Private Equity Finance Considerations
Finance insight
In our experience, three key challenges in finance function (poor operational finance, strategic finance non-existence, and lack of finance business partnership) threaten unlocking the full potential of the PE-owned portfolio company. While many portfolio companies improve operational finance under PE ownership, they need help to make meaningful progress in strategic finance. In our experience, strategic finance plays a more prominent role in portfolio company performance and whether the PE sponsor will realize the deal thesis.
Most deal partners and finance operating partners attest that mid-market portfolio companies don’t invest in finance function before the acquisition by the private equity. Because of that, portfolio companies tend to struggle to close the books on time and provide meaningful insights. Consider the example of a $200M business services portfolio company. The finance function took 45 days after the month-end to close the books and provide basic financial reports. And the company had no strategic finance function. You will wonder how the management team made business decisions on time to drive high performance when they didn’t even know the revenue, cost, and profitability until the quarter was almost over. Of course, they did not. Business performance suffered, and the PE sponsor was forced to replace the CFO and make significant changes to improve the finance function. This is not an isolated incident, and we see this situation play out routinely.
In order to establish a high-performance finance function, we recommend fixing the foundation (operational finance) first. PE sponsor and management team can leverage three improvement levers to establish the foundation for a high-performance finance function:
-
Clearly defined finance policies and standard operating procedure
-
Best practices-based business processes (record-to-report, source-to-pay, lead-to-cash, and acquire-to-retire)
-
Leverage the right set of enabling technologies – mid-market ERP like NetSuite, close process automation with FloQast
While operation finance focuses on transaction processing (GL, AP, AR, fixed-asset, tax), high-performing strategic finance function focuses on the economics of the business and drives value creation. In our experience, strategic finance is non-existent in many mid-market portfolio companies. While strategic finance function is hard to build in-house, PE sponsor and management can leverage the following three levers to establish a high-performing strategic finance function:
-
Value creation-focused analyses, actionable insights, and VCP tracking
-
Driver-based budget, scenario planning, and integration with deal-thesis
-
Business partnership to drive strategy and investment agenda