your expenses, whatever was left, you distributed it to the partners. You know, you didn't retain anything for capital. Today, you need capital for M &A because the price of M &A has gone way up. You need capital for technology. And the cost of technology has increased significantly. And AI, so there's a lot of money that has to be invested in that.

7:41And then in your people, you know, in order to, you know, attract the best people, the amount of money that you have to pay to bring in lateral partners or senior managers has gone way up. So capital is now a big factor in accounting firms, and a lot of accounting firms really weren't ready to build a capital base because the only way you do that is you take it away from compensation of the partners. So that was another reason I think private equity looked at this as an opportunity. I think private equity also believes, and I believe as well, that there's a lot of new products in markets that CPA firms can get into.

8:21There's a lot of ancillary services that you can begin to sell as you build and expand your firm. And the last thing I think is they saw an opportunity for M &A because there's so many accounting firms out there that it's easy for a PE firm to take a$50 million CPA firm. And within five years, you can make that$150 million just through acquisition and new service lines. And so I think they saw it as a real jumpstart to leverage their investment. Frank, when you talk to partners and firm leaders across other accounting firms all around the country, what today is the single biggest thing that most of them are getting wrong about where the industry is headed?

9:09What are they worried about? I think that most of the firms are really concerned about the impact of AI and technology on the business and what it's going to do to the business. I kind of flipped that a little bit. AI and technology are just tools, right? Those are tools to make us better as a firm, to make us more efficient as a firm. But I believe what they have to really focus on, and this is really important, is what is the business model that they want to create that's going to create more value for their clients and for their people? So I think they have to keep that end goal in mind. How do we create more value for our clients?

9:55How do we create more value for our people? And if you have those two objectives and you use technology to help you do that, you know, that's the kind of business model you want to have within an accounting firm. Because I think the classic accounting firm always relied on compliance related work. And I think that's changing. And I think compliance related work might become either less profitable or maybe not grow as quickly because of AI. there's going to be a lot of work that can get done by clients, a lot of work that's going to go away, all the mechanical work that our people used to work on.

10:33And I think they've got to focus on how do you create value for the client? You know, how do we create strategic advisory, CFO level guidance? How do we interpret data? How do we design and support systems? How do we manage risk? All those things I think are going to be really important in the future CPA firm model. Now, a lot of the larger firms, let's say firms 100 million or more, they're doing a lot of those things. They've got a good C-suite. They've got either PE behind them or they've got capital behind them. And I think they're starting to look at that and how that's going to impact their business.

11:13Some of the smaller firms are probably a little bit further behind and even behind in AI adoption because it's a big investment for a 15, 20, 30 million dollar firm. Let's talk about that part for a moment, Frank, because AI is clearly coming for a lot of white collar work out there. And you've had some companies in this space raise a lot of money. We had Fund Guard raise$100 million, some from Hamilton Lane. dual entry raised i think 90 million dollars for ai enabled accounting software you had rillett which is a personal favorite i think they did a great job of marketing and had their series b led by anderson horowitz and iconic so you've got some of the world's biggest venture platforms backing ai enabled accounting firms how do you think that plays out specifically in accounting And maybe more importantly, what does that mean for someone who's thinking about entering the accounting profession today?

12:15When you look at the kids that want to come into accounting today, it's really, I think, a fascinating time. If you go back and when you hired somebody out of school, brought them into your firm, I mean, a lot of the work was very mundane, very mechanical. the reason why you always had accountants jokes, you know, I'd always have people tell me, well, you must like numbers. And I would laugh because I would say, well, it's really nothing about numbers. Numbers happen to be in the mix, but I was a psychologist to my clients. I was a confidant to my clients. We made business decisions together and we supported each other.

12:59And the numbers just happened to tell a story, but it wasn't necessarily what you really focused on. But a lot of people look at it as very mechanical. And it is when you come out of school, because the first five, six, seven years of your career, you're focused on learn the rules, apply the rules, and then bill your time. Right. That was kind of the old mentality in accounting. today i think the students coming out of college are going to come in with a whole different mindset they're going to have to be trained differently trained at the college level much differently and trained at the profession level much differently and they're going to be focused on more designing systems interpreting data advising on decisions all and they're going to do it at a much earlier age than we ever did it, you know, in the old days.

13:57I think it's going to change for the better for a lot of these young people. Firms are recognized you've got to pay more for talent to attract the best and the brightest. I think it's going to be a fun time for people entering the profession. It's a great profession, particularly if you want to get into private equity. It creates all the right levels of fundamental foundations. Let's talk about that for a moment, private equity in the accounting space. PE has poured billions of dollars into accounting firms over the last few years. And to some people that might look a little bit odd. Why are investors so interested in a time and materials industry?

14:35Tell us a little bit about why you think it's been such an interesting asset area for private equity investors. I think accounting firms have a very stable revenue stream. They have a very good recurring revenue stream. And I think private equity believes that there are a lot of other services accounting firms can offer, creating more of a one-shop stop. And I echo those feelings. I think there's more we can do as accounting firms as we build out our service lines. You know, there were a couple of things broken in the, what I would call the old CPA firm model. And the two things I think were broken that PE is going to fix.

