Private equity interest in professional services remains, but the era of easy deals is over as most attractive targets have already been acquired, and investors are now more selective, writes Maria Ward-Brennan.

The bubble around private equity interest in the professional services industry has started to deflate, as most of the “low-hanging fruit” has already been snapped up.

Over the past few years, the buzz around the surge in private equity deals in the professional services sector, especially accountancy, has filled the airwaves.  

Notable deals in the sector have included British private equity firm Apax buying Evelyn Partners’ accounting arm for £700m, Cinven acquiring Grant Thornton, and Interpath Advisory being acquired by Bridgepoint.   

It was not surprising that the private equity space has its eye on this sector. As Rich McDonald, chief market commentator at IG, explained to City AM: “Private equity’s love affair with professional services has been long-standing because these businesses looked safe, sticky and cash-generative.”

This came at a time when the industry arguably faces its most critical period in the last 20 years, prompting significant interest in private equity as a much-needed lifeline. 

A report by law firm Macfarlanes in March stated that 75 per cent of professional services firms are ‘very likely’ to consider (or already have) private capital investment in the next five years. 

However, this is also a very risk-averse sector. 

Zulon Begum, a partner at CM Murray, explained that on the legal side alone, even if senior leaders are keen, it is a difficult sell to get a deal over the line. 

“It’s not an easy sell, especially for the larger partnerships. Getting a deal like this over the line is quite a significant endeavour, and managing partners would have to have an incredible amount of political capital and trust from their partners to be able to take the firm in such a strategically different direction,” she explained.

Begum added that it is “more of a dating game” between this sector and private equity.

But the dating pool seems to be drying up.

External capital has certain criteria

Private equity firms like safe, cash-generative businesses that will make it easy to navigate an exit strategy in a few years’ time. 

Aymen Mahmoud, partner at McDermott Will & Schulte, said: “Private equity will always look to focus its energy (and its dollars) on the best possible businesses and, as with any sector, there are likely to be less attractive and more attractive businesses.” 

Firms that rely on client ties that are not institutionalised, or on clients who could leave with certain partners, are much less attractive to external investors. Businesses that also do work that is bespoke and high-touch, not easily processed or tech-driven, do not catch the attention of external investors.

“The low-hanging fruit was first to be snapped up, which is why we saw the initial flurry of transactions,” Begum explained. 

Another senior legal source told City AM that “the excitement about private equity was such that everyone thought ‘it wants to buy us’, and I’m not sure that they did.”

AI jitters

The AI jitters that are reverberating through the market are posing fundamental questions for the sector.

McDonald stated that “AI has put a question mark over the most important part of that model, the people.”

“If software can do more legal and accounting work, consulting analysis, recruitment screening or outsourced customer support, then private equity investors have to ask whether they are buying a growth platform or a business model about to be repriced,” he explained.

He pointed out that the professional services most exposed to this currently are recruitment and outsourcing, noting that the stock market is wrestling with listed firms ranging from Hays and PageGroup to Capita and even RELX.

“The impact of AI (for good and bad) on a prospective target is one of the key investment committee considerations as part of analysing whether to press the go/not go button,” added Tom Whelan, partner at Reed Smith.

Private equity has not walked away from professional services, but the bar for where it puts its money has risen, and many of those holding conversations with external capital might not make it past the first meeting.