18 PAUL MORRIS: DEMYSTIFYING PRIVATE EQUITY – AN INSIDER’SVIEW
MEETING YOUR PE INVESTORS’ EXPECTATIONS OF FINANCE OPERATIONS
THE COMMON PAIN POINTS The management information produced by in-house finance teams does not always meet the needs of a PE house in terms of frequency or detail. The financial information is often historic, rather than focused on re-forecasting future results as conditions change. There can also be cultural challenges: statutory financial reporting can be seen as a necessary evil to meet regulatory requirements. The value of management information as a tool to shape and guide the strategic direction of the business is not fully appreciated. A successful PE CFO has to provide the information and insights that can drive business decisions and, ultimately, high growth. In-house finance teams may be facing new technical accounting challenges resulting from the need to account for the transaction itself, through to applying new accounting policies or even GAAP. Your existing finance team may not have experience in preparing consolidated accounts, accounting for goodwill and intangible assets, complex financial instruments (like derivatives or hedging tools) or deferred tax liabilities. Some smaller portfolio companies not have faced the rigour of a statutory audit. As a result, their financial statements can include accounting errors, for example, concerning the treatment of revenue streams or the valuation of assets. These ‘skeletons’ can lead to valuation challenges or negotiation difficulties in the completion of the PE investment. The CFO, and their team, will find that accuracy and quality become a minimum requirement.
PE houses want portfolio companies to use the first 100 days to drive change management across the business, including the finance function. Your business will likely face substantial change, perhaps expanding its client base, its offering or growing its international presence. The finance team needs to be ready to change how it works and capable of supporting the wider business as it will look in the future. You can read our in-depth article on achieving this here. The importance and value of CFO or Finance Director to a business is clear. If a CFO is not already in place, appointing one should be a priority and the next logical step in tackling these common pain points. A competent and experienced CFO should be a cornerstone of your strategic management team. The CFO does not operate alone and should be backed by a strong finance function. Unfortunately, finance functions are often perceived as an overhead and there is an understandable desire to keep them ‘lean’. However, this can leave your business vulnerable to key person risk. What impact would losing key members of the finance team have on your business? Could it disrupt your reporting timeline and critically weaken your business?
GARETH LYNTON JONES
Before completing a deal, a PE house’s investment team will be focused on your business’s normalised operational cash flow and EBITDA growth potential. They will be looking for a compelling story that expounds revenue growth, a strong, reliable margin and the ability to turn profit into cash. PE houses place significant importance on the quality of your people, so will look at the experience, expertise and competence of your whole management team. For the CFO, and the finance function, this includes the ability to prepare and make full use of the complex financial and management information that is needed to drive the kind of transformation and growth that investors expect. After the deal, the PE house will rely on your CFO and finance function to deliver high quality management information, together with relevant key performance indicators (KPIs). Clearly, your finance function has an important role to play in accurately reporting past performance but your PE investor will be more focussed on the future, closely watching earnings, profit and operational cash generation against what are likely to be ambitious forecasts and budgets. Are your people, systems and processes geared up to deliver for these demanding new stakeholders?
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