Awareness of shareholder needs - what makes Private Equity different?
Private Equity as an owner is different. Maybe.
Let’s start with the downside. The churn of CFOs with Private Equity investors tends to be high.
Randomly selecting 10 mainly DACH-based portfolio companies and reviewing the changes of CFO over the last 10 years, we see that seven of the 10 portfolio companies have had at least four different CFOs over this period. Four changes within these 10 years also represents the average of this sample; changes twice a year have also been observed.
The fundamental difference in Private Equity is that the investment cycle between acquisition and sale tends to last 3-5 years, by definition creating the timeframe for value creation. To the extent that such value creation is driven by an increase in profitability, underlying projects must be implemented at least 12-18 months before the exit is prepared, otherwise the positive tailwind would hardly be visible in the P&L and assessed to be less reliable by the next owner.
However, as many transformational projects such as footprint optimizations and SG&A rightsizing may easily take one or two years, the clock is ticking from day one and speed is of the essence. Slow progress at the start and a need to replace management will prolong the holding period and reduce the return on the investment. Whilst the value creation might still be the same, the longer time taken means that the key indicator of success for the Private Equity fund – the return or IRR – will be lower.
Another challenge is that investors are well equipped with internal analyst resources to discuss business matters with management eye to eye. The typical reaction of management is to be hesitant and opaque. This may be justified, but it will only create frustration for the owner. Creating transparency in a collaborative way is a much better starting point.
In our experience, when we replace CFOs on an interim basis, it is rarely due to a lack of knowhow. We observe communication clashes between investors and CFOs, a lack of collaboration, insufficient transparency and often a defensive behavior instead of embracing the challenge to find solutions.
The advice here remains consistent to many other CFO scenarios: take leadership and become responsible for the playbook of value creation and change. Private Equity investors spend huge amounts of time and money to analyze a company through due diligence procedures. Many consultants and experts generate dozens of ideas for improvement. Gathering this in such a playbook is so valuable and will help greatly in managing future communication with investors and supervisory boards. And, ultimately, drive success for the CFO in their role.
“…In general, the job description in both situations is very similar. But in practice, Private Equity investors have significantly higher requirements in terms of expertise, leadership, implementation skills and robustness.
Additionally, PE investors focus more on the future positioning and prosperity of the finance department, G&A and the whole company. Internal processes need to support and enable production, sales and customer services – and that requires a well-defined roadmap supporting digitalization and automation. The CFO needs to be the driver of this transformation journey and is required to have relevant project experience and expertise…”
CFO with several roles both in Private Equity and family-owned companies
- Understand that time pressure in Private Equity tends to be higher
- Reinforce the need for transparency, as the shareholder will usually take an active role
- Manage transformation - the ultimate goal in Private Equity is to be successful by driving change