15:21One of them is how do you get your young people excited about the profession and how do you reward them earlier in their careers as the firm grows? You know, if you looked at the old model, say I might hire you out of school. I would tell you that in 14 years or 15 years, you're going to be a partner at this firm. Maybe a fast track was 10, but there weren't many fast trackers. And then when you get the partner, Sam, and let's say now you're 37, 40 years old as a partner, in 25 years when you retire, we're going to pay you two, two and a half, three times whatever your compensation is at the date of retirement.

16:07And we're going to pay it to you over 12 years. I mean, you tell that to a college student today and they look at you like you have two heads, you know, because they have friends in private equity. They're getting bonuses in their second, third, fourth year. They're part of these deals. So I think that was broken. The second thing that's broken in the, I think, traditional accounting for a model was the governance. When you get into a big firm, say a Cohen Resnick, which now is, I think, probably over 5 ,000 people. We had a board of probably 12 people, 10 that were elected, two that were ex-officio.

16:46That board, it took a lot to get things done because you had different people on the board who have different objectives at different ages. So you could have a 40-year-old on the board that wants to light the world on fire, and you could have a 64-year-old on the board who just wants to get to retirement and doesn't want to spend money and doesn't want to make investments and, you know, wants their compensation to be the highest possible level that they can get. So you had competing objectives, and it was very hard to get decisions made. It's more political, right? You know, you've got to work behind the scenes and talk to the board members.

17:25Here's why we want to drive this initiative. It took time. And it was something I wasn't necessarily great at because I didn't come from that training. My training was, let's go. You know, if we decide to turn left, we're going left and let's keep moving. And in a big firm, it's hard to do that. There's going to be a lot of noise and you got to deal with, you know, I think at the time I was there, we had 270 partners and there was no way you're keeping 270 partners happy. I think PE is going to bring more of a corporate model to that governance. It's going to shorten the board. It's going to allow partners to do what they should be doing, which is serving clients and mentoring our people and allowing the board with the PE focus on acquisitions, new service lines, and they're going to make much quicker decisions and they're going to bring capital to the table that most of these firms didn't have.

18:19Yeah, it's interesting you say that. A couple of my friends who run either divisions or regions of the big four have said there's two reasons why these oil tankers are so hard to turn. And that's because one, there's never enough liquidity to do a big acquisition. And two, the partners can't all agree on something. And why would they? It's not a point of contention. It's the fact that you're never going to have the right number of people agree to something when you've got thousands and thousands of decisions. Unfortunately, it's the downfall of the partnership model, although the partnership model has lots of very attractive qualities.

19:01and one of the areas of indecision often i think historically in the industry has been offshoring the ability to find lower cost staff for different parts of the value chain and the workflow and it used to be something that many firms i know did quietly it was a bit of a dirty word in many firms because yeah you should be doing it's a client-facing business you should be doing it on home turf. And now it's a strategic priority and cost of resource and cost of execution is a critical part of running a successful business. How did you think about that and build a firm where it actually works? And what does that mean for your domestic teammates?

19:43Listen, offshoring actually has been around for a long time. When you look at the big four, big eight firms at the time. I mean, all of them had large offshore presence, whether it was in India or other parts of the world. So it's been around. Now, other firms started to adopt it probably in the early to mid 2000s. So it's an integral part, I think, of a global staffing strategy. You know, as you think about the supply of accountants isn't growing tremendously. So you always have to look for talent in other places. I think the time zone differences can sometimes be an advantage because you could be working 24 hours a day on a client.

20:30There's a lot of work that lends itself well to using offshore resources. And I think if it's done right, it's actually a benefit to your domestic folks. And the reason it is, is because it creates more of a pyramid allows them to operate at their highest and best use. So I think there's just, you know, a lot of opportunity for the domestic people to elevate themselves, to do more. And it's a great way to manage margins and make sure your margins are staying strong. You know, listen, I think it's here to stay. There's a lot of people that say, well, AI might take away some of that work from the folks over in India or Philippines, but I think we just got to train them better.

21:15We've got to train them how to use the AI tools and let them, you know, they're very smart. They want to learn more. So I think it's just a matter of when you have a foreign team, you've got to treat it just like any other office. And people sometimes forget that. And since our India office, the same way we have a California office, a New York office, a Florida office, It's our Indian office. And we've got to treat those people the same way. We have to give them career opportunities. And the more you do and the more you train them, they just become a full part of your team. You know, I remember we'd have India people working in financial services or affordable housing or commercial real estate.

21:57And we'd have someone in the U.S. that would kind of oversee a pod of people with the work. and they would have, you know, they'd have happy hours at the end of the day, you know, video conference, you know, where they'd be on and they'd get to really know each other. It was, you know, it was really kind of heartwarming to watch the way, you know, people integrated them in. And then we used to bring our people in probably once a quarter. We'd bring a pot of people from India into the U.S. and just work in the office. So they'd work in our California office for two weeks or three weeks in New York.

