The opportunity to participate in the equity of a PE-backed business is potentially life changing for a CFO, presenting the genuine prospect of a substantial and relatively short-term capital gain. But, there is no such thing as a free lunch so what, precisely, do private equity firms expect of their portfolio company CFOs and how long are they given to prove themselves?
In this article, we consider the role of a CFO in the preparation and execution phases of a transaction as well as their post deal responsibilities in order to help better understand the expectations placed upon them.
During the preparatory phase of a transaction, a disproportionate amount of the workload can fall on a CFO. They are responsible for pulling together a vast array of financial and other information, and ensuring that the story being told by the management team is borne out in the numbers presented in the management information. This requires the CFO to consider their own data with objectivity and through the lens of an incoming investor.
Of course, the CFO will need to juggle this responsibility with their day job which often means that early selection of a corporate finance adviser with the bandwidth to provide hands-on support, can be vitally important in advance of engaging with potential investors. An electronic data room and detailed financial model clearly setting out the historical and forecast value drivers for the business must be prepared and thoroughly checked and sensitized in advance of going to market.
During the Process
Nothing is more likely to “kill” a transaction than a lack of momentum and therefore the pace and quality of information flow between the company and the various due diligence providers is paramount. Due diligence providers will be well resourced for a short/sharp process and any delays by the business in providing accurate and complete financial information will be apparent to everyone involved in the process and is likely to be blamed on the finance function. The CFO needs to be front and center during meetings with potential investors, providing comfort that they own the numbers, understand the commercial value drivers and are into the detail.
The intensity of the deal process often interferes with other responsibilities (such as month end financial reporting) which can begin to slip. Unfortunately, there is a microscope on the numbers during a deal process and therefore it is incumbent on the CFO to ensure that detailed financial data continues to be provided on a timely basis, regardless of other pressures. Any slippage in the numbers or slowing down in the normal financial reporting routine is likely to slow things down, and may undermine investor confidence.
Will they stay or will they go?
Once the deal is closed, PE firms want to make sure that there is an experienced CFO in place to support the growth of the business. Since they are not involved in the day to day running of the business, PE investors are hugely dependent on the financial information provided by the CFO and will want to know from the start that they can rely on it.
Many times, the decision on whether to retain the incumbent CFO will be guided by feedback from the due diligence providers and the level of confidence they have given the PE investor that they are up to the task.
Whilst the CFO is part of the management team, from the perspective of the PE investor, they are ultimately the stewards of the numbers. Investors need to believe that they are on top of the detail and will report to the board in a balanced, accurate and open way post investment.
Post Deal Responsibilities
The level and style of communication required is a big change for many CFOs post-transaction. While the CFO traditionally reports to a company’s CEO and board, a PE-backed CFO needs to have the skills to be transparent and communicate effectively with the CEO, Board and the PE investor. Given the multiple stakeholders involved, the ability and tools to communicate performance, plans, and objectives are paramount – private equity investors rely on their CFOs to give them a clear picture of what’s going on inside the business as they are not involved on a day-to-day basis.
Having ensured there are adequate systems and controls in place to accurately capture the data and performance of the business pre-transaction the CFO will be expected to use that data and knowledge to help make commercial decisions in the business post deal. These might well include evaluating acquisition opportunities, projecting expansion plans and ensuring any overseas expansion is risk-free.
They will also be expected to work closely with their fellow directors to use the data captured within the finance function to improve and enhance other departments and hold them to account if they are not delivering against “the plan”. To the extent there is debt in the transaction is also likely that the CFO will have responsibility for banking relationships and reporting against covenants on a regular basis.
Its all about alignment!
Ultimately, the responsibility and variety in a private equity-backed business makes for an engaging CFO role. The CFO will be given a high degree of autonomy, work with a broad range of people (both inside and outside of the business), and partner closely with the CEO and investors to tackle dynamic challenges. The Management team will have a clear plan in place at completion of the deal and the CFO is a key part of the team working towards delivering it.
For those that make the cut, the 1-2% of the sweet equity typically awarded on the way can result in a significant capital gain when the PE funder exits the business. This can be taken in cash but it also provides the opportunity to roll value into a secondary MBO for those CFO’s and Management teams that want to go again!
For other CFOs approaching a transaction, the transaction itself may be their natural “swan-song”. Deep knowledge of the business gained over many years can be invaluable in navigating the transaction but doesn’t necessarily segue into the appetite for an intense and demanding three-five year PE journey. Often we see the incumbent CFO remain in place for a while after the deal to be replaced, by mutual agreement, within 18 months or so as the business, and the demands on the role, ramp up.
Ultimately whether a CFO remains with the business from transaction to PE exit (and only about 50% do), depends on an alignment of ambitions as well as the demonstration of energy and aptitude.