So You Were Bought by a PE Fund—Now What?
Acquisitions are an important way for private equity (PE) funds to accelerate growth and achieve their strategic goals while strengthening the purchased companies in the process. The impact of the COVID-19 crisis on PE activity, including investments, exits, and fundraising, is still evolving. However, record levels of dry powder—the amount of committed but unallocated capital on hand—will likely pressure PE funds to continue to seek out and execute deals, including acquisitions, especially with the opportunity to capture high-value distressed assets. While a PE fund may have many reasons to invest in a particular company—growth potential, compelling value proposition, or scalable platforms—the goal is ultimately the same: to maximize the value of the portfolio company and realize a significant return on an eventual exit. Since the pandemic is causing PE funds to reconsider their target companies, certain industries and investment vehicles may now be much more attractive.
Understanding the benefits of a PE fund investment and where the challenges lie can lead to a smoother transition after the deal.
Although a PE investment can unlock long-term growth potential for companies, the change in ownership frequently raises questions and elicits concerns for the portfolio company’s management, especially in industries where PE involvement has not been commonplace. These transactions often produce challenges and require significant changes across the company but a PE investment also brings benefits. Understanding the benefits of a PE fund investment and where the challenges lie can lead to a smoother transition after the deal.
Here are three beneficial ways that portfolio companies should expect their business to evolve following an acquisition by a PE fund.
Following acquisition, a portfolio company is likely to face increased oversight as the PE fund seeks out opportunities to streamline operations, control costs, and improve overall business performance. Post-acquisition, portfolio company leadership should be prepared to provide detailed information on newly defined key performance indicators. The pandemic has only increased the desire for PE sponsors to have regular, detailed, and accurate information regarding a business’s performance, which includes an understanding of the underlying drivers and relationships causing fluctuations and trends. Further reporting requirements may arise, such as covenant reporting as a result of increases in debt or the submission of major investments and expenses for approval by fund leadership.
Finance and accounting functions are also frequently impacted as portfolio companies engage a new auditor, which results in incremental time spent by the accounting team to educate the new audit team and field incremental audit requests, particularly in the first year. Finally, a PE acquisition commonly results in governance changes at the top levels of a company, which can include changes in the C-suite or the board, and as a result, changes to board and executive level reporting.
Each of these incremental requirements may add to the overall timeline and effort required for portfolio company leaders to manage monthly reporting requirements, develop forecasts, and finalize interim and annual audited financial statements. During the pandemic, PE sponsors are often requesting specialized reporting on a more frequent basis, even weekly. Ultimately, the incremental review should allow management to identify and eliminate excess costs, improve the precision of forecasts, and effectively manage cash flow. While the ongoing effort required to respond to each of these changes may not be certain in the initial quarters after acquisition, management should identify and raise concerns about resources, existing functions, or other issues where potential investment may be required to improve upon the quality of financial information and the underlying processes.
Increased adaptation and responsiveness will be key in the period after the acquisition to position management as a capable and vital partner with the PE sponsor. Leveraging institutional knowledge to assist the investment team in identifying areas for improvement as well as using this period of change as an opportunity to drive improvements in the business across all disciplines will be valued by the new PE sponsor.
Streamlining the close process
A PE investment often results in the opportunity for portfolio companies to invest in new tools and gain access to new relationships.
A PE fund may require its portfolio company to upgrade financial reporting systems and processes, implement new or upgraded ERPs, and approve other technology investments. These new resources can ultimately help management generate efficiencies and eliminate manual workarounds in the existing close process. For instance, businesses using outdated bookkeeping software may invest in a more sophisticated accounting system.
Not all PE funds will require such changes; however, management can seize the opportunity to upgrade outdated, manual, legacy processes and systems. Cases for operational improvement are often well received by PE owners and can result in a more streamlined finance function. As with any organizational change, the upfront time it takes to obtain the funding and implement the change can pay dividends in efficiency over the long term. PE investors can make previously out-of-reach resources a reality, leading to more effective and transparent processes.
In addition to new tools, a PE investment will bring exposure to a larger network of professionals. This larger network can result in utilizing a Big Four auditor or engaging a management consulting firm. A Big Four auditor will likely introduce a new level of precision to financial reporting, which will require additional effort in the short term but can help the company avoid unwelcome accounting surprises during the eventual exit process (see next section). Consulting firms can bring new viewpoints ranging from revenue enhancements to process optimization to help management maximize business value. Beyond adding more sophisticated auditors and consultants, PE sponsors also recognize the value that talented people bring to an organization. For those who embrace change and are willing to drive improvements to the company, PE firms will not be afraid to compensate them well.
Preparing for potential exit opportunities
The goal of any PE investment is to maximize the return from the eventual exit of a portfolio company. Management should actively discuss what exit options are on the table with their PE sponsor early in the investment lifecycle as the ultimate exit strategy to be employed down the road can influence decisions that are made today. For example, if a public offering is under consideration, a company should incur the extra expense to maintain SEC compliant financial statements for as many financial reporting periods as possible prior to the offering. Financial reporting deficiencies will prove costly when they delay an IPO and the PE sponsor’s ability to optimize its exit window.
With the potential exit options in mind, portfolio company management teams should take proactive steps to prepare for any potential exit. Beyond financial reporting, these steps include implementing a sophisticated modeling and forecasting process, including closely monitoring various financial reporting metrics such as working capital, days sales outstanding, inventory aging, and liquidity ratios. Management can use this information to manage and ultimately improve the financial health and the day-to-day operations of the company, optimizing the business for an eventual acquisition.
Implementing appropriate internal controls and governance is another area that frequently requires improvement in advance of the exit. While the level of sophistication required will vary based on exit strategy, taking the time to establish even a basic control environment during this period of change will position the company for greater success as the PE fund explores and executes the exit.
Being acquired by a PE fund is often daunting at the outset, as PE funds have a vested interest in quickly improving the overall business and profitability of their portfolio companies. Ultimately, as both the investment and management teams work to align on strategy and the underlying drivers of success, both the fund and the company’s employees will benefit from a stronger portfolio company. The company will have a greater likelihood of achieving its long-term objectives, bolstered by new tools, contacts, and stronger internal processes, as well as employees with expanded skillsets, honed through the opportunities that the PE investment provides.