Better Together: Three Ways to Maximize the PE-CFO Relationship

Innovate the management selection process

Most PE funds have a time-tested process to evaluate existing talent and identify new candidates that will enhance an investment’s management team. Traditionally, CFOs—especially those in the middle market—are intricately involved in the day-to-day finance function of the business. As sponsors consider the management selection and retention process, investing in talent at the level beneath CFO becomes critical. When talent at this level is strong, day-to-day accounting and finance functions can be optimized without direct CFO involvement, freeing up the CFO to take on strategic advisory functions critical to the success of the investment. When CFOs have confidence the books are correct, they can dedicate more energy to the PE sponsor’s bigger picture priorities, such as M&A, operating model optimization, technology enhancements, and capital structure.

Clearly define expectations and roles

Following an acquisition, a portfolio company will experience increased oversight as the sponsor seeks out opportunities to create value, improve cost structure, and drive business performance. The pandemic has only increased the desire for PE sponsors to have regular, detailed, and accurate insight into business performance, which includes an understanding of the underlying drivers and relationships causing fluctuations and trends. Most CFOs are already unsure of the reporting their PE sponsors will require and the increased oversight it may want to exercise in a pandemic can exacerbate this uncertainty. If the PE sponsor was expected to be an investor rather than an operator, how will that change in a crisis? Finance departments, particularly CFOs, want to collaborate with their investors to provide timely, accurate, and insightful information and discuss how that information is used to improve the business performance. Unfortunately, CFOs and their teams often spend too much time second-guessing what an investor will want to see and what questions they will ask. Investors should provide examples of expected key performance indicators and have an open line of communication regarding how reporting demands may change as exit options continue to be evaluated.

Further clarifying the role of the PE sponsor will help establish the nature of the relationship. Will the PE sponsor be operating as a part of the board of directors, responsible for oversight of the management team and the company, or will it serve as an advisor to the management team? Management teams may see sponsors as advisors due to the congenial nature of the relationship during the due diligence phase. Once the acquisition is complete, however, the PE fund may begin operating with more direct and hands-on oversight since it is now responsible for results. Defining this relationship with the management team can help prepare the team for the demands and additional reporting requirements that will come from the sponsor team following acquisition.

Facilitate a complicated integration and eventual exit

The goal of any private equity investment is to make a profit from the eventual exit of a portfolio company. This exit hinges, in part, on successful integration in the beginning of the relationship. PE funds may not only exclude CFOs from early and important strategic decisions, but they also fail to provide the resources necessary to facilitate a complicated integration process, especially when the PE sponsor’s strategy includes a string of acquisitions to bolt onto the first acquisition. This lack of integration may ultimately impact the long-term return on the investment.

PE funds should include the management team in the planning and strategic discussion early and solicit feedback on what additional resource costs are necessary to accomplish the deal objectives. To that end, they should share exit options with management early in the investment lifecycle. The ultimate exit strategy to be employed down the road can influence decisions that are made today; for example, a private or public exit can completely change the required inputs to the process. CFOs can provide valuable insights into what technological and other resources may be necessary to generate the highest possible return on investment. This requires a willingness to make investments, where necessary, to achieve ideal returns.

During the pandemic, building high-functioning relationships with new portfolio management teams can be difficult as face-to-face interaction is more limited. Continuing to invest in the management team below the CFO level, communicating roles among all parties, and defining integration and exit strategies will be key to maximizing deal value.