CPA firm using an APS model

[D Lewis]

We have an CPA firm - an LLC taxed as a partnership with about 80 participants.

I've been informed that they are selling an equity interest in the the company to a private equity firm.  It's a practice referred to as an Alternate Practice Structure "APS".

I've asked a lot of questions and a lot of the answers don't make sense to me.  I've never dealt with this before, so I don't know what I don't know.

I'm guessing they need an ERISA attorney, but I wanted to see if anyone here can shed some light for me so I at least know the right questions to ask.

"As part of the APS a new legal entity will be formed to separate our attest and advisory functions.  Our current named insured will be the "attest firm" owned by the current partner CPAs. and a newly formed entity will be the non attest entity.  There will be a management agreement between these two entities that explains how the non attest entity will provide administrative services such as back-office staff, IT, insurance, employee benefits and office space for the attest firm.  All individuals employed by the company today, CPAs and non CPAs will be employees of the attest entity."

They confused me by later saying both the existing firm and the new "Attest" firm will be a subsidiary of a holding company.  They have yet to tell me who owns the holding company and it doesn't make sense if they partners are still owners yet they are a subsidiary. 

On a follow up they told me:

"Present day

• All employees are employed by current LLC.

• The 401k arrangement is tied to current LLC.

• New Advisory firm is an entity that currently exists today. New Advisory does not have any employees.

• Current LLC and New Advisory are subsidiaries of the same holding company.

 At transaction close, Current LLC will move to an Alternative Practice Structure. The APS model is a well-established framework in the industry and enables external investment from private equity into CPA firms. It will look something like this:

• Current LLC and New Advisory will continue to exist with the same names and EINs.

• Current LLC will move out from under the holding company and become a standalone entity. 

• Over time, the employees will migrate from current LLC to new Advisory. It could happen all at once, but we aren't sure.

• Current LLC will have some CPAs as employees, but those individuals will also be employed and paid by New Advisory.

• We do not expect a change to the census / participation as a result of this change.

• There will be a management agreement between Current LLC and New Advisory whereas new Advisory will be responsible for obtaining and managing the employee benefits for all employees.

 As I mentioned yesterday, we would like the 401k plan to continue through the transaction with no disruption to the employees."

Finally they are telling me that other TPAs simply make New Advisory and adopting employer with Current LLC as a controlled group and move on.

I don't know if I'm making it more complicated than it is, but something doesn't seem right.

Any insights on this would be helpful as I've obviously a novice to this.

[FORMER ESQ.]

Unfortunately, PE investment in professional services is becoming more prevalent. PE's wish to gain a foothold in a new class of investments (because they are not happy with not owning everything) and the owners of the professional service firms seek some cash liquidity.

For CPA firms, the business is splt into two entities: The auditing business (the attest side) and the advisory business. The advisory business can be 100% owned by the PE, but under state law, a non-CPA (such as a PE) can only own a certain percentage of the attest business. 

For your purposes, as TPA, the question is whether the attest and advisory business are under Section 414 common control? They are likely not part of the same controlled group because under state law the PE likely cannot own 80% or more of the auditing business. BUT the two entities are likely part of the same affiliated service group. The attest business being the FSO and the advisory business being the A-Org.

[D Lewis]

Thank you so much.  I think they are not being precise with their terminology to me, so I apologize if I didn't frame things correctly.

Do we have to understand who owns the PE, or just how much the PE owns of the advisory business and possibly the attest business?

 

[FORMER ESQ.]

No, you don't need to understand who owns the PE.  It's basically an fund that invests in (and restructures) relatively mature cash-flow positive companies. PE (and its managers) are subject to Federal securities rules (primarily the 1940 Investment Advisors Act).

What is important is the PE's percentage of ownership in the attest and advisory entities. The ownership percentage is important for determining Affiliated Service Group relationships. You are correct that they are not using the proper terminology. It's not a controlled group, and almost every PE I have worked with takes the position that the controlled group rules (i.e., 414(b) and 414(c)) do not apply to a PE structure because the PE is not a trade or business, but rather an investment vehicle.