Kelly Partners Group, acquisitions with little equity down

Gustaf Hakansson: Brett (Founder & CEO of Kelly+Partners), I am excited about this interview. Let me take a stab at your story, and we will take it from there. Here we go:

So, imagine it is 1997.

Cabbies are pumping the Australian pop sensation Savage Garden's debut album all over Sydney’s business district.

A 22-year-old named Brett Kelly sits in a swanky investment bank office - hibernating in Excel - when his boss suddenly starts walking towards him.

The boss courteously asks Brett for a moment and, before skipping a beat, quips: "You don't fit in with the other people here. Brett, you are different. You would be better off somewhere else."

‍It felt disorienting - to be young, relentlessly ambitious, and suddenly without a prestigious job.

In an act of fatherly love, young Brett is given books as guidance on what to do next. One book gives Brett the idea to interview successful people and model himself after them.

A simple plan, but it was not an easy one.

Brett makes 50 calls daily for three months, trying to interview outlier achievers. The result became the 34 portraits in his best-seller Collective Wisdom: Prominent Australians On Success And The Future.

Hobnobbing with former prime ministers and business leaders sets a high bar for success. And when Brett later joins an accounting firm as a qualified tax agent, the status quo becomes unbearable.

Because Brett feels that accounting partnership structures are copied more than they are pondered, with partners cumulatively feeling entitled to 101 cents of every dollar. Therefore, they cannot reinvest for the long-term benefit of clients.

And the structures promote accounting as a mere profession; the business is always an afterthought. Activity gets confused for progress.

In 2005, when Brett’s first child was born, he got a worse promotion than promised. Feeling deceived by dishonest partners, Brett thinks: “That’s it. Either I leave the industry or improve it.”

Growing up, Brett wanted to be Warren Buffett. And, Mr. Buffett only invests in things that, with some certainty, exist two decades out. So, death and taxes were naturally the only entrepreneurial pursuits available for the down-to-fundamentals Brett.

It may have been a close call, but the young tax accountant chose taxes.

Brett employed the principles absorbed from his interview subjects, tailoring Kelly & Partners Chartered Accountants in 2006 to suit the industry’s peculiarities.

The vision is to provide private SMEs with the same high-quality service that multinational firms get. And the well-read Brett applies Walmart’s strategy of going where others do not. Building regional oligopolies before anyone notices.

Fast forward to today, and a lot has happened. Kelly+Partners (KPG) has launched 17 greenfields and made 34 acquisitions.

Brett characteristically joined the line to the 2022 annual Berkshire Hathaway meeting in the top 10 at 02:27 am, and he is set on KPG becoming a top 10 accounting firm by size in Australia.

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Gustaf: Well, feel free to correct any butcherings of your life story. And then, why don’t you tell us what you are most proud of?

Brett Kelly: Gustaf, thanks for having me. I am most proud of our people and our businesses. I am proud by the fact that our people live by our values - to make our people, our clients, and the communities they work in be better off.

As Jim Collins says in Good to Great, we focus on hiring disciplined people - people that are aligned with our values, and that is what we have done at Kelly+Partners.

I am proud that our businesses are leading in the accounting industry. We have grown our revenues at 30% CAGR since inception and we are currently operating at 33% EBITDA margins, significantly higher than the industry (19%).

I believe this is achieved through disciplined thinking and processes that are unseen in the industry. I admire great businesses (such as Berkshire Hathaway, Constellation Software, LVMH, etc.), all of which provide us with ideas on how to run the best business.

We are proud to be listed in Australia as I always wanted to prove that we could do in public what we did in private. The rigorous disclosure processes involved in being a listed company have also made us better in our reporting and our analysis of our business.

I worked on Economic Value Added (EVA) software when I was young. That informed our culture as I did not have much capital starting out. I am proud that we have continued to be capital-light, enabling ambitious people to get equity-like compensation without much capital.

Since inception, we have only raised about AUD 14m and we can grow while increasing cash flow - we believe without raising further capital in the normal course of business for a very long time.

Our succession solutions allow young professionals that are great with clients to run clients and partner with KPG to operate a successful firm. But they might lack either capital for acquiring a whole firm, business expertise, or the ability to successfully negotiate deadlocks with a retiring senior.

