Published: Sep 20, 2017
Over the next month, Stuart Kerr, CFO at Incremental Group – a Maven investee company – will draw on his 20 years’ experience and discuss the demands of a CFO in a private equity backed business. Over the next four blogs Stuart will give advice on the key risk which require addressing at the outset, how to establish a platform for growth and how to help maximise exit readiness.
Private Equity (PE) backed business are different to other businesses: a focus on cash returns, profit generation, growth and stakeholder relations requires a different approach to many family owned or corporate businesses. The role of the CFO is critical to the success of the investment in this environment. The investor’s demands on the CFO can be significant and the complexity of the environment can be challenging, but ultimately a rewarding arena to operate within. Fully understanding the importance of the CFO role and the expectations of the investors is a key priority that can set the tone for the rest of the journey.
With a typical funding structure resulting in a leveraged balance sheet, PE backed business must focus on cash returns to ensure investor debt is serviced. Understanding working capital pressures, liquidity and free cash flow is therefore a priority focus that needs to extend all the way up to Board level; it’s not just the domain of the finance team or the credit control department. Where banking covenants are involved, this immersion in cash management is taken to a whole new level of importance.
Of equal importance to cash returns is profit generation; reported EBITDA needs to be an accurate, consistent and robust metric. Most PE deals have some form of EBITDA multiple embedded in their valuation so it’s imperative that this metric is accurately reported and stands up to scrutiny on an exit process. In addition, the importance of quarter-on-quarter (and often month-on-month) EBITDA growth over the period of investment can also bring unique challenges to a PE backed business. With a typical three to five year investment horizon, it is not desirable for PE backed businesses to start making sizeable investments in the latter stages of the journey as this diminishes the ability to convert such investments into suitable EBITDA returns in the appropriate timescales.
Stakeholder relationships also require a very different approach in a PE backed business. Within family-owned or SME corporates, reporting and interaction with owners and other stakeholders can at times be irregular and unstructured, while at the opposite end of the spectrum, listed companies have formal and well prescribed engagement with their shareholders on a regimented quarterly basis. PE is different. Continual dialogue and interaction with investors is an absolute must in a PE backed environment. Providing investors with data at any point in the month is expected of an PE management team. Being able to adapt to this very different environment brings an intensity not always experienced before by those not familiar to life in a PE business.
The role of the CFO in a PE backed business also has some fundamental differences to the role of a corporate CFO. A lot of decisions and actions of a CFO should be taken with an eye on the value creation opportunity and potential impact on exit multiple. The nature of PE investment means that it is almost impossible to predict the timing of an exit so the key to success is being prepared for exit from the outset. The pace of the journey are also very different for a PE backed CFO.
These differences can create a challenging environment in which to operate; not all CFOs relish this shift and many don’t succeed but for those that understand and fulfil the expectations of their PE investor, the rewards of the journey can be significant and not just in personal wealth creation terms.
PE backed CFOs now have a broader remit than ever before, with many also having a role in driving revenue growth, delivering transformational projects, implementing new systems and driving operational improvements. However, of fundamental importance to investors is the CFO’s responsibility for robust financial stewardship, particularly in a leveraged scenario. Getting this core requirement wrong will render all successes on the non-core aspects of the role meaningless.
Part 2 - The importance of good financial stewardship (issued 29 September)
About the author
Stuart Kerr CA is the co-founder and CFO of Incremental Group and is responsible for the overall financial performance of the business and M&A. Before co-founding Incremental Group, Stuart was Finance Director at Amor Group, a PE backed business, where he led the finance organisation through a period where it doubled its revenues to £60m over 4 years and successfully managed the sale of the business to Lockheed Martin. He is a Chartered Accountant and spent 12 years with PwC focused on M&A.
About Incremental Group
Digital technology provider, Incremental Group, is one of the UK’s longest established Microsoft Gold ERP Partners with over 20 years’ experience of designing, implementing and supporting mission critical Dynamics 365 for Operations and Dynamics AX projects in both the private and public sector.