22:32And it was just such a great experience for them. And it really kind of made them feel, you know, part of the team. And that's the way you have to kind of develop those skill sets. Final question. I have to ask this question because I've seen it done so wrong through the industry. And that's where a lot of firms say they want to move up the value chain and into advisory work and try and diversify a little bit away from individual or corporate accounting and get off the hook for that. 15th of April date and most haven't done it successfully. So in your mind, what separates those firms that can make the transition into advisory work, into ancillary business lines from those that can't?

23:15Yeah. You know, the issue with advisory is that it's, it's an ocean, right? There are so many different things that come to people's mind when you say, you know, we're an advisory firm. I mean, it could mean hundreds of different things. And you have many different types of advisory services. You know, you have all your digital services. You have all your tax consulting. You have, you know, all the technology-related services, financial services, transaction advisory, bankruptcy reorganization. You have, you know, just a ton of different things. So I think to be successful, the way we did it, where I think we really made a big difference is we went to market by industry.

24:02So what we did is we obviously had an advisory team and we had a tax team, we had an insurance team, but we would get those leaders together and really start to think about what was important to commercial real estate or what was important to private equity firms or what was important to manufacturing and distribution. And they would get together and that's where we'd identify what advisory services do we need to provide in order to start to expand our advisory services into those industries. because when you were an expert in the industry and all three of those service lines, I mean, it was easy to sell.

24:49I mean, clients came to you because they knew you understood all the nuances of their industry. They don't want to pay somebody to learn that. So that's how the bigger firms are really, I think, increasing their share in, you know, in advisory. A smaller firm, it's a little harder, right? If you're a$25 million firm, you probably have some industry expertise, you know, in a couple of industries, you probably don't have a very large advisory practice. So what, what those firms need to do is to think about, pick out one or two or three services that they could consider to jumpstart an advisory practice, you know, and focus on more of a pilot program that says, okay, we're going to, we have a large real estate practice.

25:40So we're going to look at cost segregation as maybe a service line that we can provide to our real estate clients. We're going to look at becoming experts in certain real estate software. I mean, the big one used to be Yardi. I'm not sure if that's still the big one, but understanding the real estate software and how to help clients implement that and how to help clients develop dashboards and look at clean energy and all these other things. So you start small and try to build upon that because there's no, the only other way you do it is you buy advisory firms, right? You decide what type of service you want to offer.

26:24And we go out and we buy a firm that does valuations or buy a firm that does R &D credits. So we buy a firm that does some of these other service lines, technology projects, but all that costs money. I mean, these firms don't come cheap, but that's the only other way you can kind of jumpstart it. You know, when I started at Cohn Resnick as CEO, we had 50, about 50 million in revenue in our advisory practice. And, you know, one of the key pillars I had was growing advisory. And I got pushed back with some partners on the board because they felt like advisory wasn't recurring work, you know, and it wasn't like compliance.

27:06I'd look at him, I'd say, what do you mean? Yeah, look at an advisory partner. Last year, advisory partner did$3 million in revenue. This year, he did$3 million in revenue. Next year, he'll do$3 million in revenue. It's recurring. It's just not maybe the same client, but he's selling multiple projects to different clients or he's coming back with repeat clients. So they found the secret sauce on how to grow that the same way every year. And it just took a while to kind of convince partners to get away from that kind of compliance mentality of just recurring revenue day after day. But when I left, I think our advisory practice had grown to about$140 million in revenue.

27:53And I think today they got to be probably over$300 million in advisory revenue. And, you know, it's just impressive, you know, in what you can do. And it starts to snowball as you get bigger because you bring in more talent, you know. And the last way you can help grow your advisory is to hire lateral talent, which isn't cheap. You know, we'd bring in government experts from Price Waterhouse or, you know, a technology expert from Deloitte. But all these people, you know, cost a lot of money. So you have to have the capital to invest in them and you have to give them lead time to be successful.

28:31You have to support them to be successful. Well, as you say, you've got to try to do things differently to win. It's like Henry Ford said, if you always do what you've always done, you'll always get what you've always got. Thank you for spending time with us today. I enjoyed our conversation. And now I'm joined by someone at a different end of the spectrum. I'm joined by Ariel Homoko, the founder and CEO of Artifact. And we know this from the conversation we just had. The accounting profession is one of the oldest on earth. Double-entry bookkeeping was codified by a Venetian monk in 1494. And for most of the last century, that model didn't really change.

29:14And then overnight, everything changed. Private equity poured in over$200 billion of value creation across nearly 150 deals in the last five years. Deals like Blackstone taking out Citroen Cooperman for$2 billion. And 11 of the top 30 US firms now have private equity money behind them. Why is that? Well, AI is doing something to knowledge work that looks a lot like what industrial machinery did to manufacturing. And it's aimed straight at a profession that's made a very, very good living off the billable hour for a long time. So Ariel's with me today. I'm really pumped about this for many reasons.