Clancy Murphy, Drax Leadership Senior Advisor, discusses the challenges facing CFOs taking up their first role in private equity
Given the challenges that CFOs face, it is perhaps hardly surprising that so many of them are changed during the investment cycle. In 2017 there were 318 PE exits and in 73% of them the CFO was changed within 18 months of PE house making their investment in the business.
However replacing the CFO isn’t always the answer. The impact of doing this can sometimes push back the exit horizon, which no one should be keen to do. Taking the idea that most CFOs can learn this new game, providing the incumbent CFO with access to a proven and PE-experienced CFO who is able to provide direct and relevant mentoring and support in the first 12 months post investment could avoid the need for replacement.
The world of private equity is changing. Higher asset prices are making it more challenging for PE houses to produce the required investment returns within the tight parameters of a five-year horizon, so they are having to support the newly invested company in different ways to drive the targeted growth to meet the investment thesis.
Only a few years ago, and perhaps in a minority of investments today, a PE house would give a management team space in the first 12 months so that they and the team they’ve just backed could get to know each other.
Today, however, driven primarily by pricing and the conviction required by the PE house to make the investment, the PE house works far more closely with the management team, both pre and post deal, to agree detailed growth plans that will drive the value creation. Management teams are also increasingly expecting the PE team to provide support and guidance from the point of the investment.
Additionally an increasing number of PE investors expect to see tangible results within the first year of the deal cycle, in the belief that this is the most critical period for capturing the value and momentum needed for the business to achieve its potential.
At the end of the investment period, exit values can no longer be guaranteed simply by relying on the ability of the management team to deliver growth. PE investors are increasingly looking at new capabilities that will accelerate growth and deliver the value required. This may be through international expansion, acquisitions, digitisation and extending the breadth of the management team.
All of this is putting increasing pressure on the CEO and the CFO to acclimatise and deliver far more quickly than they might have been expected to in the past, a factor significantly compounded if it is the CEO or CFO’s first experience of working in a PE-backed business.
An experienced and proven Chair can help greatly by supporting the leadership team in developing an understanding of what is expected from them. However the focus is usually on the CEO and the CFO may well be left to work out what is required, supported by a CEO learning how to adapt to the PE environment, sometimes for the first time and often for the first time with this investment house.
CFOs can therefore find themselves in a role which represents a significant personal wealth creation opportunity, so the desire to achieve is high, but with little personal knowledge of what is expected of them and little, if any, legitimate channel for them to seek assurance or to develop their thinking in the direction that will allow them to develop and ensure that they are making the right contribution.
Operating in an private equity environment is different. The pace, scrutiny, constant review and short term goals make it a challenging place to be, especially for those businesses coming out of owner management for the first time. The CFO is in the firing line for much of this review and for the inexperienced it can come as quite a shock. With the CEO benefitting from the direct input from the Chair, the CFO can find themselves at a loss as to who will support them.
So what are the challenges a CFO in a newly PE backed business can expect? It can be useful to compare these to the Plc environment. In a Plc, regardless of scale, the CFO has a broad agenda which requires attention. There is a diverse shareholder base, a large finance team, and targets are quarterly and annual with multiple objectives within a 5 year rolling plan.
The PE-backed role in contrast requires the CFO to work closely and transparently with a single investor, the PE house, and to tackle the fundamental underlying issues to capture growth of the business.
Whilst this may not sound like a significant change, it creates an environment in which speed, accuracy, output and depth - focussing across a narrower agenda to that of a PLC but to a far greater detail – are vital, whilst at the same time operating within a leveraged environment with less resource. The analogy of comparing a super tanker and a speedboat is often fairly accurate.
Most CFOs are capable of making this shift, but with little or no guidance and a short time window, the opportunities to learn from mistakes are negligible and tolerance for these mistakes even lower.
A mentor to the CFO creates two strong opportunities. For the CEO, support from a PE-savvy CFO creates the environment for the CEO to really succeed. Second, removing the need to change the CFO means the original exit horizon remains undisturbed with the management team led by two key individuals invested in the success of the business from day one.
Whilst still not common, CFO mentoring is a key opportunity for any new PE investment. The cost is usually less than a new hire and the potential is exponential.