Our theoretical EVA understanding, transaction knowledge, and domain expertise differentiate us against slow-moving partnerships characterized by misaligned incentives. So, KPG is run from first-principles, where we - like a bank - optimize both sides of the balance sheet.  

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Gustaf: How does KPG differ from a regular accounting partnership? How is the alignment of interest different from a roll-up?

Brett: Our partnerships are 10-year deals that renew with a permanent ownership forever mindset (a 100-year view), and we have what we call a 51%-49% Partner Owner Driver™.

Our local operating partners sign and commit to this in the partnership agreement. We believe that only in the long term can a successful business be built.

That means that we are not rolling up all the responsibilities to HeadCo while leaving the rights in the subsidiaries. That is a model that does not work for professional services.

Acquisition debt sits at the operating business level and is secured against operating assets and personal guarantees.

However, we often negotiate to acquire 100% from the older partner only to facilitate the structuring of a deal permitting an internal successor to take the reins of 49%.

Firms pay 6.5% of revenues for the central management team and 2.5% for IP. The proceeds are reinvested into the business to make it better, to fuel the flywheel.

In return, they can centralise administrative functions, cutting costs in half. That gets us to a double in profit, while we also decrease working capital by about two-thirds.

We are capital-light, as we mainly need to fund working capital (work in progress (WIP) + debtors), where we rank about 50% better than the industry. By collecting well - by mostly engaging via fixed fees and not accepting jobs that we cannot finish - we dodge the professional services killer of having profits locked up in the business.

In sum, we engage in micro-LBOs. The sellers are taking the risk that we successfully manage their firm successions. We provide expertise, allowing firms to continue operating, which benefits their clients and team.

Vendors get some cash upfront and the rest after two years. We borrow for the up-front cash at a ring-fenced subsidiary level, whereas the rest effectively is vendor financing.

That gets us to a place where we acquire firms without putting down equity or very little. We effectively are consultants, but with skin in the game - getting paid in equity. That has quite the effect on return on equity.

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Gustaf: Your second-largest shareholder (after you), recommended that I would ask how KPG increases acquisition EBITDA margins from 19% to 34% and why other accounting firms do not copy your playbook?

Brett: The short answer is that our playbook is full of trade secrets but, more importantly, part of a system that is probably impossible to duplicate…

Michael Porter’s HBR article “What is Strategy?” shares the “activity-systems map” idea. The thesis is that you can copy the product to a degree but not a combination of activities put together in a unique way! See an example for IKEA:

Our activity-system map is a tangled web, as our activities support both each other and our value proposition toward our people, customers, community and company sellers. They all reinforce each other.

It is a complex system built on simple premises, in which the parts seamlessly support each other to create a self-reinforcing flywheel.

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Gustaf: How do you attract the best partners? I think the wording of your acquisition announcements says a lot about your culture “Regional Victorian Firm ‘chooses’ Kelly+Partners”.

Brett: We want people and firms to choose Kelly+Partners for our values, behaviors, and the difference we make to clients as well as our communities.

I usually say that the Big 4 are called the Big 4, not the Great 4.

We are leaner and can offer income streams not available at other firms. Partners get base profit distributions, profit shares, KPG stock, and can also own shares in our growing wealth business, investment fund, and property portfolio.

We remove the administrative burdens and let partners focus on what they like best, serving clients. By standardizing around 80% of work, they can focus on adding value to customers and get time over for work-life balance.

Often we look for partners that exhibit our values - that they want to make their people and their clients better off. We want to continue attracting energetic people to compete in a slovenly industry.

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Gustaf: How did you come up with the idea of the KPG Owner's Manual?

Brett: From Berkshire Hathaway. We also received a lot of repeated questions from our shareholders early on and we thought that it would be a great idea to publish answers to these questions as part of a permanent document. We wanted to be transparent about our business, our values, our thinking - as Warren Buffett would say, we wanted to disclose everything about the business that we would like to know if we were a shareholder in the company.

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Gustaf: What happens upon a succession in one of your firms? Have there been any disagreements with your subsidiary partners so far?

