Nassim Khadem Reporter

Nassim covers the accounting and tax rounds for BRW, as well as general business news. She previously worked for The Age newspaper covering general news, state politics and economics.

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Mid-tier muscle

Published 04 April 2012 16:39, Updated 05 April 2012 06:49

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It’s ironic when accountants fail to do what they preach. News that BDO’s combined Victorian-NSW practice – with 68 partners and 500 staff – was turfed out of the BDO international network due to bad debts came as a shock.

How does a profession that turns a dollar by advising other businesses on how to keep their balance sheets in order, fail to do so itself? And where does the future of mid-tier accounting firms now lie?

“The theory is that accountants can’t go broke,” Vincents Chartered Accountants managing partner David Rose says. “But as a result of this, anyone who goes to banks with a non-goodwill transaction will be scrutinised a lot more.” In simple terms, a goodwill model is where partners buy into a firm and cash out when they leave. It is a traditional model now under question.

The problems at BDO came about because the NSW-Victorian practice was overleveraged. It had debts estimated at $100 million stemming from the 2007 amalgamation of its Sydney, Melbourne and Canberra offices.

At the time, some senior partners cashed out the value of their goodwill. As part of the deal, the firm borrowed more than $65 million from Bankwest to pay these partners about $75 million.

National chairman Tony Schiffmann says the offices in Brisbane and Perth are still going strong. BDO International is said to be looking at deals with PKF and Moore Stephens. By dumping its badly functioning practices, BDO hopes it can rely on its global brand and high performing practices in other states.

Most accounting professionals believe that over the next few years there will be more consolidation.

There will be fewer firms operating in the mid-tier space, but they are likely to be bigger, have one national structure and a clear identity.

“There will be more rationalisation, more groups merging and more groups doing alliances and joint ventures for the sake of market reach and scale,” says author and headhunter to professional services firms James Evangelidis.

When a firm like BDO splits, it creates opportunities for others to acquire its clients. Grant Thornton, the nation’s seventh largest accounting firm, is considering taking on about 400 of BDO’s staff and more than 50 partners from Victoria and NSW. The merger would make it the nation’s fifth largest firm, with $240 million annual revenue.

Grant Thornton chief executive Rob Quant says consolidation is “not unexpected, unprecedented or unusual”. In the past, the big eight became the big four and now we’re in the midst of another change, “but this time,” Quant says, “it’s all about the mid-market”.

Quant wants his firm to be the number one choice in the mid-tier space, claiming it is more of a corporate than partnership model. “Our structure is unlike mid-tier firms,” he says.

“We operate on a corporate model that gives us the financial firepower to grow organically and through further acquisitions. Bringing further expertise into the firm and doubling our size in NSW and Victoria will amplify these advantages. This will be a game-changer for us, for our industry and our clients.”

But many in the profession question his strategy. Being bigger isn’t a panacea. Evangelidis says firms like BDO and Grant Thornton (if the merger goes ahead) will have to work hard to win back the trust and respect of the clients.

“What I’m hearing in the market is that some clients are quite concerned about whether they’ll be paying for advice from a business that’s had trouble keeping its own house in order,” he says. “There’s a feeling of ‘why should we trust you when you don’t know how to run a business?’”

He says there are two key traits that will set mid-tier firms apart – the right leadership and a strategy to stop the big four from poaching their private clients.

“The biggest threat to second tier is their own leadership and own strategy,” he says. “And secondly, the fact that the big four are doing private client consulting really well.”

One mid-tier firm that has taken on the big four in the private client space is the nation’s fastest growing firm, Kelly + Partners. Its revenue jumped 52.5 per cent in 2010-11, hitting $14.3 million. Chief executive Brett Kelly says the problem with most mid-tier firms is that they are “big-four wannabes” and don’t have a distinctive strategy.

He says this means the mid tier will keep losing clients to the big four and smaller specialist firms and Grant Thornton may just end up with “a big version of themselves”.

The mid-tier firms that are expected to thrive are those that have a specialist focus, such as insolvency experts McGrathNicol and KordaMentha.

Beaton Research & Consulting head George Beaton agrees the mid tier is going through an identity crisis. He says on the one hand it competes against the big four in the public company audit and advisory space, and on the other it tries to act like a small firm offering a more personalised service.

“The second tier – many of which have sought alignments with a global network – is inherently unstable,” he says. “It has been so for decades. It’s struggling to define itself.”

The end result, he says, is moving deck chairs around – regrouping and rebranding – taking a new name but with no real purpose. “It’s the classic stuck-in-the-middle dilemma,” he says. “It’s the Alice in Wonderland notion of, ‘if you don’t know where you’re going, any road will do’.”

Other mid-tier players question Grant Thornton’s strategy. “As opposed to scale, we believe in getting good people and the right cultures together,” RSM Bird Cameron national chairman Kim Hutchinson says. “Putting 50 new partners and 400 staff into another group will be a challenge in terms of the financial and the cultural integration. The benefits of scale will have to be considerable.”

He says as well as seeing more nationally-structured firms, the mid tier will have to rebuild brands. “Weak brands will disappear,” he says.

“A brand is more than just a name at the front door. It’s the culture behind your door ... and respect for clients that matters.”

Pitcher Partners chairman Don Rankin says BDO’s NSW-Victorian practice was too internally focused. Firms that develop a niche and get the right people to do it will stand out, he adds.

In the future we may only see three or four mid-tier sized firms but they will have strong revenue and profit based on client loyalty. “If you take your clients for granted, you fail,” he says.

HLB Mann Judd Australasian Association chairman Tony Fittler says the BDO Grant Thornton merger “is not possible until BDO has got themselves out of trouble”.

He also believes that consolidation will happen across the profession and that even the smaller firms of seven or eight partners will begin developing into firms of 20 to 25 partners.

William Buck managing director Nikolas Hatzistergos says that at a time when the market is under pressure in terms of its natural growth rate some firms have to grow by consolidation. “Certainly BDO and Grant Thornton have ambitions be a natural alternative to the big four,” he says.

“But we have a different view. We’re in the private wealth space and take on clients suited to us; we don’t chase top 100 companies.”

Beaton believes the end result may be that the more successful state offices break away from their national partnerships to merge with successful state offices from other firms.

“The really strong offices will get together and form a fifth force to challenge the big four,” he says.

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