How the Big Six make small fees pay

Do large firms of accountants distort the market for advisory work on m anagement buy-outs? Peter Carty reports

The largest firms of accountants - the Big Six - are accustomed to accusations of putting in low bids, or "low balling", to secure company audits. But they also come under attack for charging artificially low fees for advisory work on management buy-outs. Competing corporate finance boutiques and merchant banks complain of being undercut by margins of up to two-thirds.

In contrast to other areas of corporate finance that are traditionally dominated by merchant banks, buy-outs were virgin territory when they arrived in the UK at the start of the Eighties. As well as performing due diligence work - checking the numbers used in negotiations - accountants rapidly established themselves in the role of corporate finance advisers on deals.

Accountants now dominate the buy-out advisory arena. According to statistics from KPMG Peat Marwick, of the 269 deals worth more than £l0m between 1 January 1990 and 30 September 1994, Big Six accountants were advisers to management teams on 125.

An adviser often adds value to deals, for example by negotiating better terms for management teams from venture capitalists and vendors. Fees reflect this and can be more lucrative than for due diligence work.

However, corporate finance boutiques and merchant banks say that the Big Six put in artificially low bids to secure work.

"You could call it mispricing, rather than lowballing," says John Beatty, managing director of PBTC Corporate Finance Limited, an arm of the Private Bank and Trust Company. "We suspect that their internal pricing systems aren't good," agrees Gareth Pearce, head of corporate finance at Smith & Williamson, the unique combination of merchant bank and medium-sized accountancy firm.

They assert that the Big Six sometimes fail to build the real risks of transactions into fee structures, notably the fact that large numbers of buy-outs founder. Mr Pearce puts the abort rate at about half.

Chris Beresford, head of buy-outs at KPMG Peat Marwick, makes no bones about dropping fees, but says that it is done in a calculated way: "We do shave the price in circumstances where we like the deal." For his part, he points out that the boutiques and banks have the advantage in negotiations of being able to take equity stakes, something accountants cannot do for the time being.

However, accountants do have one clear advantage. They can use buy-out advice as a basis for gaining future audit and tax work from the new companies set up as a result of buy-outs. "They run it as a loss leader," says PBTC's John Beatty. "That makes ourlife extremely difficult."

Far from denying this, Mr Beresford says that advising buy-out teams can actually be a better way of securing audits than participating in conventional tender processes. "Beauty parades can cost you more in time than it would take to advise a management team," he says. However, he denies straightforward lowballing to win increased market share, saying it would be futile in the face of strong competition from other accountancy firms: "That would be suicide."

Current market trends do not bode well for accountants' competitors. Research carried out by Coopers & Lybrand on completed buy-outs for the year to 30 September 1994 revealed that in more than half of the deals examined managements were not reported as having received independent financial advice. Clearly, there is less advisory work to go round.

One factor underlying the statistic is the rise of the Institutional Buy-out (IBO), in which venture capitalists cut deals direct with vendors, only involving managements at a later stage. IBOs are particularly popular structures for the bigger, £10m-plus deals, which have often yielded the juiciest fees.

In addition to reducing the scope for advice, IBOs also introduce more downward pressure on fee levels. The power relationships within a buy-out deal are fundamental to fee distribution. If the corporate finance adviser approaches the venture capitalist - who may be one of several potential equity providers in an auction process - it negotiates over fees from a position of strength. Bringing in the business is what really racks up the fees - "the secret for a house like us is finding the deal," says Mr Beatty. The reversal of this position in an IBO, giving the venture capitalist the whip hand, is not advantageous for advisers.

In addition to the rise of the IBO, venture capitalists at present have more funds with which to chase deals. According to statistics from the British Venture Capital Association, British independent venture capital funds raised more than £2bn during theeight months to 3l August. More funds means greater competition for deals and lower margins - and more pressure on advisers' fee levels.

But low fees, of course, are good news for management buy-out teams. Deals are less costly to put together and stand a greater chance of success. "It's a great shame that fee levels should be an obstacle to getting deals done," as Mr Beresford puts it.