There is an alternative

Are accountants about to take over corporate finance work the way they once captured tax from the lawyers? John Griffith-Jones, managing partner of corporate finance at KPMG’s London office, laughs and says no – but the figures tell a different story.

In 1995, his own firm was ranked 18th in the Acquisitions Monthly league table of advisers in quoted and unquoted merger & acquisition deals, with u1.9bn-worth of transactions under its belt. One slot behind, Ernst & Young was breathing over its shoulder with business of almost equal value.

Not scaling the upper echelons yet, but the accountancy firms were nestled between well-known investment banks like BZW in 17th place and UBS in 20th.

Good company. But even with a near-50% rise in corporate finance fee income last year – and the year before that – there is something in Griffith-Jones’s denial that rings true. For now, at least, the typical deal that accountancy firms handle is a minnow compared with the multi-million pound tombstoners that its nearest rivals look after.

KPMG’s average, for example, was less than u15m, while E&Y’s deals came in below u20m. BZW averaged almost u200m per transaction, while US giant Morgan Stanley clocked up u13bn-worth of deals with just ten transactions.

Griffith-Jones doesn’t expect the shape of those figures to change in a hurry: ‘It’s unlikely that BT would use us to do a major transaction.’

But what is apparent is that his firm, and his hard-running competitors in the accountancy profession, are the high-volume deal-doers. They are operating at an end of the market that the big City merchant banks are not targeting and are often not well-suited to work in.

Geoff Westmore, head of corporate finance at Coopers & Lybrand, explains: ‘Investment banks are becoming more of a balance sheet product. They ignore the heartland of corporate UK.’

SBC Warburg, for example, may have global reach, either through its own offices or through years of experience in working together with the world’s major lead underwriters and investment managers. But those sorts of contacts in Zurich, Tokyo and New York do not bring much to the party when a u10m merger deal is being arranged between a couple of Humberside engineering firms. It is the accountancy firms’ national, regional reach into the industrial landscape that is the real asset: they have a vast pool of audit, tax and management consultancy clients who may, sooner or later, require an audit firm’s corporate finance services. Merchant banks lack that in-house hit-list of potential clients.

Accountancy firms, arguably, have at least two other advantages over investment banks for certain types of deals: their independence and their technical competence.

The independence of the accountants is reflected in the fact that their fees are earned through advisory work, not underwriting. Griffith-Jones explains: ‘We’re not making money out of the transaction itself. We’re giving advice on the best way of doing it. Especially with the larger integrated houses, you could argue that the earnings from underwriting commissions far outweigh the fees they earn for advice.’

Pricing new issues

This reliance on underwriting fees puts pressure on the pricing of a new issue to ensure that it ‘gets away’ safely and isn’t left with the underwriters. The glorious, headline-grabbing news that a company’s shares score a significant premium on the first day of trading can also mean that the vendor – the bank’s client – could have raised more money through tighter pricing of the deal.

As Marc Cramsie of independent merchant bank Singer & Friedlander says on the following pages, the giant integrated investment houses ‘increasingly need to win the large global transactions’. Fees for advisory work are relatively fixed, but underwriting fees are geared to the value of the transaction.

Technical competence, regulatory work, due diligence, indeed the whole business of crawling over the books of a company to get under its skin, is what accountants are very used to and very good at. Griffith-Jones puts it another way: ‘Where do all good merchant bankers come from? The accountancy firms.’

Acquisitions Monthly, the monthly M&A bible, recently polled merchant bankers on the ‘threat’ being posed by the accountants. The bankers countered claims of accountants’ independence by asserting that their impartiality was compromised by a desire to sell additional add-on services.

In truth, both bankers and accountants have to work to rules and protocols; both must manage conflicts of interest, and the most professional outfits on both sides of the fence do it well.

There are certain types of work, however, that the accountancy firms simply must leave to the merchant bankers. The first of these is underwriting equity issues. Accountants haven’t got the kind of cash needed to guarantee that a u100m flotation won’t flop, even though, with institutional investors as sub-underwriters, the risk of something going horribly wrong is almost minuscule. There is still plenty of advisory work that can be done in such deals, however, and there are plenty of brokers who are happy to do the underwriting with accountancy firms providing the advice.

