EY is finding out that divorce is never easy—even when it’s an amicable split.
Ernst & Young’s leaders have yet to settle key issues essential to their planned break up of the $45 billion professional services firm. According to people familiar with the firm’s deliberations, details still in flux include how to divvy up tax partners between the advisory business and audit practice, how to structure any stock-based compensation for advisory staff, and perhaps the most basic question: Who will run the newly decoupled businesses?
EY leaders expect that about 75 of its 140 affiliates will consider sometime in early 2023 whether to support splitting apart the global firm, the people said—a shorter window than the firm had predicted back in September when EY leaders announced they would seek partners’ approval beginning this year.
No votes have been scheduled yet, a person familiar with the firm’s deliberations said.
EY, which audits more public companies in the US market than any other Big Four firm, plans to take public its consulting business along with a substantial portion of its tax practice in late 2023.
That would leave the assurance practice, which includes the firm’s financial accounting advisory and audit work, and dozens of small market affiliates who won’t take part in the split to continue operating as a partnership, people familiar with the deal said.
But leaders first need to secure approval from affiliate firms and partners around the globe. They also need a pass from regulators—and even their clients, whose records will either be retained by the legacy EY firm or handed over to the newly created company.
Working through client consent issues and navigating 75 sets of approvals are among the biggest challenges facing the firm, which aims to complete an equity and debt transaction next year to pay down its pension liabilities, pay out partners and fund the new business.
“It’s feasible, but there is a lot to be done in the next 13 months to get it done by then,” said Steven Berger, a shareholder with Vedder Price P.C. who represents accounting firms in mergers and acquisitions.
Complex Deals, Decisions
The details yet to be ironed out include naming the leaders of the new company and the stand-alone audit firm. Partners will know those names ahead of a vote, said a person familiar with the firm’s discussions.
The firm is also still working on how to structure possible equity ownership in the advisory business for both partners and staff. Offering ownership to workers earlier in their career will be a new recruitment tool to reach a broader range of workers and is a key feature of the break-up plan, people familiar with the deal said.
Still, the fragmented leadership of the partners and various affiliates makes EY’s divestiture more complicated than recent spin-offs like those of General Electric Co. and Johnson & Johnson, said Jay Ritter, a finance professor at the University of Florida.
“That’s where you’ve got the complications, where it’s going to take a lot longer than for a typical company,” Ritter said of the firm’s likely IPO.
It’s common to not yet have all the answers for a transaction this complex, Berger said.
EY will have to divvy up office space, IT systems, and address tax issues related to separating assets. With an expected IPO, the firm will have to meet securities requirements in various countries and the new business and audit firm will have to ensure they don’t work together or appear to work together to comply with US regulators’ expectations.
“Its an evolutionary process,” he said. “You answer one question, three more come up.”
Tax Practice Divided
EY leaders are still working through which tax partners will move to the new business and which will continue to work for the audit firm, said Marna Ricker, the global firm’s tax leader and former leader of the US tax practice.
“It’s a highly complex transaction and strategic alternative to consider,” said Ricker. “We’re just being very thoughtful and really diligent on how we think about it, how we do that in a way that again is very careful in addressing all of our stakeholders.”
Ricker said firm leaders are working with partners but the goal is to sufficiently staff core areas for both the assurance practice and the new advisory business.
“We are going through a very thoughtful process around that,” Ricker said. “There is some to sort through, but you know, when you really get through looking at what people do today, it aligns pretty naturally.”
Roughly three-fourths of the tax practice will join EY’s advisory service to form the new company and will provide services that range from strategy to tax controversy work, Ricker said.
Freed from auditor independence restrictions and related mandatory rotation requirements, the new business will be able to build longer-term relationships with its clients and avoid audit-related disruptions that halt services. That could open the door to providing more managed tax services and outsourcing, she said.
“Being able to team alongside them on a long-term basis around tax technology and transformation and able to operate all or some parts of their tax departments—that’s a big area of focus and certainly a big piece of where we see the market going,” Ricker said.
The remainder of the tax practice will support audits but also continue to provide tax compliance work and support transactions and international structuring, she said.
EY auditors count some of the largest US companies among their clients, including Amazon.com Inc. and Facebook parent company Meta Platforms Inc. Firm leaders have said previously that the audit practice will have the staff, auxiliary services and other resources its needs to succeed on its own and provide the robust audits that investors depend on.
Timing the Market
Neither the risk of a likely recession nor this year’s collapse in the volume of US IPOs is likely to set back EY’s plans to complete any transaction by late 2023.
EY is an established business with a strong revenue track record, and that should allow it to avoid the market volatility that reset valuations for tech companies and other high-growth businesses this year, said Ritter, who tracks the IPO market.
Investors will value EY not as a start-up or emerging tech company but as a mature company with predictable profits, Ritter said.
A slowing economy could soften demand somewhat for professional services in 2023, however, suppressing revenue growth for firms like EY, said Fiona Czerniawska, the CEO of Source Global Research, which tracks the consulting industry.
Revenue growth next year is likely to come in at 6% to 7%, just shy of pre-pandemic norms for professional services globally, Czerniawska said. Companies face staffing shortages and a laundry list of corporate goals, including technology updates like switching to cloud-based applications, and that means they will continue to need help from consultants like EY’s professionals, she said.
“Economic uncertainty isn’t a show-stopper for any of this,” she said.
That gives EY breathing room to consider its options and set up its advisory arm for success. “Get the model right, and it’ll be a very, very safe investment,” Czerniawska said.