Brett: In a succession, we (the partner group of the operating business) would work together to identify younger partners (either from the existing team or recruiting new members).

Rarely do we disagree with our subsidiary partners. We leave it with them to think and act in the best interests of the business and we guide them to do so. Because of our unique structure and our sharing in our responsibilities and rewards, our interests are aligned which makes it a lot easier. Every month we would have a partners meeting with each operating business to understand the issues they face and help them solve them.

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Gustaf: What does the runway look like, and how do you benefit from scale?

Brett: We want to become a top 10 accounting firm in Australia which means revenue of $125m+. We believe we can achieve this in time. Organic growth is essential, but our journey will be supported by marquee and tuck-in acquisitions.

We do not like to talk about “synergies” as that is a word that has been abused many times in the past. As we become larger and scale, we have a stronger brand and a larger group that in turn attracts better people into the business.

We are succession specialists in a market with over 10,000 firms that soon could benefit from our expertise. But our main focus is profitable growth. We also can see global opportunities for our business insight and system.

Our business system aims to be like Danaher’s in that it can be adapted to other geographical markets in the same industry. And while the M&A function still primarily will involve Ken and I, we will look to have our long established partners take responsibility as M&A scouts for certain geographies to increase the cadence and volume of new partnerships.

We are becoming the #1 acquirer of choice for accounting firms in Australia, and over the next five years, we will look at expanding the TAM. Focusing on countries like NZ, USA, UK, and Canada.

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Gustaf: What do valuations look like, and how are acquisitions financed?

Brett: We always look at payback and we try to achieve a four to five-year payback with our acquisitions. We finance our acquisitions with debt, never do we issue equity to make acquisitions.

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Gustaf: How is the business development team structured?

Brett: The acquisition team consists of me, supported by Kenneth, CFO, and our general counsel, Joyce. Joyce was our first employee and is still with the business.

Acquisition team members tend to make acquisitions no matter what, but at some stage we may consider growing our business development team.

We have been going at it for 15 years and have a database of about 10,000 firms that we reach out to.

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Gustaf: You are impressively appreciative of others. What people and books have been most influential for you?

Brett: Warren Buffett, Mark Leonard, and Bernard Arnault come to mind. Warren Buffett and Arnault are similar in that they have a reputation for permanent business ownership. They have built a reputation where people want to sell their companies to them, and KPG is getting there, and aims to achieve that reputation amongst SME accounting firms, too.

As for books:

• Good to Great
• The Snowball
• The Outsiders
• 100 Baggers
• The Warren Buffett Way
• How to Win Friends & Influence People
• Think & Grow Rich

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Gustaf: How can investors and owner-operators contact you?

Brett: Please get in touch directly via phone +61 419 206 475 or email at brett.kelly@kellypartners.com.au

You can find our acquisition criteria here. You will see similarities with Buffett’s acquisition criteria which we based it on.

‍Reach out if you are an accounting practitioner with a business that meets all of the following criteria:

• “Your values are aligned with Kelly+Partners, namely ‘We want the best for others’, ‘One team, one way’ and ‘We do what we say’;
• Demonstrated consistent revenue (future projections are of no interest to us);
• You are not affiliated with / or partly owned by an accounting network;
• Your core business is the provision of accounting and taxation services;
• Your target client is Private businesses and their owners”

The larger your business is, the greater our interest becomes.

We promise confidentiality and a fast answer — usually within five minutes — as to whether we are interested.

You can learn more about us here:

• Here is a link to a presentation I did for London Business Schools MBA class: https://youtu.be/wvgm7JiSTwM
• KPG Owner’s Manual: KPG Owners Manual | Kelly+Partners Group Holdings Limited
• Presentation at our recent AGM from William Thorndike Video Presentations | Kelly+Partners Group Holdings Limited the author of the business book The Outsiders that is an inspiration for our progress (link to Google talk here Talks at Google - The Outsiders)
• Presentation at our recent AGM from Lawrence Cunningham Video Presentations | Kelly+Partners Group Holdings Limited the author of The Essays of Warren Buffett, the first book published on Warren, and probably the world’s leading Buffett authority