The other area which is off-limits is contested takeovers which involve a conflict of interest. At present, if one audit client tries to take over another audit client, the audit firm must stand back. There is a debate going on as to whether such firms should be allowed to act for the defence: ‘There is a case for saying that there is no reason why you should have to stand down at the very moment when you’re most needed,’ Griffith-Jones explains.

But as things stand, he admits that those are not the kind of deals for which accountants are best suited – yet. ‘We’re much more at home with negotiated transactions,’ he says.

Mandate-hungry merchant bankers are also renowned for approaching plcs with deal ideas, making unsolicited suggestions for divestments or acquisitions.

But there is no reason why accountants can’t behave in similar fashion.

KPMG, for example, approached the quoted engineering company Rubicon Group, suggesting a takeover of a privately-held business in the same field, Calder. It was a u100m deal.

One route to getting more corporate finance work is the Alternative Investment Market (AIM), which celebrated its first birthday in the summer. AIM introduced the novel concept of the nominated adviser, whose role is to take on board the regulatory duties that the Exchange itself carries out for companies on the main market, the Official List. When a company floats on AIM, the nominated advisers ‘sign off’ to the Stock Exchange, not the client, that the company has complied with all the AIM admission rules. It is also responsible for ensuring that the company complies with the continuing obligations of AIM membership.

Keith Smith of brokers Gerrard Vivian Gray says in law firm Olswang’s AIM guide that the nominated adviser ‘is de facto, if not de jure, the market regulator. The nominated adviser thus has “one foot in each camp” since his responsibilities are owed solely to the Exchange, but, of course, he must maintain a duty of care to his client, the company, by providing continuing advice in respect of all matters affecting the company with regard to AIM.’

To date, about sixty organisations – a mixture of independent stockbroking firms, integrated investment banks, boutique corporate finance houses and accountancy firms – have been accepted as nominated advisers. Between them, they have launched about 210 companies onto AIM (though many came from the now-defunct ‘matched bargain’ Rule 4.2 market, or from the USM, which winds up at the end of the year). Put together, these companies are valued at around u4.5bn.

The Big Six, Grant Thornton and Smith & Williamson have all become nominated advisers. The attractions are obvious: high-profile work that dovetails with the requirements of many of their existing clients.

Brian Moritz, senior partner of Grant Thornton in London, says, for example, that ‘the AIM market is almost tailor-made for a typical Grant Thornton client – a substantial, privately-owned company looking to expand, probably needing more working capital to do so or wanting to acquire companies for paper.’

Grant Thornton was accepted by the Stock Exchange as a nominated adviser in the summer. It has yet to bring a company to market, but it has two clients that are likely to float this month, and it expects to have another four on AIM by round about the end of the year.

Moritz believes that while bigger competitors are all active in this market, their heart isn’t really in it: ‘Whatever the Big Six say, AIM is really below their attention level. They’re looking at FTSE companies.’

Certainly, KPMG may have AIM in its sights, but it is clear that it is only a ‘subset’ of the firm’s larger ambitions in the full list market.

But as Griffith-Jones puts it: ‘You take your breaks where you find them.

The interesting thing about AIM is that it is the junior end of the market and our strategy would be to start with work that we can handle. That tends to be at the bottom of the market rather than the top. To that extent AIM was a heaven sent opportunity.’

It was also a level playing field, in one sense: ‘It was new. And no one has a track record on day one, so it’s a good place for new chaps to start. So we grabbed it.’

Nominated advisers and brokers

To date the KPMG team has acted as nominated adviser for three companies, though it now fulfils that role for only one. One former AIM client wanted to do a reverse takeover of another client, so conflict of interest considerations compelled the firm to hand over to someone else. A second AIM client decided that it was an unnecessary duplication of effort to have a separate nominated adviser and a nominated broker. It switched the advisory role to the broking firm.

That is likely to be an occupational hazard of AIM for nominated advisers who are a little more distant from the stock market than are most stockbroking firms. Neil Austin, KPMG’s head of new issues and a member of AIM’s advisory committee, explains: ‘If you’re in a situation where you want to continue to do transactions and buy more companies, there’s sense in keeping your financial adviser as well as your broker. If your sole contact is just going to be contact with investors and publication of results, then clearly that’s a broker’s role.’

But while losing a client can spoil your day, it doesn’t mean that it was a mistake for a company to have chosen an accountancy firm in the first place. What they bring is the wealth of experience in due diligence work. As far as the AIM regulations and expectations are concerned, this has been an unresolved problem. AIM was originally thought of as being a very cheap and quick source of equity capital. Those hopes have been dashed. Experience has shown that the flotation process can be longer than for a typical issue on the Official List.

Griffith-Jones says that it was once thought that the total cost for an AIM float could be as little as u25,000. The true figure is probably more like ten times that figure, and not far short of the cheapest Official List flotation.

Law firm Boodle Hatfield reports that ‘there has been little guidance on the degree of due diligence in the AIM rules. It could be that advisers may decide to do very little due diligence so as to provide a much cheaper service. This may be dangerous where respectable advisers are squeezed out of the market because they are not prepared to damage their reputation by reducing the level of due diligence they perform’.

Because the Exchange does not vet the contents of an AIM prospectus, the onus is on the nominated adviser to ensure the accuracy of its contents – and u25,000 doesn’t buy a lot of comfort for anyone, investor or adviser.

It has been suggested that the due diligence standard that nominated advisers will require their AIM clients to ‘buy’ is, if anything, even higher than that for fully listed companies. Austin refutes this argument: ‘AIM is exactly the same as a full listing. It’s a publicly quoted company.

You can’t have two standards of due diligence. You do proper due diligence or you don’t. It just gives you an added level of exposure as a nominated advisor because you’re the only person there.’

But if AIM is more expensive and more difficult than was first thought, it is worth thinking about it as an alternative to venture capital. ‘If you go and raise similar amounts of venture capital,’ Griffith-Jones says, ‘you allow the venture capitalists to crawl all over the place and run up quite a serious due diligence bill; arguably, a rather more effective due diligence bill because it’s targeted specifically at the company rather than a whole load of compliance rules.’

It is possible, too, that a venture capital deal will also result in entrepreneurs having to surrender a larger slice of equity. An AIM listing also offers the ability to make acquisitions by issuing shares, a strategy that would not immediately appeal to most venture capitalists.

AIM itself seems likely to flush out some of the cheaper and nastier advice firms. The market authorities are currently conducting an annual review of all the nominated advisers. A spokesman for AIM explains: ‘We take a more detailed look at what has been going on, the sorts of companies that the nominated advisers have brought on, how those companies have fared, whether they filed announcements as they should have, whether they’ve been advised properly, and whether enough due diligence had been undertaken when these companies were brought on.’

Advisers might get a few verbal suggestions for improvement. (Indeed, AIM itself seems likely to learn a few lessons.) A handful will get warnings to ‘pull their socks up’. There is even talk that one nominated adviser will be found to be so lacking in skills and ability that it will be struck off. Accountancy Age understands that the accountants have come out of the annual review well.

Ultimately, AIM forms just one part of the corporate finance ambitions for accountancy practices. One constraint is the shortage of experienced staff. Jobs pages are filled with vacancies for corporate financiers to join Big Six firms. For many chartered-qualified merchant bankers, it marks an opportunity to ‘return to the fold’.

But it also means that the major firms are now able to offer corporate finance career opportunities to chartered accountants who might otherwise have gone off to join Warburgs or Goldman Sachs. It’s a different type of corporate finance work but, while it’s unusual at the moment to find an accountancy firm involved in an M&A deal worth more than u100m, that isn’t the end game. ‘The real question is where we can go to,’ Griffith-Jones says, ‘because it’s only just beginning.’

Look what happened to the tax lawyers.

John Griffith-Jones (managing partner of KPMG corporate finance):

‘Where do all good come merchant bankers come from? The accountancy firms.’

Neil Austin (KPMG head of new issues): ‘AIM is exactly the same as a full listing. It’s a publicly quoted company. You can’t have two standards of due diligence.’